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Resilient economies and improving financing conditions should support a stabilization of the overall credit quality in 2024, with defaults expected to peak in the third quarter before trending down. Yet, risks to the base case remain high. A worsening of geopolitical tensions, in a year with a record number of elections, or a longer-than-expected period of high rates are among the top risks that could lead to weaker business activity and market liquidity, fueling further rating deterioration.

What We're Watching

Market conditions and most economies have proven surprisingly resilient coming into 2024. Corporate profitability has remained largely intact outside a few sectors, labor markets are still strong, and financial markets are providing an opportunistic window for capital raising. But risks are still lurking, which could derail our base case of a soft landing.

Geopolitical uncertainty—including the Russia-Ukraine war, the Middle East conflict, and U.S.-China tensions—has become the top risk to global credit conditions, according to S&P Global Ratings' Credit Conditions Committees. We view this risk as "high," given the threat it poses to supply chains, global trade, price stability, and market sentiment.

The second "high" risk is that interest rates could remain elevated for longer than markets expect—thus straining many of the weakest borrowers—if strong labor markets and the slow decline in core inflation in developed economies delay or derail central bank efforts to loosen monetary policy this year.

S&P Global Ratings' global and regional Credit Conditions Committees define the base-case scenarios used by our analytical teams to inform their rating deliberations and identify the downside risks that can affect credit ratings across asset classes. We classify risk levels as "moderate," "elevated," "high," or "very high"—by considering both the likelihood and potential macro-credit impact over the next one to two years. We also assign trends to these risks.

What We Think And Why

Geopolitical risks have come to the fore. The protracted Russia-Ukraine war, a widening Middle Eastern conflict, the potential for further escalation in U.S.-China tensions, and domestic issues in certain emerging markets could disrupt business activity, trade, supply chains, and investment flows—as well as increase financial market volatility. This year features more than 70 elections in roughly 40 countries whose outcomes could add complexity to already strained international and domestic dynamics for many countries. Protectionism is expected to continue and, if heightened, would further constrain global trade and growth. Perhaps the most consequential elections will be in the U.S.: in addition to the presidential election, 33 of the 100 Senate seats and all 435 seats in the House of Representatives are on the ballot. The outcome could have significant ramifications not just locally, but globally—potentially increasing geopolitical polarization.

Against the backdrop of geopolitical uncertainty, interest rate pressures are starting to decline in expectation that major central banks will start to cut rates later this year. S&P Global Ratings Economics maintains its expectation that the Federal Reserve will enact 75 basis points (bps) of rate cuts in 2024 with the first cut likely coming in the summer, and forecasts the European Central Bank to cut rates three times in 2024, starting in June.

But strong labor markets and the slow decline in core inflation among developed markets could delay or even derail central banks' efforts. This would weigh on market sentiment, which had already been pricing in deeper cuts than central banks' base cases. Higher rates in developed markets would further impact lowest rated credits and burden emerging market debt levels directly and through unfavorable exchange rates on non-domestic credit.

Looking ahead, the "elevated" and "worsening" risk of larger and more frequent natural disasters could increase the physical climate risks that public and private entities face and threaten to disrupt supply chains. 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. Simultaneously, the multidimensional shift toward a net-zero economy heightens policy, legal, technology, market, reputational, and other transition risks although with different pathways across countries and sectors. Regardless, this will likely require significant investments.

Amid increasing technological dependency and global interconnectedness, cyberattacks also pose a potential systemic threat and significant single-entity event risk. Criminal and state-sponsored cyberattacks are likely to increase; with hackers becoming more sophisticated, new targets and methods are emerging. Meanwhile, increased digitization and the introduction of artificial intelligence (AI) by public and private organizations will foster broader structural transformation to economies around the world.

What Could Change

The macroeconomic response to higher rates is playing out largely as S&P Global Ratings Economics anticipated, with slower activity and reducing inflation pressures. (The outperformance in the U.S. is a notable outlier.) We expect major central banks to implement the first cuts around mid-2024 followed by gradual subsequent cuts on a long road back to neutral territory.

But softer economic growth globally and still-elevated interest rates will pressure low-rated corporates in consumer-related sectors and across emerging market economies—and the lagged effects of the ongoing credit correction could mean a bumpy ride to recovery throughout 2024. We expect defaults to peak around the third quarter of this year as base rates begin to slowly decline, with the trailing-12-month speculative-grade default rate likely to stabilize at 4.75% in the U.S. and 3.5% in Europe by year-end (from 5% and 3.75% in the third quarter of 2024, respectively).

Most countries should still see slower growth in 2024, and our Credit Conditions Committee has assessed the risk level of a sharper global economic slowdown as "elevated." Credit headwinds are rising from still-high interest rates, the lingering impact of permanently higher prices, declining savings buffers, countries' increased fiscal burdens, and compounding challenges crunching the commercial and residential real estate sectors. And China's slowing growth is a risk to watch—as it faces weakening consumer and business confidence, weak exports, real estate sector troubles, and high leverage among corporations and local government financing vehicles. Slower growth could impact other regions, given China's large proportion of global trade and demand.

Writers: Molly Mintz and Joe Maguire