Geopolitics, rate uncertainty clouds forecasts

Credit conditions are expected to improve in the second half, but heightened geopolitical tensions and a prolonged period of high interest rates are the primary risks to that scenario, warns S&P Global Ratings.

The rating agency said in a report that overall credit quality is expected to stabilize later this year, with debt defaults peaking in the third quarter before declining as financial conditions ease.

“Market conditions and most economies have proven surprisingly resilient coming into 2024. Corporate profitability has remained largely intact outside a few sectors, labour markets are still strong, and financial markets are providing an opportunistic window for capital raising,” S&P said.

However, risks also remain high, S&P cautioned — headlined by the uncertainty that accompanies intensifying geopolitical concerns with the record number of elections taking place this year, and the threat of rates staying higher for longer than expected.

The report noted that geopolitical uncertainty — including the ongoing conflicts in Ukraine and the Middle East, and rising stress in U.S./China relations — has become the top risk to global credit conditions.

“We view this risk as ‘high’ given the threat it poses to supply chains, global trade, price stability, and market sentiment,” S&P said.

And the more than 70 elections on tap this year, in roughly 40 countries, could impact “already strained international and domestic dynamics for many countries.”

The other “high” risk, according to S&P, is the prospect of interest rates remaining higher for longer if inflation proves hard to tame.

S&P analysts continue to expect the U.S. Federal Reserve will cut rates by 75 basis points this year, starting in the summer, and that the European Central Bank (ECB) will also cut rates three times in 2024. However, “strong labour markets and the slow decline in core inflation among developed markets could delay or even derail central banks’ efforts,” it said.

“This would weigh on market sentiment, which had already been pricing in deeper cuts than central banks’ base cases,” the report said. “Higher rates in developed markets would further impact lowest-rated credits and burden emerging market debt levels directly and through unfavourable exchange rates on non-domestic credit.”

Looking further out, the threat of climate-related risks represent an “elevated” and “worsening” source of risk.

“This may quickly become a headline risk in the near-term, as the El Niño phenomenon is expected to disrupt agricultural commodities this year — particularly among emerging markets,” it said.

At the same time, cyberattacks also pose a potential systemic threat amid growing reliance on technology and increased interconnectedness, S&P warned: “Criminal and state-sponsored cyberattacks are likely to increase; with hackers becoming more sophisticated, new targets and methods are emerging.”