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A worsening geopolitical landscape, the possibility of an economic downturn, a longer-than-expected period of high borrowing costs, and growing threats to global trade are the top risks that could derail our base case for global credit conditions.

What We're Watching

Most economies have seen solid growth so far this year—and ratings upgrades have outnumbered downgrades among corporates, financial institutions, and sovereigns.

U.S. speculative-grade corporate bond spreads reached a new low of 230 basis points (bps) in early May and remain around 250 bps—indicating investors' high demand for debt. And while other regions haven't seen all-time lows in spreads, the trend is similar. Even European speculative-grade spreads remain roughly 40 bps narrower than they were at the start of the year, despite widening since the announcement of snap elections in France.

The surge in market demand has resulted in strong growth in bond issuance thus far in 2024. Improvements in aggregate credit quality from the first quarter have continued with the highest sustained pace of net upgrades since monetary policy tightening began in early 2022.

Speculative-grade issuers saw net upgrades through the first half of 2024, albeit with some resulting from weaker issuers defaulting and dropping out of the rated population in recent months. All regions have had more upgrades than downgrades in the second quarter (through mid-June), led by Asia-Pacific with only 26% of all rating actions being downgrades.

But current market performance may prove to be a high point. While long-awaited monetary-policy easing has begun in some advanced economies, the U.S. Federal Reserve remains on hold for now, and some emerging markets are dialing back their easing as a result. We expect growth to slow in some major economies in the second half of this year, while rates remain elevated. Regional differences in the pace of cuts will produce rate divergence globally, which could add to volatility and capital outflows to higher-yielding locations, according to our Credit Conditions Committees.

What We Think And Why

Global corporate bond yields have fallen some after a spike last October but have largely remained at historically high levels since the second half of 2023. We expect central banks to only gradually cut rates over the next 12 months—which may limit declines in corporate yields. As more debt is refinanced at higher rates, increased costs may pressure cash flows, particularly if combined with decelerating revenue from slower economic growth.

In North America, borrowers could enjoy more favorable credit conditions if the U.S. economy settles into a soft landing and the Fed begins to lower its policy rate. However, credit deterioration could linger with interest rates likely staying high for longer than we previously anticipated. On top of the downside risk posed by prolonged high financing costs, input-price pressures persist, and commercial real estate losses could worsen amid cyclical and secular headwinds. U.S. elections could also lead to market volatility and policy uncertainty.

In Europe, we expect growth will gradually pick up, even as the disinflation trend continues—enabling the European Central Bank to return to a neutral policy stance by the third quarter of next year. Geopolitical risks (primarily related to potential spillovers from the wars in Ukraine and Gaza) represent the main systemic risk. The principal macro-credit tail risks include a protracted period of slow growth or interest rates that remain higher for longer than we expect.

Asia-Pacific's credit conditions appear stable. Our credit cycle indicator for Asia (excluding China and Japan) signals a credit recovery in 2025, but China and Japan see risks of a credit correction. Surprise election outcomes globally could cause shifts in political orientations and dilute policy predictability, causing volatility.

Credit conditions across emerging markets continue to improve amid resilient economic activity, supported by solid domestic demand, and improving global trade and financing conditions. But the second half of the year could be challenging, as political noise from U.S. elections could sour investors' appetite for emerging markets' debt. The potential for volatile financing conditions could turn rating trends negative.

Globally, defaults look set to slowly subside—with the descent through next March likely to be slower than the recent rise in defaults. Softer economic growth in some major economies and still-high interest rates will pressure low-rated corporates in consumer-related sectors and emerging markets.

What Could Change

The protracted Russia-Ukraine war and a widening conflict in the Middle East, along with domestic polarization in certain markets, could escalate and provoke greater unpredictability in governmental responses, force increased remedial spending by already stretched government budgets, disrupt investment flows, and increase financial market volatility. The more than 70 elections in roughly 40 countries this year could add complexity to already strained international and domestic dynamics for many sovereigns. More specifically, tariffs on Chinese goods levied by the Biden Administration in the U.S., along with similar rhetoric from presidential candidate Donald Trump, will likely strain bilateral trade flows between the world's two largest economies.

Some central banks have started cutting rates, and others are set to start—but the pace of cuts will be much slower than their rise, keeping borrowing costs elevated. Higher rates in developed markets would further burden emerging market debt, both directly and through unfavorable exchange rates on nondomestic debt. Growing rate divergence between the U.S. and other major central banks could produce shifts in foreign exchange rates and capital flows.

And while resilient economies have reduced recession odds in recent months, we expect some countries to see slower GDP growth. Elevated interest rates and the lingering effects of permanently higher prices pose headwinds globally. We expect default rates to remain elevated through the remainder of this year, above long-term averages, before starting to come down gradually over the course of 2025.

Writer: Molly Mintz and Joe Maguire