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While in the short term we do expect some temporary relief coming from positive economic surprises and supportive news on the trade front (should coronavirus impact be limited), on a medium-term horizon our economic scenario confirms the fragility of the profit cycle. Exceptional features of this cycle are lower growth due to trade war escalation, unprecedented low interest rates due to unconventional monetary policy and a fairly resilient labour market due to the strong domestic sector resilience. Notwithstanding these specificities, the 2020 is still compatible with a late cycle phase; but the most likely scenario for the end of 2021 is the transition into a correction phase
Annalisa USARDI, Lorenzo PORTELLI
The new European leadership (at the head of the European Commission and the ECB), combined with historically low real interest rates, provides a unique opportunity to rethink priorities in order to meet the challenges at hand (economic, financial, environmental and security challenges). In economic terms, strengthening Europe and improving its competitiveness means tackling all these challenges simultaneously. At the level of economic policy, the link between monetary and fiscal policy must inevitably be rethought. But that's not enough. The expansionary policy mix must be accompanied by an improvement in the financial architecture. We identify two pillars on which the European authorities shold be able to act significantly in 2020-21: the Capital Market Union and budgetary rules. This is a prerequisite for dealing with the inevitable macrofinancial shocks that the future holds. Against this backdrop, the voices of Christine Lagarde and Ursula von Der Leyen (Presidents of the ECB and the Commission respectively) are eagerly awaited.
Over the last decade, easy financial conditions encouraged an increase in sovereign and corporate debt. Indeed, the leverage of American companies has reached record high levels and US corporate debt has been used for financial risk-taking to fund corporate payments to investors, as well as for mergers and acquisitions. At the opposite, the leverage of European companies has remained at low levels as European companies have remained more cautious over this cycle. In 2019, we have evolved in a new regime: the global economy has entered a synchronised slowdown and major central banks have returned to an easing stance. What are the risks for companies in this new context? We are following closely: The downgrade risk in the US Investment Grade universe. Net leverage for US issuers have resumed their upward trajectory in recent months. In 2020: (1) companies to make a trade-off between maintaining share buy backs and the stability or their debt (2) the downgrade risk to increase among firms facing increase pressure on profits. The default rate risk for low-quality high-yield bonds. Sluggish earning growth poses the biggest threat for companies to pay interest on their debt despite the low cost of financing. Indeed, at this stage of the cycle, we think that interest coverage is more closely related to earnings than to its interest expense: interest coverage could be quickly eroded by a hit to earnings. A selective approach is required in the low-rated Euro and US High Yield segments.
Fixed Income and Credit Strategist