Credit Spreads to Widen as Defaults Increase, IACPM Survey Says

Credit spreads are poised to widen over the next three months, causing corporate defaults to rise, according to a survey by the International Association of Credit Portfolio Managers.

The outlook for investment-grade debt in North America plunged to minus 23.4 from negative 2.2 at the end of June and dropped to negative 30.4 from minus 20.9 for junk-rated borrowings, according to the survey, set for release today by the IACPM, whose 89 members include banks, insurance companies and money managers in 17 countries. A negative reading indicates deteriorating conditions.

Respondents said the Federal Reserve’s Sept. 18 decision to refrain from cutting back its monthly bond-buying program spurred a “relief rally” in credit markets, leading to spreads tightening excessively. Because “neither interest rates nor credit defaults can go any lower,” both will climb, according to the IACPM.

“When the Fed did not taper last month, there was a rally in multiple markets as a result,” Som-lok Leung, the New York-based executive director of the IACPM, said in a telephone interview. “Most people viewed that response as too much.”

Corporate Defaults

The trailing 12-month global speculative-grade corporate default rate was 2.8 percent at the end of September, down from 2.9 percent in the second quarter and 3.3 percent a year earlier, according to an Oct. 7 report from Moody’s Investors Service. The ratings firm forecasts the measure will climb to 3 percent by the end of 2013.

High-yield, high-risk, or junk, debt is graded below Baa3 by Moody’s and lower than BBB- at Standard & Poor’s.

“There certainly will have to be a rise in rates and that will affect credit quality,” Leung said. “When cost of financing rises, that creates stress for corporations.”

The Fed will pare the monthly pace of asset buying to $70 billion from $85 billion at their March 18-19 meeting, according to the median of 40 responses in an Oct. 18 Bloomberg News survey of economists. The 16-day budget impasse in Washington, which resulted in 800,000 government employees being furloughed and prevented the publication of key economic data, reduced growth by 0.3 percentage point this quarter, economists said in the survey.

The agreement reached last week funds the government through Jan. 15, 2014, and suspended the debt limit until Feb. 7, setting up another round of confrontations that may further affect credit forecasts, according to Leung.

European Outlook

“I hate the phrase ’kick the can down the road’, but there’s no other way to describe what we’ve done and a lot will depend of how those discussions go,” Leung said. “I don’t think you can strongly predict very much.”

The credit spread outlook index for investment-grade European debt increased to 11.1 from negative 7.7 at the end of June, according to the report. The credit spread outlook index for speculative-grade European debt rose to zero from negative 24.3.

“Survey respondents may not be convinced Europe’s problems have been resolved, but they appear to be at least contained,” the IACPM said in the report.

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