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, S&P Global Ratings said in its “Global Credit Outlook 2023: No Easy Way Out“.
Inflation continues to run hot in many regions, which means central bankers are likely to remain hawkish in the near term. Supply bottlenecks persist as the Russia-Ukraine war rages on, and China’s COVID lockdowns continue. What’s more, some major economies are set to slip into recession as price pressures sap consumer demand and higher borrowing costs crimp investment. Moreover, the lag between rate hikes and their effects means that prices will stay elevated–and consumer purchasing power diminished–for some time. Additionally, governments largely lack the fiscal capacity to spend their way through this turn in the credit cycle, having piled on debt during the pandemic.
“In the near term, we expect credit pressures to intensify, with a world order that’s increasingly fragmented and fragile,” said Alexandra Dimitrijevic, S&P Global Ratings’ Global Head of Analytical Research and Development. “Sectors dependent on discretionary spending, such as consumer goods and retail, energy-intensive sectors such as chemicals, and rate-sensitive sectors such as housing, will likely suffer most. Others such as commodities and energy producers are benefiting from the current environment.”
Sovereigns will continue to feel credit pressures, with slower economic activity weighing on fiscal balances and countries generally having less fiscal flexibility after the pandemic. Credit conditions in emerging markets will remain under particular pressure from the combination of a strong U.S dollar, high energy and food prices, and a slowdown in global demand.
Growth is slowing almost everywhere, and the consensus view is that a sharp slowdown is all but inevitable. We now forecast a contraction in GDP of 0.1% in 2023 in the U.S., with a shallow recession in the first half; the eurozone coming in flat for the full year; and growth in China of 4.8%. The determination of monetary policymakers to bring inflation (expectations) back to low and stable rates suggests that policy rates still need to go higher. We estimate that the U.S. Federal Reserve’s policy rate will peak at 5.0%-5.25% in the second quarter and the European Central Bank’s at 2.25% in the first quarter.
“The big miss on correctly identifying last year’s incipient inflation pressure as persistent implies that policymakers will err on the side of doing too much rather than too little,” said S&P Global Chief Economist Paul Gruenwald. “As a result, the window for a soft, non-recession landing is closing fast; a meaningful slowdown is highly likely to come.”
Across regions, 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 is especially concerning given high debt, and could particularly hurt lower-rated borrowers.
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 before the pandemic, and debt levels higher, with 29% of nonfinancial corporates rated ‘B-‘ or lower. 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. While credit ratings reflect our base-case scenario, we also monitor top global risks that could derail the baseline expectations, leading to further credit deterioration.
They include the risks that:
- Tight and volatile financing conditions persist amid entrenched inflation, increasingly pressuring the debt-service capacity of more vulnerable borrowers.
- A deeper and longer-than-expected recession in the largest economies further damps global growth.
- Persistent input-cost inflation and high energy prices, combined with weakening demand, squeeze corporate profits and put pressure on governments’ fiscal balances.
- Amplifying geopolitical tensions roil markets and weigh on business conditions.