Is a recession approaching? | all news

The slowness of the European Central Bank seems ripe for a policy error, believes Lisa Coleman of JP Morgan AM.

US bond prices put the probability of a recession at 30%, while European securities put the risk at 50%. That’s a one in two chance. Valuations are factoring in the consequences of the withdrawal of central bank liquidity, rising borrowing costs and pressure on corporate margins as they face rising commodity and intermediate goods prices. Corporate health and credit market update with Lisa Coleman, head of the Global Investment Grade Corporate Credit team at JP Morgan Asset Management.

What is your outlook on global bonds?

On the one hand, quality credit spreads, particularly in Europe, have widened considerably this year. On the other hand, corporate fundamentals remain solid and they maintain robust balance sheets. Companies are therefore well prepared for a more difficult economic context, but the momentum is slowing down. The best of the essential improvement for bondholders is behind us as macro uncertainties have turned looming. Central banks continue to insist on bringing stubbornly high inflation under control with cycles of rate hikes, signaling the end of ultra-loose monetary policies. This tightening of financial conditions will contribute to further turbulence in the markets. However, we foresee a favorable environment for active management based on rigorous credit selection.

Won’t rising inflation and the cost of debt weigh on company revenues?

The strong first quarter earnings season in both the US and Europe largely reflected corporate pricing power amid supply constraints and rebounding demand for services. However, these results are largely in the rear-view mirror, as uncertainties about inflation and longer-term growth expectations prevail. Operating trends remained positive in the first quarter, but EBITDA expansion is starting to falter on both sides of the Atlantic. Deleveraging is slowing in the US, where the median industrial company is no longer reducing debt, while European companies continue to deleverage. Margin pressures show little sign of easing in most sectors, and we expect headwinds from input cost inflation to prevail this year.

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The implications of shrinking central bank liquidity, rising borrowing costs and margin pressures continue to weigh on sentiment.

How will rising financing costs affect borrowers?

Its average cost has increased with higher Treasury yields and wider spreads. For the first time since 2018, the average coupon issued on US investment grade debt is higher than the average coupon at maturity. However, we are not worried in the short term, as corporates have taken advantage of attractive all-in yields to terminate their debt, which has lengthened the maturity profile of the investment grade segment and lowered the short-term maturities of current clues.

How are consumers behaving in this higher price environment?

Household attitudes are changing as inflation takes its toll. Wage and commodity price pressures, coupled with supply bottlenecks, mean that many companies are passing cost increases on to the consumer. Privileged goods during the pandemic, such as furniture and electronics, are replaced by services, such as travel. Among retailers, value-oriented stores with lower prices are benefiting. The situation also varies between food producers, given the differences in their ability to reflect inflation.

Are companies suspending investment in capital goods due to rising capital goods and economic uncertainties?

Quite the contrary. In both Europe and the United States, capex is a top priority when it comes to allocating liquidity. European utilities, for example, have ambitious carbon transition plans that require greater investment. In the United States, shareholder activities such as buyouts are also on the agenda as liquidity begins to return to pre-crisis levels.

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How are flows changing in the global bond market?

Money inflows into bond funds have been in line with central banks’ accommodative measures, and it is logical to expect that flows will shift as policies tighten. Most notably in European credit markets, where the withdrawal of the ECB’s purchase program for the corporate sector marks the end of the ‘buyer of first resort’. Over the past few months, high-quality US stocks have been steadily divested weekly, which is a stark contrast to previous record inflows, and perhaps heralds a larger shift in reallocation among stockholders. corporate debt.

What are the elements included in the valuations?

The implications of shrinking central bank liquidity, rising borrowing costs and margin pressures continue to weigh on sentiment. As a result, the spreads of the best rated companies have widened considerably since the beginning of the year. Since the end of 2021, US investment grade bonds have gained 50 basis points to reach an option-adjusted spread (OAS) of 142 points, while euro securities have underperformed, with a spread of 94 bp to achieve an OAS of 189 bp. Current uncertainties regarding inflation and longer-term growth expectations mean that spreads should continue to trade in a higher range. Any volatility should serve as a catalyst for tactical adjustments in risk positioning.

You pointed out that European credit prices imply a 50% probability of recession, while US bond prices put the same risk at 30%…

The war in Ukraine, which is exacerbating supply chain pressures resulting from the pandemic, as well as Europe’s continued reliance on energy supplies from Russia, have rightly made investors more wary of the European credit. The European Central Bank’s sluggishness also seems more conducive to a policy error.

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