Global Credit Conditions Weaken Broadly Amid Increasing Market Volatility

Warta Ekonomi -

WE Online, New York - Standard & Poor's Ratings Services recently published its quarterly updates on credit conditions in North America, the Asia-Pacific region, Europe, and Latin America, providing opinion on the evolution of macroeconomic conditions and broad financial trends that could affect credit quality.

While global credit conditions for much of 2015 split between the U.S. and Europe moving at one speed and Latin America and Asia-Pacific at another, the prevailing sentiment today is that credit conditions are generally less favorable for all regions.

Underpinning the dimmed outlook are fears about global growth, particularly China's ability to rebalance its economy, jittery financial markets,  still-weak commodity prices, and funding difficulties. Still, pockets of resiliency remain amid the diminished growth prospects, with the U.S. and Europe still growing, albeit at a slower clip. Europe is also contending with deposit rates falling below zero while bracing for U.K.'s referendum on EU membership on June 23.

Geopolitical risks remain a top concern. Historically, terrorist attacks similar to the recent ones in Brussels (New York 9-11, Madrid 2004, and London 2005) have not had a large or lasting effect on consumer and business confidence per se. But more frequent and random terrorist activity around the world could lead to a longer and deeper slide in business and consumer confidence.

The U.S. and Canada

Credit conditions in North America were less favorable in the first quarter of 2016 than at the end of 2015. Economic fundamentals remain resilient in the U.S., where the slower pace of Fed rate hikes relieved investors. In Canada it was a different story; the decline in oil and other commodity prices sent ripples through much of the economy. We see these factors, as well as global growth concerns (particularly from China), financial market volatility, and funding difficulties as the main risks to credit conditions in North America.

Domestic demand in the U.S. is driving comparatively steady growth in the world's biggest economy, more than offsetting the drag from sluggish conditions overseas. At first glance, the fourth-quarter real (annualized) GDP growth of 1.4% seems soft. But, together with continued healthy job gains, it suggests we'll see at least moderate economic expansion this year. We forecast that U.S. GDP will grow by 2.3% in 2016, with underlying momentum continuing into 2017 and 2018, when we expect growth of 2.5% and 2.4%, respectively.

We expect the positive factors for U.S. credit conditions to be a resilient private sector led by consumers, offsetting drags from net exports, energy-related capital spending, and the inventory cycle. Improving residential investment, gains in employment and wages, and the government sector contributing positively to growth.

Canada, as a major commodity-exporting nation, has felt the pain of falling natural resource prices. Although prices have stabilized somewhat, the latest wave of price declines for many of the commodities Canada produces is further depressing the terms of trade (the price of exports relative to imports) and eroding the country's growth prospects.

Companies' earnings are being squeezed, they're reducing investment to preserve financial liquidity, and they are cutting costs, contributing to rising joblessness and eroding household incomes. With these headwinds threatening the recovery, we see Canada real GDP growth averaging only 1.4% in 2016, in line with our January 2016 forecast update. We expect commodity markets to stabilize heading into 2017 and real GDP to increase 2.2% next year, followed by another 2.2% gain in 2018.

Even as the U.S. recovery continues to build momentum, slower revenue and profit growth and increasing leverage are signs of a maturing corporate credit cycle. Lower speculative-grade corporate debt issuance and wider credit spreads--notwithstanding the spread narrowing that has taken place since February--suggests a repricing of risk is underway. Despite the recent stabilization in markets, asset gatherers, including domestic equity and hedge fund strategies, continue to experience outflows, which may signal wavering investor risk appetites. These shifts are among other indicators of elevated liquidity risk and a potential squeeze on credit availability.

For example, leveraged loan issuance volumes are sharply lower, in part because of concerns around underlying corporate credit quality. Tighter bank lending standards in the U.S. are contributing to North America's less accommodative financing conditions. Although funding positions remain adequate for most large complex banks, banks more generally continue to build reserves, anticipating a pick-up in charge-offs from historical lows.

Europe, The Middle East, and Africa (EMEA)

The market jitters at the start of 2016 reflect worries about a weakening in major European economies. For sure, fourth-quarter 2015 saw a slowdown in eurozone GDP growth (to 1.5% year on year). As a result, most eurozone economies have entered 2016 with a small carryover: 0.4% for the eurozone as a whole and for Germany, 0.3% for France, and 0.2% for Italy. Only Spain came out with a strong gain of 1.2%.

What's more, the upturn that started in 2014 has been a single-engine consumer recovery. Yet, we believe the foundations underpinning consumer demand remain firm. And investment prospects, especially in the construction sector, may not be as bleak as suggested. Finally, while weakish global trade growth is undoubtedly squashing European foreign sales, intra-European trade will likely pick up as domestic demand in key markets such as Germany continue to benefit from strong tailwinds. In addition, ECB monetary policy will ensure that credit conditions remain extremely accommodative.

