Britain’s vote to detach from the European Union as well as tepid global economic growth will foster more corporate debt defaults and wider credit spreads, according to a quarterly International Association of Credit Portfolio Managers (IACPM) survey.
The outlook for defaults and spreads deteriorated the most for Europe, where the ripple effects of June’s so-called Brexit vote will take time to play out.
While credit portfolio managers expect the Brexit impact will be contained to Europe, historically low to negative interest rates elsewhere are also damaging in swaths of the credit markets, the survey found.
A flurry of buying by investors reaching for safe-haven assets with positive yields pushed U.S. Treasury yields to historic lows last week. Investors in this environment increasingly reach for yield in riskier assets, where default projections are rising.
“In some ways, ultra-low interest rates are as troublesome as Brexit,” Som-lok Leung, IACPM’s executive director, said in a statement. “They put tremendous pressure on a range of credit market participants, including investors such as pension funds, looking for acceptable returns and other market participants with long-term and or/leveraged debt exposure.”
The Federal Reserve, after raising rates last December for the first time in almost a decade, has been holding off on further rate hikes. Anticipation about the Brexit vote and its ramifications was one of the reasons, IACPM said.
Considering the uncertain Brexit fallout, sentiment is most dour for European corporate debt defaults, according to the survey.
Sixty-eight percent of those polled look for rising corporate debt defaults in Europe. In comparison, 60% see corporate debt defaults rising in Asia, 59% in North America and 50% in Australia.
The possibility of other countries, including Austria and the Netherlands, looking to leave the EU is being closely monitored as is the uncertain timing of Fed policy tightening.
“The current economic cycle is historically long in the tooth and the negative factors that have been in place for some time, such as slowing growth in China and continuing troubles in the energy patch, are still in place,” said Leung.
The IACPM gauge of credit spreads over the next three months eroded, as worsening expectations about Europe overpowered improvement in the view for North American debt.
With credit spreads seen widening in all regions, the 3-month outlook index eroded to negative 39.7 from negative 38.0 the prior quarter.
Similarly, increased defaults are expected in every global region, although an improved view in Asia, North America and Australia was overshadowed by intensified concerns about Europe.
The overall IACPM 12-Month Credit Default Outlook Index climbed from a nearly seven-year low the prior quarter, but remained fairly pessimistic at a minus 52.8 reading at mid-year. The prior quarter’s negative 56.2 was the most negative since minus 72.3 in June 2009.
Negative numbers indicate an expected credit deterioration with higher defaults and wider spreads.
Source: Reuters (Reporting by Lynn Adler; Editing By Michelle Sierra and Jon Methven)