July 19, 2018 / 10:02 AM / in 10 months

Rising interest rates, trade wars erode credit outlook: survey

NEW YORK (LPC) - Corporate credit spreads are seen widening and defaults likely will escalate as interest rates climb and global trade wars loom, according to a quarterly survey by the International Association of Credit Portfolio Managers.

The outlook is weakest for North America, where the economic expansion is seen far along and the Federal Reserve has already raised interest rates seven times since late 2015 and is expected to hike twice more this year.

“In the US and the rest of North America, it’s a classic inflationary environment,” Som-lok Leung, IACPM’s executive director, said in a statement. “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.”

IACPM is an association of more than 100 financial institutions in 21 countries.

Rising interest rates pose a particular threat to highly indebted companies, and those needing to access capital markets as borrowing costs increase.

IACPM’s 3-month credit spread outlook index sank to a reading of minus 66 in the second quarter from minus 56.2 the prior quarter.

The outlook was last this negative a decade ago during the financial crisis, when the reading was similar at minus 69.1 in the second quarter of 2008.

Negative numbers indicate an expectation that credit spreads will widen and defaults will increase.

IACPM’s 12-month credit default outlook index eroded to minus 51.1 in the quarter from minus 47.2, the most negative reading since minus 52.8 in the second quarter of 2016.

The survey found slightly less negative views for Europe.

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

A smaller 56% of those surveyed look for higher defaults over the next year in Europe than the 66% of respondents that expect rising defaults in North America.

Hanging over the credit markets globally is also the threat of trade wars, which are inflationary and could drive up defaults, as well as the ripple effects of Brexit, the association said. Those surveyed said it is too soon to predict the ultimate impact of either situation.

The International Monetary Fund on Monday warned in its World Economic Outlook update that growing and sustained trade conflicts are increasingly likely, Reuters reported. The US is particularly vulnerable to a slowing of exports due to retaliatory tariffs from trading partners, according to the IMF.

Reporting By Lynn Adler; Editing by Michelle Sierra

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