IACPM survey forecasts wider spreads and rising defaults

With the threat of a global trade war hanging over most of the world, a new credit outlook survey is forecasting wider credit spreads and rising credit defaults.

The International Association of Credit Portfolio Manager's three month Credit Spread Index is the most negative since the financial crisis.

The Credit Spread Index is minus -66.0 in the latest reading, while the aggregate 12 month Credit Default Outlook Index is negative -51.1. 

The results are the worst since the Credit Spread Index was minus -69.1 in the second quarter of 2008 and the Credit Default Index was negative -52.8 in the second quarter of 2016. 

While there is concern regarding credit conditions globally, there are different circumstances behind the worries regionally, the survey respondents found. 

North America is further along in the economic cycle than Europe, so respondents forecasting conditions in the region are focused on the Federal Reserve and rising interest rates which are coming in response to a stronger economy and concerns for higher inflation.

“In the US and the rest of North America, it’s a classic inflationary environment,” commented Som-lok Leung, head of the IACPM.

“As interest rates rise, one would expect to see wider spreads and higher defaults and, in fact, this is a trend we’ve seen for the past few months.” 

Australia optimistic

In Europe, on the other hand, while the European Central Bank has announced an end to quantitative easing in December, it also says it will keep its key lending rate at zero until next summer. 

Reflective of this, a somewhat smaller number of survey respondents expect credit defaults to rise in Europe compared to North America. 66 per cent of respondents think defaults will increase in North America versus 56 per cent who believe defaults will rise in Europe. 

“Europe is still in an easing mode, so the credit outlook is more moderate, at least in the short term,” added Leung. 

“Spreads may widen, because they have nowhere else to go, but there’s no rush to see significantly higher default rates.” 

Survey respondents are even more divided over the direction of defaults in Asia and Australia. 

52 per cent of respondents believe defaults will rise in Asia but 48 per cent say they will remain at current levels. 

In Australia, while 43 per cent of respondents believe defaults will increase, a majority, 57 per cent think they will remain the same. 

Trade war

Hanging over most of the world, though, is the threat of a global trade war. Trade wars are inflationary, which could certainly result in increased defaults. 

At this point, however, while there is some early evidence of a reaction to the threat, such as reduced barge traffic in the US, survey respondents say it is far too early to predict the ultimate impact.

Brexit is another concern but, again, the picture is unclear. Recent events have increased uncertainty, especially for the financial services sector, but it is premature at this point to forecast the final disposition of the process. 

The IACPM has more than 100 financial institutions in 21 countries around the world. Members are surveyed at the beginning of each quarter. 

Survey results are calculated as diffusion indexes, which show positive and negative values ranging from 100 to minus -100, as well as no change which is in the middle of the scale and is recorded as "0.0." 

Positive numbers signify an expectation for improved credit conditions, specifically fewer defaults and narrower spreads, while negative numbers indicate an expectation of deterioration with higher defaults and wider spreads. 

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