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Credit Outlook: New Headlines, Same Themes

Despite numerous headwinds, we expect strong underlying fundamentals will continue to support further tightening in corporate credit spreads.

Dave Sekera, CFA, 03/29/2011

We expect credit spreads will continue to tighten. 

Issuer specific credit deterioration will most likely be self-inflicted as issuers look to improve shareholder returns at the expense of bondholders. 

Strategic acquisitions and LBOs will continue; covenant analysis will be paramount. 

Disaster in Japan causes backup in credit spreads.

Over the past year, improving economic fundamentals underpinning the strength in corporate credit have outweighed what seems like a continual barrage of financial and environmental crises. The ongoing recovery has led issuers to generate strong free cash flows, increase liquidity, and strengthen balance sheets. Even with the 10 basis-point backup in credit spreads in mid-March due to the disaster in Japan, credit spreads tightened by 4 basis points last quarter.

In addition to continued improvement in the underlying fundamentals, the technical backdrop in the market has been positive. Demand for corporate bonds continued at a healthy rate as investors deposited $4 billion in investment-grade and high-yield mutual funds thus far this year.

Although there continue to be numerous headwinds, we expect the strong underlying fundamentals will continue to support further tightening in corporate credit spreads.

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