Contradiction in the Credit Markets

While corporate credit spreads are still narrow, credit portfolio managers see defaults rising in the next 12 months, especially in Europe.
Matthew HellerJanuary 21, 2015
Contradiction in the Credit Markets

Corporate credit defaults will continue to rise over the next 12 months but the outlook for credit spreads is relatively benign, according to a survey of credit portfolio managers.

The International Association of Credit Portfolio Managers said in its latest outlook survey that respondents see rising defaults in every global region including North America, but are increasingly concerned about defaults in Europe.

The association’s overall Credit Default Outlook Index improved to -22.4 from -28.0 at the end of September, while the index for Europe deteriorated  to -31.4 in the latest reading from -22.0 in the previous survey. Positive index numbers indicate an expectation of fewer defaults and narrower spreads, while negative numbers indicate an expectation of higher defaults and wider spreads.

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Despite the soured outlook on defaults, the association’s Credit Spread Outlook Index was only modestly negative, at -4.3.

“In many ways, these results are indicative of the wider financial markets,” Som-lok Leung, Executive Director of the IACPM, said in a news release. “We are well along in the current economic cycle so people are naturally inclined to believe defaults will rise; however, central banks continue to flood the markets with liquidity so short-term credit spreads remain exceptionally tight.”

The current economic expansion has lasted for an unusually long period, amounting to almost six years in the United States.

The IACPM suggested that the key question facing risk managers — and the financial markets in general — in 2015 is how long central banks will continue to provide enormous amounts of liquidity and how long the current cycle will last. “Both portfolio managers and market participants as a whole will have to decide how to prepare for this uncertain future,” it said.

According to Leung, the difference between the outlook for defaults and spreads could also reflect the difference in the forecast period. Survey respondents are asked to forecast defaults over the next 12 months, while the outlook for spreads is just over the next three months.

“On the other hand, perhaps market participants have simply gotten overly complacent and the real question then is how long can central banks continue to drive this level of market complacency,” Leung said.

The members of the IACPM oversee corporate loan portfolios at more than 100 banks, insurance companies, and asset managers globally.

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