American credit market outlook

There's no denying that the rally in the companies with the poorest credit quality has been one of the most remarkable on record, representing also a complete reversal of fortune in less than a year.
But economists and portfolio managers say thirst for yield that has sharply reduced risk premiums for the debt of junk-rated companies may now be all over.
Indeed, by some measures risk premiums, or credit spreads, on companies with ratings in speculative territory has fallen to levels comparable to the halcyon days of the mid-1990s when balance sheets were not as laden with debt as they are now.
"In some ways, speculative grade spreads have overshot themselves," said Kamalesh Rao, an economist at Moody's Investors Service.
While credit spreads across the spectrum have shrunk sharply on expectations of the improving economy to help earnings, balance sheet and credit quality, leading to fewer defaults, it's hard to come up with the right superlative for what's happened to junk spreads.
One example is just what's happened in recent months. While there was a brief setback in spreads recently, the overall decline continued for both investment-grade and junk spreads - but much more so for junk spreads.
Take the difference between the average seven-year maturity spread on debt rated single-A, a mid investment-grade rating, versus Ba, an upper junk rating - a way of estimating how investors are discriminating between difference levels of risk.
Eight months ago that spread between investment-grade and junk stood up near the highs of the credit downturn that ended last year, at 354 basis points. But now it stands at just 188 basis points, around the lowest levels since the late-1990s.
Some junk spread proxies are even lower than some averages during the docile mid-1990s, while investment-grade spreads remain above those averages.
The reasons are pretty clear. Balance sheets are getting in better shape, revenue and profits were very strong at the end of last year.
As a result, ratings downgrades are not outpacing upgrades nearly as much as they were. Default rates are dropping, as well as projected high-yield losses.
For that reason, portfolio managers like Gary Pzegeo at Gannett, Welsh & Kotler, which manages $5.5 billion of fixed-income assets, believe "there's a good fundamental argument for further relative appreciation."
Analysts at Banc of America Securities said that Moody's forecast for global speculative default rate is still declining and now is forecast for 3.4 percent at the end of this year.
"Declining loss rates should continue to lead to declining spreads in high yield," they wrote in a recent research report.