Very Wide Spreads Warn of Danger Ahead

WEEKLY MARKET OUTLOOK FEBRUARY 18, 2016 CAPITAL MARKETS RESEARCH Moody’s Analytics markets and distributes all Moody’s Capital Markets Research, Inc. materials. Moody’s Capital Markets Research, Inc is a subsidiary of Moody’s Corporation. Moody’s Analytics does not provide investment advisory services or products. For further detail, please see the last page. Very Wide Spreads Warn of Danger Ahead Credit Markets Review and Outlook by John Lonski Very Wide Spreads Warn of Danger Ahead. » FULL STORY PAGE 2 Topic of the Week returns next week The Week Ahead We preview economic reports and forecasts from the US, UK/Europe, and Asia/Pacific regions. » FULL STORY PAGE 5 The Long View Check our chart here for forecast summaries of key credit market metrics. Full updated stories, “The slump in capital formation is broad based according to the anticipated -15% year-over-year drop by Q1-2016’s US$ denominated investment-grade bond issuance” begin on page 14. » FULL STORY PAGE 14 Ratings Round-Up by Njundu Sanneh Yet Some Companies Benefit from Falling Energy Prices. » FULL STORY PAGE 17 Market Data Credit spreads, CDS movers, issuance. » FULL STORY PAGE 19 Moody’s Capital Markets Research recent publications Links to commentaries on: Citi, Hess, CoCos, Anadarko, Apache, T-bonds, MRO, EDF, Encana, Devon, UK, spreads, bank risk. » FULL STORY PAGE 23 Credit Spreads Investment Grade: Year-end 2016 spread to be less than its recent 182 bp. High Yield: After recent spread of 872 bp, it may approximate 750 bp by year-end 2016. Defaults US HY default rate: after January 2016’s 3.1%, Moody’s Credit Policy Group forecasts 4.7% by January 2017. Issuance In 2015, US$-denominated investment-grade (IG) bond offerings advanced by 17.5% to $1.297 trillion, while US$-priced high-yield bond issuance sank by -19.5% to $289 billion. For 2016, US$-denominated IG bond issuance may sink by -1.8.% to $1.302 trillion, while US$-priced high-yield bond issuance may drop by -19.7% to $288 billion. Click here for Moody’s Credit Outlook, our sister publication containing Moody’s rating agency analysis of recent news events, summaries of recent rating changes, and summaries of recent research. Moody’s Capital Markets Research, Inc. Weekly Market Outlook Contributors: David W. Munves, CFA 1.212.553.2844 david.munves@moodys.com John Lonski 1.212.553.7144 john.lonski@moodys.com Ben Garber 1.212.553.4732 benjamin.garber@moodys.com Njundu Sanneh 1.212.553.4036 njundu.sanneh@moodys.com Yukyung Choi 1.212.553.0906 yukyung.choi@moodys.com Irina Baron 1.212.553.4307 irina.baron@moodys.com Franklin Kim 1.212.553.4419 franklin.kim@moodys.com Xian (Peter) Li 1.212.553.1404 Xian.li@moodys.com Moody's Analytics/Europe: Tomas Holinka +420 ( 221) 666-384 Tomas.holinka@moodys.com Anna Zabrodzka +420 ( 221) 666-388 anna.zabrodzka@moodys.com Moody's Analytics/Asia-Pacific: Faraz Syed +61 (2) 9270-8146 Faraz.syed@moodys.com Emily Dabbs +61 (2) 9270-8159 Emily.dabbs@moodys.com Editor Dana Gordon 1.212.553.0398 dana.gordon@moodys.com CAPITAL MARKETS RESEARCH 2 FEBRUARY 18, 2016 CAPITAL MARKETS RESEARCH, INC. / MARKET OUTLOOK / MOODYS.COM Credit Markets Review and Outlook Credit Markets Review and Outlook By John Lonski, Chief Economist, Moody’s Capital Markets Research, Inc. Very Wide Spreads Warn of Danger Ahead Ultra-wide high-yield bond spreads have offered useful insight regarding where the US economy is in the business cycle. The high-yield bond spread’s month-long average has been at least 800 bp for only 32, or 8.6%, of the 373 months since year-end 1984. Of special importance is how a recession was either fast approaching or already present whenever the high-yield spread’s month-long average first broke above 800 bp more than two years after a business cycle bottom. Thus, the high-yield bond spread’s 848 bp average of February-to-date merits widespread attention. The high-yield spread’s month-long average previously first broached 800 bp at least two years after a cycle trough in August 2008, November 2000, and October 1990. Only November 2000 is similar to February 2016 in that both months overlapped business cycle upturns. Nevertheless, one major difference between November 2000 and February 2016 centers on how much higher November 2000’s average expected default (EDF) frequency metric of 11.9% for US/Canadian non-investment-grade companies was relative to February-2016-to-date’s average of 8.1%. Mostly because of an exceptionally steep high-yield EDF metric, the high-yield spread’s multi-variable regression model predicted a high-yield spread of 869 bp for November 2000 that was wider than November 2000’s actual gap of 835 bp. By contrast, the same model currently predicts a 722 bp spread for February 2016, which is substantially less than February-to-date’s average of 848 bp. The actual high-yield spread last exceeded the predicted spread by