New economic worries and stress in the U.S. banking sector have taken a further toll on investor sentiment according to the latest Fitch Ratings/Fixed Income Forum Survey of senior fixed income money managers conducted in June.

Approximately two-thirds of investors now expect the credit markets to stabilize no earlier than 2009, in contrast to the January 2008 survey when most expected stability to return in 2008. Nearly all investors place stability in the housing market as a 2009 or later event and half of investors surveyed believe a recession is highly likely in the U.S. over the coming year.

When asked to comment on the degree of risk posed by a series of key macroeconomic factors, inflation and oil price volatility, not surprisingly, registered the biggest gains in terms of factors considered most detrimental to the credit outlook. Survey results confirm that the dramatic spike in oil prices in the first half of 2008 has further clouded the outlook for the U.S. economy, raising the spectre of a slow-growth, high-inflation environment.

In the recent survey there was an interesting divide in opinions on the outlook for the financial sector, with investor expectations essentially split between deterioration and improvement in credit quality over the coming year. However, the failure of a financial institution received the most votes as a high risk factor going forward. This response, given prior to the recent troubles at IndyMac and Fannie Mae and Freddie Mac, held steady even after the first-quarter rescue of Bear Stearns, suggesting strong investor scepticism that the worst of the crisis at financial firms had passed, a concern that has proven more than justified.

"Taken together, the recent batch of survey responses suggests that risk tolerance, at least among more traditional fixed income investors, remains low, which in itself presents a problem for the credit outlook," said Mariarosa Verde, Managing Director and Head of Fitch Credit Market Research. "Investor confidence is the ultimate ingredient in getting the credit markets back on track."

Survey participants continued to be bearish on the direction of corporate default rates over the next 12 months, with nearly all participants expecting higher default rates. In addition, most investors expect an increase in corporate leverage over the coming year.

"Given the slowdown in the broader economy, it is not surprising that investors expressed the most concern about cyclical industries, the high yield corporate sector, as well as structured finance areas exposed to the housing market," said James Batterman, Managing Director in Fitch's Credit Policy Group.