New risks are emerging, and established risks are evolving—all of which require a new playbook for issuers and investors in the debt markets.
S&P Global Ratings expects additional credit deterioration in 2024, largely at the lower end of the ratings scale. An environment of increasingly rapid change requires financial market participants to adapt their playbooks.
Looking ahead at 2024 and beyond, we are closely watching how credit headwinds, capital flows, geopolitical uncertainty, energy and climate resilience, and crypto, cyber, and tech disruption transform the global economy and financial markets over what promises to be yet another challenging period.
Crypto, Cyber, & Tech DisruptionThe transformation of global and regional financial systems amid the adoption of new technologies—from generative artificial intelligence to blockchain and beyond—is accelerating an era of growth and discovery while also heightening single-entity and systemic cyber risk, forcing corporate and government entities to adapt their playbooks.
The surge in U.S. data center numbers and capacity should support credit quality for sectors exposed to the trend, including power generators, data center owners and developers, electricity utilities, and midstream gas companies.
S&P Global Ratings expects U.S. data centers will require 150 to 250 terawatt hours (TWh) of incremental power per year to 2030, with grid infrastructure likely the biggest hurdle to meeting that demand.
We expect that demand will result in sustained higher prices for power generators, increasing electricity demand after two decades of stagnation, and a reinforcement of the role of gas, with additional demand of between 3 billion cubic feet per day (bcf/d) and 6 bcf/d by 2030.
Risks relating to this rapid data center growth include financial pressures from increased capital expenditure, a potential for a backlash against power price increases, and environmental impacts including rising carbon emissions due to renewables' limited near-term ability to meet data centers' power needs.
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Geopolitical UncertaintyGeopolitical risks have returned to center stage, with the war between Israel and Hamas, the prolonged Russia-Ukraine conflict, and ongoing U.S.-China tensions. This increased geopolitical fragmentation affects corporates and governments in their strategies for supply chain and energy security, with potential broader implications on food prices, global trade, and inflation—while increasing the potential for event risk.
The fate of some of the Tax Cuts and Jobs Act's (TCJA) corporate tax provisions, such as interest deductibility, bonus depreciation, and deductions for research and development (R&D) expense, will be a key topic in 2025, regardless of the U.S. election outcomes this November. An extension of the deductions beyond 2025, particularly if done retroactively, would be a benefit for post-tax corporate cash flow and potentially stimulate more capital expenditure and R&D expense.
While it's too early to determine the direction of corporate tax rates or the possible extension of the pertinent TCJA tax provisions, a higher corporate tax rate would add to a company's tax cash outflow, and thus reduce our funds from operations (FFO) calculation. The effects on credit ratios would appear most directly from changes to FFO and, thus, to FFO-to-debt ratios and FFO-to-interest coverage.
The corporate alternate minimum tax (CAMT) and Share Buyback Excise Tax have limited reach and are unlikely to deter corporations from moving forward with their financial plans. Although the 4% Share Buyback Excise Tax may be somewhat punitive, most companies plan for such tax changes, in our view.
The U.S. has not yet enacted the Economic Cooperation and Development (OECD) agreement. Instead, it enacted its own minimum tax rules on foreign earnings. The outcome of the U.S. elections will provide direction on whether the U.S. will adopt a minimum tax consistent with the OECD.
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Energy and Climate ResilienceNew challenges are also emerging from the necessity to accelerate the world’s transition to a low-carbon economy to limit the potential dramatic consequences of climate change. Extreme weather conditions and worsening physical risks continue to increase and influence credit fundamentals. However, we believe companies' and governments' readiness to address these risks, in large part, remains low and could become even more challenging to overcome in an environment of slower growth and tighter financing conditions.
Governments globally are not abandoning energy transition targets, but political priorities are coming under pressure.
Against the background of tighter fiscal constraints and a worsening geopolitical landscape, policymakers across the world increasingly focus on cost of living, energy security, economic competitiveness, and defense spending.
Distributional questions are increasingly being raised in connection with the energy transition, amid concerns about voter backlash and cost-of-living pressures.
The economics of the energy transition differ across geographies. While net energy exporters can afford a slower shift toward non-hydrocarbon resources, net importers in Europe and Asia can't.
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Capital FlowsWith the era of easy money over, investors are rebalancing their portfolios to adjust for shifting risks and returns. Borrowers (especially those at the lower end of the ratings ladder facing tighter access to credit) will need to adapt to the reshuffling of capital flows from long-duration speculative assets to safer havens—as well as adapt to the knock-on implications for overall market liquidity, foreign exchange reserves, and investment in emerging markets.
Potential changes to liquidity regulations for U.S. banks, particularly large banks, could lead to more robust liquidity risk management over time and could lower the odds of seeing bank failures similar to that of Silicon Valley Bank.
For now, U.S. banks continue to navigate through liquidity pressures (marked in many cases by large unrealized losses on securities and low cash holdings), including by limiting growth.
While a rise in deposits and a slowing of the Fed's quantitative tightening have recently supported banks' liquidity, an unexpected increase in liquidity strains could lead to negative rating actions.
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Credit HeadwindsWe are back to an environment of higher real interest rates, concluding an era of cheap money that started in the wake of the Great Financial Crisis. Borrowers across all asset classes will need to adjust to tighter financing conditions and softer economic growth. With a durably higher cost of debt, a ramp-up in maturities, and slowing economic activity in the cards for 2024, the focus comes back to credit fundamentals and liquidity analysis.
A global rate-cutting cycle has begun, but the pace and timing of future cuts are still highly uncertain. Rates remain at decade-high levels, pressuring some issuers--particularly those with floating-rate debt instruments.
Additionally, primary issuance of floating-rate debt remains strong, and if the descent of interest rates disappoints, it could place increasing pressure on these issuers.
Issuers with floating-rate instruments tend to be lower rated. Year to date, 62% of instruments associated with North American defaulters have been floating rate, with most of those defaults occurring via a distressed exchange.
Just over three-quarters of current weakest links have at least one floating-rate instrument. Unhedged, lower-rated floating-rate borrowers remain particularly vulnerable to the timing and extent of future rate cuts.
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