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.
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.
CFA, Credit Strategy