(Editor's Note: In this series of articles, we answer the pressing Questions That Matter on the uncertainties that will shape 2024—collected through our interactions with investors and other market participants. The series is aligned with the key themes we're watching in the coming year and is part of our Global Credit Outlook 2024.)

With central bank policy rates likely at or near their peak, how quickly borrowers can expect a U-turn toward rate cuts is of paramount importance to their refinancing strategy.

How This Will Shape 2024

Times have changed—quickly.   A protracted period of exceptionally low borrowing costs, combined with longer tenors on new debt during the pandemic period, provided corporations the best financing conditions we've ever seen. And this was preceded by more than a decade of falling interest rates compounded by central bank asset purchases and backstops, coaxing investors into ever riskier debt.

Sky-high inflation created a new landscape for lending conditions.   The onset of the highest rates of inflation in more than four decades forced central banks into sharp monetary-policy tightening in the past two years. The response by corporations was a 35% global reduction in overall bond issuance in 2022, with a 10% growth rate this year still keeping 2023's total below 2019's. And the majority of debt that has been issued has been largely limited to refinancing rather than more growth-oriented ends.

Central banks have entered a new, post-pandemic phase of tighter monetary policy.

Barring a major economic collapse, this will force corporations to reconfigure their balance sheets and financial planning, given that more income will need to be used to service debt. Our initial projections for overall corporate bond issuance in 2024 calls for very modest 3% growth—but given expectations for the path of policy rates by the Federal Reserve, this otherwise modest (but positive) annual total may fluctuate considerably throughout the year (see chart 1).

Chart 1

Many companies already appear to be postponing coming to market in the hopes that interest rates will start to fall in the next six months.   While we feel current rates and slowing growth will keep 2024's bond issuance growth lower than this year's pace, some issuance that we expected in late 2023 may be pushed deeper into 2024, thus boosting our 3% growth projection.

While market sentiment may be optimistic amid increased hopes for central banks to pivot, we've been here before—at the same time a year ago, in fact.   And for borrowers, waiting is a gamble. Rates may not fall as far or as fast as some hope, investors will prefer higher-yielding assets if rates do fall, and the timeframe to address large refinancing needs in 2025 is running thin.

The pain won't be felt evenly across sectors.   At the lowest rating levels ('B-' and below), there are five sectors globally that have more than $100 billion in debt outstanding (see chart 2). And of the $790 billion among these five, roughly 82% comes due in 2024-2028. Four of these five sectors—high technology, health care, media and entertainment, and consumer products—are the largest in terms of their presence in the leveraged loan market and have (aside from high tech) been the largest contributors to global defaults this year. In contrast to bonds, leveraged loans have felt rate hikes more immediately since they typically have floating rates with benchmarks very tightly tied to moves in policy rates.

Chart 2

What We Think And Why

Even with a pivot by central banks, effective long-term rates look set to remain historically high.   While we think the Fed will start a cycle of interest-rate cuts in June, we think the federal funds rate will be at 4.7% at the end of 2024 and average roughly 5.25% for the year. We also expect the European Central Bank to start cutting rates in the second half of 2024, albeit at a slower pace.

Changing supply and demand dynamics are influencing benchmark U.S. Treasury rates.   (And Treasury rates have pulled other non-U.S. government bond yields up with them). There's been a substantial $2 trillion increase in Treasury supply since December 2022, alongside reduced Treasury holdings among some of the largest buyers—including the Fed, via quantitative tightening. So, while short-term policy rates might decline next year, the transmission mechanism to lower rates in the long term may run into some obstacles, keeping effective borrowing costs elevated.

What Could Go Wrong

We see a potential lose-lose situation.   Given the high level of uncertainty for the path of economic growth and what has already proven to be "sticky" inflation, there's a potential lose-lose situation ahead for corporate borrowers.

If inflation lingers amid robust economic activity and tight labor markets, central banks will need to keep policy rates high.   On the other hand, if rate cuts happen faster than we expect, it will likely be because the economy stumbles—perhaps into recession.

Economic downturns always hit credit harder than higher rates do.   This is because they erode top-line (revenue) growth, making all expenses—including interest rates—more cumbersome. And for corporations, history has shown that recessions come with rapidly rising market yields and wider spreads, even if risk-free benchmarks fall (see chart 3).

Chart 3

Related Research

Global Financing Conditions: Stubborn Rates Portend Slower Issuance Growth In 2023 And 2024, Oct. 26, 2023