October 19, 2017 / 1:29 PM / a year ago

LPC: Global defaults, credit spreads to rise led by North America -poll

NEW YORK, Oct 19 (Reuters) - Corporate debt defaults and credit spreads will increase globally, with a more bearish outlook for North America than Europe, following a prolonged period of cheap credit and ardent investor demand that has spurred red-hot borrowing, according to an International Association of Credit Portfolio Managers quarterly (IACPM) survey.

Economic improvement and low unemployment will help drive up interest rates, ultimately shaking the long-term steady state of credit markets in which defaults have stayed low, the poll found.

Unlike the US Federal Reserve, the European Central Bank is still holding interest rates at zero and not yet committed to cutting back on its massive bond buying program, known as quantitative easing. The time difference explains why defaults should happen sooner in the United States than in Europe, according to IACPM.

“In the United States, we’re living in a period of easy credit and zero defaults,” Som-lok Leung, IACPM’s executive director, said in a statement. “At some point, that has to change, with higher interest rates and rising defaults.”

The Federal Reserve has raised interest rates four times starting December 2015 and is expected hike by another quarter percentage point to a target range of 1.25%-1.50% this December.

For now, however, credit markets appear to continually be lulled by ongoing stock market records and gradual economic gains.

IACPM’s 3-month Credit Spread Outlook Index eroded to a negative 18.8 reading from negative 16.4 the prior quarter. Negative numbers, which remain across regions, indicate expected credit erosion with wider spreads and increased defaults.

Even so, the index is far less negative than the minus 47 a year earlier, underscoring the view that conditions may remain stable in the near term despite concerns that market rallies may be overdone.

IACPM noted that Richard Thaler, winner this month of the Nobel Economics Prize, among others experts have highlighted the divergence between market behavior and political events.

Thaler told Reuters he is puzzled by the steady rise of global stock markets, and that “the unbelievably low volatility in a time of massive global uncertainty seems mysterious to me.”

BlackRock Inc’s Chief Executive Officer Larry Fink also warned last week that financial markets are ignoring underlying risks, which could mean a “big correction” if a major surprise world event occurred, Reuters reported.

About half of portfolio managers polled by IACPM look for short-term credit spreads to stay at current levels, meantime. As for defaults, 36% think defaults will hold steady while 53% look for an increase during the next year.

In Europe, the fallout from Brexit and more recently Catalonian demands for independence from Spain could also stoke higher defaults and widen yield spreads in the longer term.

Still, two-thirds of portfolio managers surveyed look for corporate defaults to remain at current levels over the next year, and almost half expect investment-grade spreads will stay the same for the next three months.

“There are certainly major concerns but Brexit, to take one issue, is a moving target and we’re not seeing much movement at the moment,” Leung said. Offsetting this, at this time, is strong employment and wage growth along with record low unemployment, he added.

IACPM’s 12-month Credit Default Outlook Index improved to negative 36.3 from negative 38 the prior quarter. A year ago, the reading was negative 48.1.

IACPM is an association of more than 90 financial institutions located in more than 20 countries. (Reporting By Lynn Adler; Editing By Michelle Sierra)

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