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Portfolio managers see worsening credit conditions despite Fed moves

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Credit portfolio managers expect a worsening credit-spread environment over the next quarter, despite expectations the Fed might cut interest rates this month for the first time in a decade.

Managers also continue to forecast growing levels of corporate defaults over the next year, according to the latest quarterly survey on the global credit-spread and corporate default outlook by the International Association of Credit Portfolio Managers.

The survey of managers from more than 100 institutions in 20 countries, released Thursday, revealed a larger share of managers expect to see an unfavorable spread environment amid growing signs of softening in the credit market along with early indications of weakness in European and U.S. manufacturing.

This, despite indications the U.S. Federal Reserve Board of Governors will likely cut interest rates later this month.

“There’s certainly a view of where markets are now, and what the Fed does or doesn’t do will have an impact on what that action is,” said Som-lok Leung, executive director of the IACPM. “But the bias overall is currently more negative than it was last period relative to spreads, and roughly as negative relative to defaults.

“The Fed has been communicating pretty strongly that easing is in the works,” he added. “But the Fed has always said they’re going to be very data driven … they telegraphed what they would do given current data, as data outlook could change.”

The IACPM’s three-month credit spread outlook showed a larger number of global managers expect credit deterioration in spreads over the coming quarter. Based on a diffuse index scaled from -100 (negative credit trends) to +100 (improvement in the credit environment), the index was -19.1, a further slide in negative views since -3.3 was calculated for the first-quarter IACPM survey issued in March.

For North American managers, the index worsened to -34.4, compared with -6.7 in March.

The 12-month credit default outlook (also built on a diffuse index) showed growing expectations of North American corporate defaults to -59.5, compared to -50 in March.

While reporting seeing weakness in worldwide credit markets, the IACPM cautioned the results indicate the trouble signs are “modest” so far. “They report a pickup in defaults but note the increase is from an extremely low base,” according to an IACPM release. “They are also keeping close tabs on Europe, which is showing signs of distress, as well as US manufacturing activity which appears to be slowing.”

For example, the latest Purchasing Managers Index, issued in June, had a reading that was a slight decline in May and was at its lowest score since October 2016, “but is still generally expansionary,” the release stated. The index is still not indicating manufacturing production is contracting.

But, Leung said, “there’s a big difference between bad and really bad. In terms of defaults, for example, rising and really rising are totally different. Defaults can’t climb significantly higher at the moment because interest rates are so low.”

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Spreads Corporate defaults IACPM