US HY recorded an excess return of nearly 5% in 2017.This positive performance was supported by a broad synchronised upswing in the world economy, highly accommodative monetary policies and very low volatility. On the back of this rally, spreads are closing in on cycle lows. What should we expect?
One third of companies now seem to be in a challenging situation. We are in the late phase of the cycle: (1) US corporate debt at historic highs and (2) critical situation of interest coverage by profits.
We expect the default rate to continue decreasing next year to very low levels (forecasts between 2.5% and 3%). This trend could be explained by the recovery of the energy sector and exceptional funding conditions.
The decrease in the default rate is already in the price. However, the tightening of financing conditions would lead to a rapid rise in the default rate. This scenario could happen in 2019 and we have to keep in mind that the market will price in downgrades at least a year before they occur.