Assuming nothing unexpected happens—which recent history suggests is improbable—Moody’s Investors Service foresees the 2019 outlook for nonfinancial corporates in North America as positive, if dimming, according to a report published December 4.
The positive factors the rating agency notes include GDP in the US of 2.3%, although it anticipates growth slowing to 1.5% in 2020, and moderately strong growth of 1.9% among the G-20 countries, and 4.6% among emerging markets. In addition, the default rate continues to decline, there’s good liquidity and low refinancing risk, and assuming interest rates continue to rise gradually most companies should be able to manage their interest rate exposure, the report says. The positive outlook assumes median EBITDA growth of 4.5%
Plus, the vast majority of industry sector outlooks globally (ISOs) are positive (51%) or stable (44%), with only 5% negative. In 2018, the only two sectors to garner negative ISOs are newspapers and magazines, and telecommunications.
Moody’s says the outlook could turn negative if US GDP in 2019 drops to 1% or less, or into negative territory, or there are “likely broad-based recessionary conditions.” EBITDA falling to 1% or less, for US, North American or global ISOs would also prompt a shift to negative, as would significantly negative signals from the Moody’s proprietary credit-cycle gauge indicators.
Federal Reserve Chairman Jerome Powell said November 28 that the central bank’s benchmark interest rate is “just below” neutral, which market observers largely interpreted as fewer rate hikes next year. Moody’s, however, anticipates monetary policy “normalization” continuing next year in advanced economies, and “little scope” for rates falling further in emerging markets.
“We expect the US Federal Reserve to continue to raise interest rates, with the upper bound of its target range peaking at 3.5% by the end of 2019 or the beginning of 2020,” the report says. The Fed raised the rate in September to 2.25%, and is expected to increase it by another quarter-point by year-end.
At a recent NeuGroup meeting, a rate specialist at Bloomberg noted interest expense as one of the top three challenges corporates face, in addition to tariffs and increased labor costs. Although Libor remains historically low, at just over 2.7% for three-month Libor, investment-grade and noninvestment-grade companies have taken on massive amounts of debt. The executive noted that Libor approached 6% before the 2008 crisis.
“Some corporates are now proactively seeking to lower debt on their balance sheets,” he said, adding that others have successfully pushed out maturities.
Moody’s says that global financial conditions will continue to tighten next year, while the premiums investors demand to hold longer-term debt and credit spreads will continue to increase.
“Tightening liquidity and rising spreads will affect funding costs across sectors, especially given the global rise in debt levels,” the report says. “In the US and Europe, rising nonfinancial corporate leverage and weakening covenant quality signal late-cycle risks. Emerging market economies will remain vulnerable to further tightening of global liquidity, combined with currency pressures.”
In terms of risks, the rating agency foresees rising inflation stemming from higher wage pressures potentially leading to monetary policy tightening too quickly or by too much, especially in the US.
“Faster-than-expected monetary policy normalization could lead to sharper financial market adjustment,” the report says. “Further, an escalation of trade or geopolitical tensions, or slower-than-expected growth in China, could also lead to sharp adjustments in financial markets.”