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Positive stance on the US IG market

The dollar credit markets have performed well in recent weeks, bolstered by stronger than expected US growth of around 2%, the gradual normalisation of monetary policy and, especially, the resurgence of optimism related to a possible tax reform. Dollar IG credit spreads tightened by 9bp in September and by more than 23bp since the beginning of the year. They are now close to their lowest points recorded since the crisis. Why are we maintaining our positive recommendation on dollar Investment Grade credit?

The tax reform could have a positive impact on the fundamentals of US companies via

(1) a general decrease in the corporate tax rate,

(2) the repatriation of 2.5 trillion dollars of cash held abroad mainly by the Tech giants,

(3) non-deductibility of coupons. The third option is likely to encourage companies to substantially reduce their debt.

Technical factors also remain very positive.The monetary policies dictated by the developed countries' major central banks have had a considerable impact on dollar-denominated "Investment Grade" corporate bonds.

  • American companies, encouraged by low rates and strong investor appetite, have been very active in the debt market. Corporate bond issue volumes have increased very significantly since 2009. The IG bond market has virtually doubled in size since the collapse of Lehman Brothers.
  • At the same time, demand for quality fixed-income products has increased at an unprecedented pace. To stimulate inflation and growth, the ECB and the BoJ have broken through the taboo of the zero-rate barrier and introduced negative rates. One-third of global debt still offers a negative or close to zero yield. This environment has driven investors to look for yield on the US market. Ultimately, outstanding debt held by foreign investors has increased by 45% since 2012, to $3.8trillion and account for 40% of the market. We expect this trend to continue in 2018.

Corporate indebtedness is now nearing all-time highs. These issuers have fully exploited the low interest rates and highly accommodative monetary policies pursued by the major central banks. With the money raised, companies have been able to extend the average maturity of their debt. US IG index duration was 7.2 in late September, compared to 6.8 in late 2012. This new capital has also been used to finance M&A transactions and share buybacks. Corporations overall have had very little incentive to invest in an environment of lacklustre growth. This increase in debt was widespread and involved all sectors.

Recently, companies have adopted more conservative behaviour. The pace of debt growth have declined while earnings growth have improved. They have been less active on the M&A market: the value of ongoing transactions fell 16% over the last three 

months. The slowdown was also marked for share buybacks. Ultimately, there has been a slight decline in leveraging in the latest earnings publications. This trend – which is relatively unusual in an expansion phase – is expected to continue in 2018. Moreover, with rates so low, "Investment Grade" companies have been able to maintain satisfactory interest coverage ratios.

We are maintaining our positive recommendation on US Investment Grade credit.Spreads should continue to benefit from foreign investors' strong demand for dollar-denominated assets, and from improved fundamentals.

 

M&A

 

Valentine AINOUZ, Strategy and Economic Research at Amundi
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Positive stance on the US IG market
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