Taking into account all of those factors, we have revised downward our GDP growth forecast for the eurozone to 1.5% in 2016 from 1.8%, and to 1.6% for 2017 from 1.7%. However, we've axed our inflation forecast for 2016 to 0.4% from 1.1%, owing to a fresh drop in international commodity prices in second-half 2015 and earlier this year.

We deem Brexit risk, or the possibility of Britain leaving the EU, as elevated, and the one to watch in the second quarter. Our baseline forecast assumes that British voters will affirm the country's membership in the EU in the referendum on June 23, 2016, in a close call. If the "leave" camp wins, a period of economic and financial uncertainty will begin whose outcome and duration are hard to predict. The Bank of England would be ready to defend the pound sterling. The government has tools in its bag as well, and has just announced a cut in Britain's Corporation Tax rate to 18% in 2017 from 20%, already the lowest in the Group of 20.

Negative rates will further erode profitability, which we see as the key risk all European banks face today (except the Nordics), making it harder for them to adjust their business models to a tougher regulatory environment. Faced with limited profitability for the longer term, banks could adopt riskier behaviors, such as seeking higher returns--by extending riskier loans or investing in riskier assets--or heightened price competition to capture market share. They're likely to increasingly raise fees to help close the gap. This is all despite a cost of funding that is moving even lower. Combined with the ECB's asset purchases, we believe that negative rates will further reduce banks' return on assets.

Asia Pacific

Credit conditions in Asia-Pacific were less favorable in the first quarter of 2016 than in the last quarter of 2015. We expect conditions to remain choppy in the second quarter because of fears over China's ability to rebalance its economy, still-weak commodity prices, and capital flows affecting currency exchange rates and credit spreads.

While market concerns over China's GDP growth appear to have calmed, we believe that more economic reforms in the country are needed. On March 31, 2016, we revised the rating outlook on the People's Republic of China to negative reflecting our expectation that the economic and financial risks to the Chinese government's creditworthiness are gradually increasing. This follows from our belief that, over the next five years, China will show only modest progress in economic rebalancing and credit growth deceleration. In addition to China, we regard the near-term negative momentum in Asia-Pacific credit quality as likely to continue in terms of downgrades and defaults.

Banks remain the predominant source of funding for corporate borrowers in Asia-Pacific and they have further stepped into the funding breach given the dramatic drop on capital market funding undertaken in recent months. While net interest margins are generally under pressure, the major banks in Asia-Pacific have managed to keep their credit costs under control and have strengthened their capitalization.

The likelihood of banks tightening loan supply remains tied to the risks of GDP growth and economic and credit weakening beyond their expectations relative to balance-sheet capacity, pricing, and willingness for risk. At this stage, we do not see banks tightening loan supply.

In South and Southeast Asia, with the recent depreciation of regional currencies, questions have surfaced about how robust financing and refinancing (particularly in 2016) conditions are going to be for some corporates. A significant adverse decline in investor sentiment could lead to conditions deteriorating quickly, particularly for speculative-grade issuers.

Latin America

We expect credit conditions in Latin America and the Caribbean will continue to weaken through 2016, though effects on ratings will vary by country and sector. This represents a continued downward movement in the expectations we cited last quarter. Headwinds for the region are now mostly internal factors: the recession in Brazil, lackluster growth elsewhere in the region, and still relatively weak currencies. On the other hand, external factors have moderately improved, including still low but slowly rising commodity prices, and steadier capital flows to the region given still very low global interest rates.  

We have adjusted our Latin America real GDP growth forecasts lower as compared to our January update. We now forecast regional real GDP to contract by 0.7% in 2016 (from a 0.2% contraction previously) and to expand by 1.8% in 2017 (compared to 2.1% previously). This is mainly driven by the downward revision of our GDP forecast for Brazil to -3.6% in 2016 (versus -3.0% previously) and to 0.5% for 2017 (versus 1.0% previously). We still expect a modest recovery across the region in 2017, as commodity prices begin to gradually rise and external demand picks up.

Financing conditions continue to look weak in Latin America despite some recent rallies in oil prices that enabled Brazil to tap into slightly cheaper debt financing (though it remained the highest it paid for 10-year bonds since 2009). Investors are becoming slightly optimistic on regime change in Brazil, though bond purchases are driven by weak supply levels of Latin America debt rather than a stronger risk appetite. This comes as business confidence teeters above five-year lows, according to the National Industrial Confederation/IIF.