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December 2015
World Outlook 2016: Managing with less liquidity
Figure 16: Private sector credit growth back to pre-credit
'bubble levels
—Net borrowing of the non-ftenciel private sector
%of GDP. seer
-5
.10
1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014
Sauce Dead* Sent Itserarth. Now AntociLI. f.Yid It was SEA
'Figure 17: Cumulative inflows into US funds since the
'Euro area debt crisis
80%
7%
—
US Ecnat$44
—
US MM
60%
—US Gout tends
60%
40%
30%
20%
10%
0%
—US
High Yield
-10%
-20%
Jun-2010
Jun-2011
Jur-2012
Jun-2013
An-2014
Sane Ciniectie Sent Amin* EOM
(Geo) Politics: The Middle East will likely remain, directly or indirectly, an
important source of (geo) political risk. One direct effect would be via the
rebuilding of risk premium in the oil market (with the associated implications
on inflation and bond markets). An indirect political risk would manifest itself
in terms of the debate around the handling of the refugee crisis, with
associated implications on border controls and by extension the functioning of
the single market. This could support anti-EU sentiment in general and be
particularly relevant in the UK ahead of the EU referendum.
Francis Yared, (44) 20 7545 4017
Jerome Saragoussi +1(212)250-3529
Abhishek Singhania, (44) 20 7547 4458
Dominic Konstam, (1)212 250 9753
Stuart Sparks, (1)212 250 0332
Jun-2015
Page 48
Deutsche Bank AG/London
CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e)
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EFTA01458980
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December 2015
World Outlook 2016: Managing with less liquidity
US Credit Strategy: US credit feels the pressure of high
commodity exposure
US credit markets have made a U-turn midway through 2015, as doubts began
to surface with respect to issuer fundamentals, exposure to commodities and
EM, and more recently even certain developed market names. The cavalier
attitude that energy sector problems will remain contained has also seen
defectors as oil prices set new lows during the course of the year and bonds
came under even more pressure. At the same time, the expected pickup in
consumer spending still takes time to materialize.
The US credit market reflects a much more realistic view of a potential for
rising credit losses from here, with spreads in both HY and IG being at 3- to 4-
year wides. Naturally, we like these levels better that those prevailing just a
few months ago, and unless those credit losses start materializing soon, the
market could be positioned for a strong rebound. Evidence we look at
suggests that this is not the most likely outcome just yet, however.
At the core of our view is that the epicenter of this cycle will be in commodities
and EM. These areas continued to show few signs of imminent turnaround at
the time of this writing. A McKinsey study earlier this year estimated total of
new debt created since 2007 at S50trIn, capturing all global sovereigns,
corporates, and consumers. Much of it was raised with a belief in the
commodity super-cycle. Today, we know that such a belief was wrong, and so
it would only be logical to assume that meaningful debt write-downs are
inevitable. The question really is whether they remain limited to commodity/EM
areas, or spill over to a wider set of sectors.
We see three primary risks to the upside from here. The first one, least
predictable but most relevant, is the Chinese economy turning the corner. The
second, somewhat evident, is equities continuing to diverge in the face of
commodity meltdown. The third, perhaps the most obvious, is more stimulus
from central banks, at least outside the US. We discuss each of these in
greater detail in our full year-ahead publication to be released soon. That they
are listed here as risks, and not base case, gives readers a preview as to our
assessment of their probabilities.
Overall, we expect the push-and-pull to continue, with those seeking more
yield and those seeing signs of a cycle turn. We expect variable degrees of
success to be claimed by each side at different points over the course of 2016.
We find ourselves believing in moderate increases in ex-energy defaults to
3.2% next year, up from 1.9% today, and a continued pressure on HY spreads,
where USD DM ex-energy index could widen by about 100bp.
Higher vulnerability of HY makes IG a more attractive alternative, in our eyes,
especially in light of its current levels; we expect IG to widen only by about
10bps from here, or well inside of a normal 1:4 relationship to HY. European
credit should remain better bid than the US, and loans should continue to quietly