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Moody's Weekly Market Outlook Summary

Core Content

Moody's Weekly Market Outlook provides a detailed analysis of credit markets, focusing on trends in lending, default rates, and economic indicators across the US, Europe, and Asia-Pacific regions. The report highlights the interplay between liquidity, inflation expectations, and the behavior of banks and businesses in the context of the broader economic cycle.

Main Views

1. Credit Market Trends

• High-Yield Bond Spreads:

  • The composite high-yield bond spread averaged 375 bp in July 2017, the lowest since July 2014.
  • The narrow spread is attributed to abundant liquidity rather than improved corporate earnings.
  • If systemic liquidity contracts, spreads are expected to widen significantly.
  • The VIX index, which measures market volatility, has been exceptionally low, contributing to the low spreads.
  • A model incorporating the VIX index and other factors predicts the high-yield spread will approach 308 bp, consistent with July's VIX level of 10.26 points.

• Default Rates:

  • Moody's forecasts the US high-yield default rate to drop from 4.1% in Q2-2017 to 2.9% in Q2-2018.
  • This decline suggests a more favorable environment for lending, but the default rate remains above its 2014-2015 levels, which were lower when spreads were higher.
  • The market is warned that the current low spreads may not adequately compensate for default risk.

• Banks' Lending Behavior:

  • Banks are more willing to lend to businesses, as evidenced by a decline in tightening of C&I loan standards and a sharper drop in widening interest-rate spreads.
  • The reduced aversion to business lending by banks is linked to the narrowing of high-yield spreads.
  • However, business demand for C&I loans has softened, indicating late-cycle conditions.

2. Economic Outlook by Region

United States

• Core PCE Deflator: Expected to remain unchanged in June, with a year-over-year increase of 1.3%.
• Nonfarm Payroll: Forecasted to rise by 185,000 in July, slightly above the six-month average.
• Unemployment Rate: Expected to drop to 4.3% from 4.4%.
• Average Hourly Earnings: Projected to increase by 0.3%, maintaining a year-over-year growth of 2.4%.
• Trade Deficit: Expected to narrow to $43.9 billion in June from $46.5 billion in May, with a decline in imports and a rise in exports.

Europe

• Euro Zone GDP: Forecasted to grow by 0.6% q/q for the second quarter, with Spain and Austria showing strong performance.
• ISM Surveys: Both manufacturing and nonmanufacturing indices are expected to decline slightly, reflecting a weakening in confidence.
• UK Economy: Stuck in low gear, with weak manufacturing and construction data, and a slowdown in growth.
• Inflation: UK consumer price growth decelerated to 2.6% in June, below the previous 2.9%, but still expected to average 2.8% in 2017 and peak at 3% by Q4.
• Monetary Policy: The Bank of England is unlikely to tighten policy, given weak growth and inflation data.

Asia-Pacific

• China's Economy:
  • Export growth likely remained firm in July, driven by global demand.
  • Core consumer prices have eased, but a recovery in food prices could boost headline inflation.
  • Housing and heavy industries are expected to see decelerating price growth, keeping wholesale prices stable.
• Indonesia: GDP is expected to improve slightly in June due to net exports.
• Australia:
  • Trade surplus is forecast to widen to A$3 billion in June from A$2.5 billion in May.
  • Retail sales growth is expected to rise to 0.8% m/m, reflecting improved household spending and job additions.
• Malaysia:
  • Trade surplus is projected to increase to MYR6.7 billion in June from MYR5.5 billion in May.
  • Electronics exports are expected to cool, and petroleum export values likely declined due to weaker demand.

Key Information

• Liquidity Impact: Systemic liquidity is a major factor in keeping high-yield bond spreads narrow, and its contraction could lead to significant widening.
• Inflation Outlook: The Fed and BoE are closely monitoring inflation, but core PCE and CPI growth remain below target levels, suggesting a cautious approach to monetary tightening.
• Credit Market Dynamics: The relationship between credit spreads and default rates is crucial, with spreads currently undercompensating for default risk.
• Economic Indicators:
  • US: Nonfarm employment, unemployment rate, core PCE, and trade deficit are key.
  • Europe: Euro Zone GDP, ISM surveys, and UK inflation data are highlighted.
  • Asia-Pacific: China's exports, Indonesia's GDP, Australia's trade and retail sales, and Malaysia's trade surplus are central.

Figures and Data

• Figure 1: Highlights the narrowing of high-yield spreads due to liquidity and increased bank willingness to lend.
• Figure 2: Shows the correlation between the banks' aversion to C&I loans and the default rate, with a leading indicator effect.
• Figure 3: Illustrates the divergence between banks' willingness to lend and business demand for C&I loans.
• Figure 4: Indicates late-cycle conditions as business borrowing demand declines.
• Figure 5: Suggests that the upcoming slowdown in new high-yield bank loan programs may signal an increase in default rates.

Conclusion

The report underscores the importance of liquidity in maintaining low credit spreads and highlights the potential for spreads to widen if liquidity dries up. While banks are more willing to lend, business demand for credit has softened, indicating a mature cycle. The US and Europe are expected to maintain stable economic growth, while the Asia-Pacific region shows resilience in exports, albeit with some signs of slowing momentum. Inflation remains a key factor in shaping monetary policy decisions.