Global rating outlooks stabilised further during 1H14 and the structural trend of rating compression towards the 'BBB' range has stalled, said Fitch Ratings.
Net rating outlooks improved in all sectors, led by sovereigns, with the still negative balance halving to 7% from 14%. Key positive rating actions include the upgrade of Spain and the revision of the outlook to stable on Italy's rating, (both 'BBB+'). The exception was European financial institutions, as the expected reduction in sovereign support for banks led to the assignment of negative outlooks on a number of entities at end-1Q14, despite the widespread improvement in capitalisation, it said.
The post-crisis structural trend of rating compression towards the 'BBB'-range has stalled, with some sectors showing a slight improvement in rating mix. The ratio of ratings in the 'AAA' to 'A' range rose marginally or remained stable across the board.
Fitch forecasts economic growth in developed markets will increase to 1.8% in 2014 and 2.2% next year. The US should see a strong recovery in 2H14 with annual growth of 2.3% and a declining output gap. The eurozone crisis has passed its acute phase and both Germany and Spain should see healthy growth.
Now that recovery is gathering pace, the Fed and the Bank of England are faced with the challenging task of reducing the flow of easy money, although the ECB and Bank of Japan are more concerned with deflation. Fitch regards eurozone deflation as a serious risk, but not its base case. Reducing the flow of support money also risks bouts of market volatility which could damage emerging-market access to finance at a time when growth is slowing in many countries.
Several years of QE have stoked inflation in select financial asset classes, notably high yield and certain prime housing markets, such as London. As investors watch keenly for signs of a peak, sudden sell-offs risk dislocating these markets as well as causing contagion. The search for yield has also affected insurance company investment portfoilos, with risk profiles rising, albeit from low levels. Furthermore, plentiful market liquidity and low sovereign yields are weakening the resolve of governments to continue fiscal consolidation, capping the recent trend of positive sovereign rating actions.
