December 12, 2022
As we look at the global credit markets for the year ahead, some of the shocks that have reverberated across economies and markets are showing early signs of easing. While nothing is assured, our base-case scenario assumes policy rates will peak by the middle of the year in the largest economies, with the global economy slowly regaining momentum as China lifts its COVID restrictions and supply disruptions ease further.
This could lead to a stabilization of financing conditions in the latter half of the year, assuming central banks succeed in trimming inflation. But uncertainties remain high, with a focal point being the unfolding war between Russia and Ukraine and its implications for energy markets.
As we end a year in which COVID, a war in Europe and an associated energy crisis, and high inflation roiled markets and slowed the global economy, early signs of easing of some of these pressures provide hope that credit conditions could stabilize in the second half of 2023. But finding a way out of the strains weighing on credit leaves little room for error.
In the near term, S&P Global Ratings expects pressures on credit ratings to intensify, as corporate borrowers find it more difficult to pass through high input costs to consumers struggling with rising prices and a mild recession in some of the world’s largest economies. We forecast speculative-grade corporate default rates in the U.S. and Europe to double. As major central banks remain hawkish to fight inflation, governments have diminishing fiscal options to deploy after piling on debt during the pandemic.
Many borrowers built up enough buffers during the long stretch of favorable financing conditions to ride out a rough patch—at least for some time—supporting credit quality in many sectors. However, ratings are lower than they were prior to the pandemic, and debt levels higher, with 32.5% of corporations with ratings in the ‘B’ or ‘CCC’ categories.
Risks to our base-case scenario remain firmly on the downside, given an increasingly fragmented and fragile geopolitical situation. Tighter financing conditions on the back of an entrenched inflation, a deeper and longer-than-expected recession, and persistent input-cost inflation could squeeze further corporate margins and government balances, leading to sharper credit deterioration.
Strained Financing Conditions
Sharply higher policy rates and quantitative tightening by major central banks are pressuring already-strained financing conditions—which is especially concerning against the backdrop of high debt levels, and could hurt lower-rated borrowers, in particular. A real or perceived monetary-policy misstep (in either direction) could increase volatility in credit markets and result in an even sharper repricing of financial and real assets, higher debt-servicing costs, and tighter access to funding. This also poses risks for EMs that rely heavily on foreign funding, have large external and/or fiscal imbalances, and are exposed to further strengthening of the U.S. dollar.
Global Recession Risk
As many major central banks aggressively raise interest rates, persistent high inflation eats into consumer purchasing power, and energy scarcity continues in Europe, the U.S. and Europe’s largest economies could fall into deeper downturns than we expect, accompanied by a steep rise in unemployment. At the same time, China’s persistent COVID policy and prolonged weakness in the property sector could hurt consumption and business confidence. A worse-than-forecast recession in the U.S. and Europe, and further slowdown in China, could further weaken global growth.
Price Pressures
Hawkish central banks have yet to meaningfully bring down inflation, and economic activity is already slowing—increasing downside macro risks and the likelihood of stagflation. As input-price pressures persist, companies that have been able to pass through increased costs to maintain profit margins are now finding this more difficult as consumers’ purchasing power erodes and pent-up demand after the pandemic fades. Concurrently, the strong dollar points to higher imported inflation for Asia-Pacific and EMs, compounding margin pressures.
Geopolitical Tensions
As the Russia-Ukraine war drags on and the risks of escalation (potentially involving NATO allies) increase, the effects on markets and economies could deepen. While European governments have lately succeeded in easing the continent’s energy crisis, the effectiveness of these measures is finite, and the conflict could keep upward pressure on energy—and food—prices. Meanwhile, tensions between the U.S. and China continue to simmer. Heightened global tensions among major countries add to “event risk” and could spur market volatility, further disrupt supply chains, depress investor confidence, and diminish global cooperation regarding environmental and public health priorities.
Climate Considerations
The Russia-Ukraine military conflict has forced policymakers to prioritize energy security and affordability over sustainability in the short term. In this light, the phase-out of carbon-intensive energy sources has been delayed in Europe—even as investments in some renewable energy ramp up. As other countries, too, delay decarbonization, they’re exposed in variable ways to the environmental challenges, whether through physical risk, adaptation costs, or overhauling fossil-fuel industries. The dire need for policy action could disrupt industries, with potential implications for business and financial risks in energy-intensive sectors.
Digital Disruption
Amid increasing technological dependency and global interconnectedness, cyber attacks pose a potential systemic threat and significant single-entity event risk, with the Russia-Ukraine military conflict raising the prospect of major attacks. Criminal and state-sponsored cyber attacks are likely to increase; with hackers becoming more sophisticated, new targets and methods are emerging. As public and private organizations accelerate their digitalization, a key to resilience is a robust cybersecurity system, from internal governance to IT software. Entities lacking well-tested playbooks (such as active detection or swift remediation) are the most vulnerable.
Source: S&P Global – Global Credit Outlook 2023: No Easy Way Out
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