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Technical factors could change the game for US credit

Technical factors could change the game for US credit:

1 / The refinancing needs of US companies will increase significantly in the coming quarters.The level of indebtedness of these companies reached record high levels in 2016. Much of the debt sold by companies in recent years has been used to fund M&A transactions and  buyback their own shares. The size of the US IG market has just doubled in recent years.

2/ Investor appetite will be a key factor for US credit. Demand has increased at an unprecedented pace in recent years. In a low yield environment, foreign investors have been motivated by the search for yield: US credit has been treated to some extent as a rate product. Foreign investors currently account for 40% of the USD corporate bond market.

The risk for this asset class is a sudden change in the current yield environment – result of a surprise rise in inflation. In this scenario, the yield on US IG bonds would be less attractive. 

AINOUZ Valentine , Deputy Head of Developed Markets Strategy Research
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Technical factors could change the game for US credit
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Corporate fundamentals are at the centre of the game

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.

Valentine AINOUZ

Deputy Head of Developed Markets Strategy Research