After an unprecedented era of remarkably favorable financing conditions, circumstances are rapidly changing--redefining the global economy and challenging credit markets. These intensifying headwinds could expose many borrowers to operational and structural pressures as central banks aggressively tighten monetary policy. At the same time, the ongoing Russia-Ukraine war continues to exacerbate inflation and cost pressures with high commodity, energy, and food prices, and slowing global economic activity signals consumers' concerns.

Recession risks are rising around the world alongside the heightened prospect of markedly deteriorating credit conditions. On a global scale, the second half of this year will likely be characterized by limited access to, and a higher cost of, credit. As Russia's invasion of Ukraine drags on, the humanitarian crisis, degrees of uncertainty and risk, and economic costs continue to grow--as reflected in the latest downward revisions to our global economic forecasts and our risk assessments. Central banks are hastily reversing a decade of ultra-loose monetary policy, even against the backdrop of slowing growth and heightened recession risk in the U.S. and Europe.

But for now, fundamental credit quality is proving resilient--whether looking at ratings actions, the net ratings bias, or the level of defaults (which remain low). Many factors are underpinning this: headroom built into ratings given the strength of the post-COVID recovery; the solid liquidity position of most companies amid highly favorable financing conditions in recent years, which allowed them to extend maturities; and overall lower ratings levels now than prior to the pandemic.

We see market volatility as a response to new or developing fundamental stressors. In the past three decades, each period of acute market stress has appeared during or before a recession--which is more of a driver of ratings downgrades and defaults than the market volatility itself. Lower-rated issuers will be the most vulnerable if access to capital markets becomes restricted.

While U.S. market participants have become more accepting of the increasing presence of issuers rated 'B-', which account for roughly a quarter of our rated speculative-grade issuers, investors now face increased risk of higher default rates and lower recoveries amid rising rates and fewer protections from credit deterioration. With slowing growth and rising policy rates pushing U.S. speculative-grade spreads higher, the U.S. distress ratio recently had its biggest increase since May 2020.

Even in our current base-case default-rate projections, we believe U.S. and European speculative-grade corporate defaults will rise from their very low levels, to 3% by March 2023. To be sure, overall global nonfinancial speculative-grade refinancing risk will likely remain manageable through 2023 in North America and Europe, the Middle East, and Africa following last year's record issuance.

Against this backdrop, S&P Global Ratings has run multiple scenario analyses to assess potential challenges from varying degrees of downturn--evaluating the implications of interest rate and EBITDA stresses for rated U.S. speculative-grade corporates; how a recession could affect rated European speculative-grade nonfinancial corporates; what implications higher borrowing and inflation costs will have on Asia-Pacific rated corporates overall; and the direct fiscal cost to sovereigns from a 300 basis-point (bps) increase in the cost of refinancing central government debt. These stress tests followed the publication of a stress scenario analyzing what a 300 bps rise in both interest rates and inflation could mean for unrated corporates globally.

Under current conditions, we believe between 16%-25% of rated Asia-Pacific entities could face downside risks to credit quality through 2023. But a renewed recession could put particular pressure on U.S. and European speculative-grade entities ratings.

In the U.S., a moderate-stress environment will likely increase the proportion of rated U.S. speculative-grade issuers with negative outlooks to 20%-25% by year-end, from the 15% seen today--with 'B-' rated issuers most vulnerable to downgrades, after those in the 'CCC' category. In a high-stress scenario, the proportion of issuers generating negative free operating cash flow could double. While our scenario analysis found that most rated European speculative-grade corporate entities are better positioned to endure a mild or moderate downturn, a severe recession would deliver a 20% decline in EBITDA by the end of 2023, in line with previous cycles.

Unrated corporates would face similar risks in the face of a 300 bps rise in interest rates and inflation. According to our analysis, loss-makers could nearly double--to 12% from an already-high 7%--with China's corporates most affected.

And for sovereigns, the first-order effects of a 300 bps rise in refinancing costs could be fiscally challenging for at least six out of 19 emerging market economies, including Brazil, Egypt, Ghana, Hungary, Kenya, and Ukraine.

As we continue to assess evolving global credit conditions and their implications for borrowing costs, credit quality, and markets, S&P Global Ratings developed and is trialing its proprietary Credit Cycle Indicator (CCI) to track and consolidate leverage, asset prices, and market liquidity globally. Covering Asia, emerging markets, the eurozone, and North America, the CCI will be a leading indicator for potential credit stress. Our preliminary results show that peaks in the CCI tend to precede major credit stress events by six to 10 quarters. The CCI currently indicates that heightened credit stress is likely to develop in late 2022 or early 2023.