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An increasingly tense geopolitical landscape, the prospect that interest rates won't fall as quickly as markets expect, and slower-than-forecast growth in the world's biggest economies are among the top risks that could derail our base case for global credit conditions.

What We're Watching

With the onset of the global rate-easing cycle, global credit conditions look set to improve toward the end of the year. However, this outcome is not guaranteed, given the risks posed by disparities in growth prospects among major economies, heightened geopolitical strife, and still-elevated borrowing costs.

We forecast global GDP growth to slow somewhat in 2025 as U.S. economic activity slips to below-trend, Europe's pace picks up, and China's is set to slow further. We expect global growth of 3.2% this year and 3.1% in 2025.

On the bright side, we've seen significant credit resilience, with strong refinancing activity across most ratings and sectors despite elevated interest rates through most of this year. Upgrades continue to outpace downgrades, and defaults have started to moderate. We expect the pace of defaults to ease further, albeit at a slower pace than they rose due to residual strain for the lowest-rated borrowers.

Market turmoil in August proved short-lived but showed that financing conditions are especially vulnerable to negative news. Investor risk appetite is rooted in assumptions for steady, sustained rate cuts, but we think all-in borrowing costs are likely to fall much more slowly than they rose and will settle at higher long-term levels than before the pandemic.

What We Think And Why

The protracted Russia-Ukraine war and the escalation of the conflict in the Middle East could add to market volatility, impede investment flows, and further disrupt global trade. And while most of this year's elections have concluded, much will depend on the outcome of the U.S. elections in November, with material ramifications for the various military conflicts, climate concerns, and trade policy.

With the caveat that the U.S. elections could create some financial market volatility (especially if the result of the presidential race is in dispute), credit conditions look set to steadily improve in North America as the U.S. economy settles into a soft landing, input-cost pressures ease, and benchmark borrowing costs decline.

After the Federal Reserve kicked off its easing cycle with a rate cut of 50 basis points (bps), we now believe policymakers will cut the key rate by 25 bps at the two remaining policy meetings this year and reach a terminal rate of 3.00%-3.25% by the end of 2025. Still, financing costs could remain overly burdensome for some borrowers, especially those at the lower end of the ratings spectrum, if monetary-policy easing is derailed or risk aversion increases.

In the EU, we continue to expect growth to pick up gradually as higher real incomes spur consumption and employment remains high. As inflation declines, we expect the European Central Bank (ECB) will ease interest rates by 25 bps per quarter until the deposit rate reaches about 2.5% in the third quarter of 2025. Geopolitical risk remains high, and Europe's risk management increasingly focuses on ensuring economic security and a free and fair single market. Principal macro risks include a protracted period of subpar growth, wage pressures that prevent a further decline in inflation, and bouts of volatility if markets overestimate the pace of rate cuts.

Asia-Pacific's credit backdrop is increasingly nuanced, amid mixed growth and interest rate prospects. We expect most of the region's central banks will gradually follow the Fed in cutting rates, and we anticipate refinancing conditions will improve, with issuers able to tap offshore markets. In China, a sticky property downturn and slower consumption are compounding drags on confidence. While the latest round of monetary stimulus could support liquidity in the system, cautious lending and household spending might limit uplift.

Credit conditions will likely remain supportive for emerging market (EM) issuers as long as the U.S. soft landing materializes. The prospects for monetary easing down the road will likely lead to continued improvement in financing conditions. Moreover, a moderate slowdown in the U.S. economy should support global trade volumes. Nevertheless, several evolving trends could derail the favorable conditions.

What Could Change

As the Fed, the ECB, and other central banks embark on a cycle of monetary-policy easing, the pace of rate cuts could be much slower than their rise—and, perhaps, more importantly, slower than markets expect. And while some economies have shown surprising resilience, we expect to see slower GDP growth in certain areas.

Against this backdrop, the pace of rate cuts will likely vary among regions. Higher rates in developed markets would further burden emerging market debt, both directly and through unfavorable rates on nondomestic debt. A significant divergence in rate trajectories between the U.S. and other major central banks could cause shifts in currency-exchange rates and capital flows.

The widening of the Middle East conflict to include Lebanon and Iran puts at risk our base-case expectation of limited cross-border strikes between Israel and military proxies in the region, which hinges on local governments' military restraint and a hostage deal that presages a durable ceasefire.

Moreover, growing protectionism is threatening global trade. Ongoing tensions between the U.S. and China have strained trade flows between the world's two biggest economies. And Europe, a traditionally open trading bloc, has also added protectionist measures to counter state subsidies to strategic industries in China—which could accelerate the reconfiguration of supply chains away from China. This could have a global impact, producing yet unknown "winners and losers," with increased supply-chain complexities and possible inflationary pressures in some markets.

Writers: Molly Mintz and Joe Maguire