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Credit portfolio managers project flat spread trends in 2Q

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Global credit portfolio managers have a mixed outlook for risk premiums and corporate defaults in the second quarter.

The latest quarterly survey from the International Association of Credit Portfolio Managers indicates that concerns over near-term widening in credit spreads have waned in North America and Europe, thanks to a slowdown in rate hikes by the Federal Reserve and a temporary reprieve from potential Brexit instability.

But the results also show many still believe there’s no avoiding a future rise in corporate defaults.

The poll, which was conducted in March, revealed one of the biggest quarter-over-quarter shift in credit-spread outlook in nearly four years. More than 50% of managers in both regions expect spreads to remain unchanged over the next three months for speculative-grade corporates tracked by the Markit CDX High Yield Index and the Markit ITraxx Europe 5-Year Total Return index; by comparison, in the previous survey, more than 50% of managers thought spreads would widen during the first quarter.

Last December, just 12% of portfolio managers in North America and only 28% in Europe saw spreads remaining flat through the first quarter.

IACPM views widening spreads and default rates as indicators of deteriorating credit conditions for managers, and reflective of worsening macroeconomic activity.

“It’s definitely a very different from the end of last quarter,” said IACPM executive director Som-Lok Leung, in an interview. “In the U.S., the change in the stance of the Fed is a large part of it,” as well as “less pessimistic” views on U.S.-China trade tensions that had sparked concerns late in 2018 over the global economic impact on manufacturing and agricultural tariffs between the two nations.

While trade concerns are “far from resolved, the general consensus is it looks less bad,” said Leung.

The percentage of managers (23%) expecting credit spreads to narrow for high-yield corporates through June is only slightly more than those (21%) who forecast tightening spreads in last December’s polling.

The shifting credit-spreads outlook improved the IACPM’s global three-month index from a negative (-)38.4 last December to a "virtually neutral" negative (-)3.3 for March’s survey, according to the trade group.

Both the IACPM credit default and credit spread outlook index are diffuse indexes ranging in values from 100 to negative (-1) 100; positive numbers reflect managers’ expectations for improved credit conditions, while negative numbers indicate anticipated deterioration in higher defaults and wider spreads.

In Europe, “getting an extension to Brexit provides some short te-m stability,” said Leung, resulting in a shift to just 23% expecting widening spreads for companies on the ITraxx 5-Year index compared to 50% last December.

That number was derived on polling numbers through April 9, he said, the day before UK and EU negotiators agreed to an extension delaying Britain’s exit until October 31 for further work on a withdrawal agreement. Leung said this likely reflected managers’ beliefs that there would be an extension to find a more orderly exit plan.

“Now we’re looking at Halloween” before Brexit concerns will again plague European portfolio managers, said Leung.

For corporate defaults, the outlook is not as improved, with only 51% of North American managers expecting rising default levels over the next 12 months compared to 73% that saw higher corporate defaults coming in the next year.

But that change only shifted the IACPM’s 12-month North American credit default outlook index to a slightly less negative area (-50), in line with where it has stood for much of the past year.

The IACPM’s quarterly survey polls managers in over 100 member institutions in 20 countries in North America, Europe and Asia.

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Spreads Credit quality Europe