Investors, issuers, and policymakers will have little room for error in maneuvering through the strains weighing on credit this year. S&P Global Ratings believes 2023 will begin as a journey through intensifying credit pressures, leading to (if all goes well) more stable financing conditions by year-end.

Disruptions of the recent past--a global pandemic, a war and energy crisis in Europe, wide macroeconomic swings with supply chains and inflation taking center stage--show just how fast the world can radically transform. And this new pace of change is reshaping credit markets. While some of the tumult has eased, a number of shocks are still reverberating across economies and markets. Slowing global economic growth will continue to create complications for rated credit, private markets, and the future of money.

Against this backdrop, we will be closely watching how market participants confront credit headwinds, deal with reshuffling capital flows, navigate geopolitical uncertainty, seek energy and climate resilience, and manage crypto and cyber disruption. The capacity of these trends to instantly disrupt our interconnected world--and the credit markets that underpin it--is evident.

New risks are constantly emerging, and well-known risks will evolve. Despite the mixed optimism that has marked the start of this year, fundamental changes such as higher-for-longer interest rates, more permanently elevated inflation, and volatile liquidity, combined with exogenous climate and digital risks, will disrupt patterns and solidify new market dynamics for years to come. As this extremely dynamic risk environment continues to challenge borrowers in 2023, our analytical frameworks and expertise will enable us to quickly assess and quantify emerging challenges and credit trends as part of our ongoing ratings surveillance.

This report is part of S&P Global Ratings' "What We're Watching" 2023 research focus.

Confronting Credit Headwinds

Slower economic growth and rapidly rising interest rates are defining the role of debt across markets. On top of the rising cost of capital in primary markets, corporate borrowers are facing the headwinds of sticky inflation, a potential global economic downturn, eroding customer demand, and still-shaky supply chains. We expect this combination to lead to credit deterioration as fundamentals for many corporates and some sovereigns deteriorate further, although unevenly, across industries, rating levels, and geographies.

As central banks remain resolute in their endeavor to ensure inflation expectations remain anchored, benchmark borrowing costs look set to stay higher for longer. This raises the question of how much economic slowdown or outright contraction might be necessary to wring out any remaining price pressures. The answer will determine downgrade and default risks for lower-rated borrowers with more vulnerable capital structures and business models: A sustained period of elevated borrowing costs will ratchet up debt service pressures on floating-rate debt and, with companies having to refinance, could lead defaults to double by the end of the year.

Reshuffling Capital Flows

With 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.

Navigating Geopolitical Uncertainty

International and domestic flashpoints--the COVID-19 pandemic, the Russia-Ukraine war and associated energy and commodities crises, U.S.-China tensions over the South China Sea and technology supply chains, and social unrest unfurling from Iran to Brazil and beyond--have undoubtedly fueled geopolitical fragmentation recently. The regionally divergent outcomes of geopolitical tensions on financial markets and global trade may result in the reshoring of supply chains to improve resilience and to the revamping of business models as global demand patterns change.

Seeking Energy And Climate Resilience

The conundrum of balancing decarbonization with energy supply security and affordability is one not easily managed. The energy crisis in Europe, global supply-chain bottlenecks, and emerging markets' growth are limiting reductions in greenhouse gas emissions, despite countries' implementation of decarbonization policies. Europe's ability to meet its energy needs while continuing to lead the world toward net-zero--with either regulation or technology as the key driver--may set the tone for the year.

Governments' focus on climate transition policies will continue to increase amid more frequent and severe weather-related events, but the current energy crisis will reshape physical and transition climate-related risks. This will affect efforts to limit emissions worldwide. We believe physical risks from climate change, and the associated financial and economic costs, will keep rising even if significant progress is made on decarbonization in the coming years.

Managing Crypto And Cyber Disruption

The transformation of global and regional financial systems amid the adoption of new technologies--from artificial intelligence to cryptocurrencies, tokenization, distributed ledgers, and beyond--is accelerating an era of growth and discovery. It is also heightening single-entity and systemic cyber risk. Entities with weaker cyber governance and risk management will be more exposed to rating implications this year.

Technological advancement is, as always, fraught with risk. But managed adequately, the opportunities that new technologies present can usher in a new period of growth and discovery.