Challenging Days Ahead for the Bond Market

Dave Sekera: Escalating global political discord, weakening commodity prices, tightening domestic monetary policy, and required funding for outstanding M&A will likely keep corporate credit spreads throughout the first quarter within a narrow trading range near the currently elevated levels.

Based on the underlying fundamentals within the energy and metals and mining sectors, our credit analysts expect commodity-price levels will remain under pressure in the near term. This will lead to higher default and bankruptcy rates in those sectors later this year; yet we expect defaults will remain low elsewhere. Low commodity prices have adversely impacted near-term economic conditions; but over the longer term, these lower prices will help to support consumer spending.

While Chinese economic growth appears to be dwindling rapidly--and considering it is the second-largest economy in the world--its impact will slow down the overall global economic growth rate. This slowdown will continue to pressure top-line growth and operating margins for global corporations, but we expect the direct impact on the U.S. economy will be relatively modest.

Technical conditions in the investment-grade bond market will remain challenging early this year. There is a significant amount of overhang of new issuance waiting in the wings to be brought to market. In addition to the normal amount of refinancing that needs to occur, there are numerous multi-billion-dollar acquisitions that still need to be financed. On those days when volatility subsides, the new-issue market will be flooded with new issues, and this deluge of additional supply will constrain the amount that credit spreads would otherwise be able to normalize.