(Editor's Note: In this series of articles, we answer the pressing Questions That Matter on the uncertainties that will shape 2025—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 2025.)

Continued U.S. outperformance driven by higher investment implies that equilibrium rates may have risen. To date, borrowers have largely been able to deal with higher rates due to resilient growth. Donald Trump's reelection increases the risk rates will rise.

How This Will Shape 2025

Globally, our current soft-landing baseline includes gradually falling policy rates.   The resilience of services spending and labor demand in the face of sharply higher rates has been a surprise in most economies in the post-pandemic period. This resilience gives us confidence that a soft landing—where output, employment, and inflation do not undershoot—is likely. In a soft-landing scenario, central banks are able to lower rates steadily, gradually moving away from tight financial conditions to bring economies onto sustainable paths with potential growth, full employment, and inflation on target.

The path of the U.S. economy—and interest rates—is central to the global macro view.   Despite the rise of China and the "Global South," the U.S. remains the world's largest economy, the dollar remains the main global currency in terms of reserve holdings and trade and capital flows, and U.S. Treasury bonds remain the world's risk-free asset. As such, what happens in the U.S. has an outsize influence in the global economy. The ongoing outperformance of the U.S. economy and the re-election of Donald Trump seem likely to materially influence the global economy.

But we've seen "disappointments" already, with minimal impact for most borrowers.   Market expectations for rate cuts are often more aggressive than those of central bankers, and this has been the case since 2022. In fact, 2024 has arguably played out as a year of disappointments for rate-cut expectations. At the beginning of the year, markets expected the U.S. Federal Reserve to cut interest rates roughly 150 basis points (bps), but this quickly changed to as few as one 25-bps cut in April-May. Speculative-grade bond spreads subsequently fell to new all-time lows (at approximately 230 bps in early May), setting off more than 60% growth in high-yield bond issuance and roughly one-third ($400 billion) of the U.S. leveraged loan market securing lower spreads via repricing on average of 50 bps through mid-year. Despite what may have played out to be a disappointing path for interest rates, this hardly got in the way of a productive year for issuers and even credit quality. We've downgraded about 49% of the global speculative-grade corporations we rate (including financial services)—well below the annual average of 62% and the lowest since 2021's record of 33%. And in a pivot since midyear, rate cut expectations increased to 100 bps at the end of October, which has unsurprisingly become even more likely.

What We Think And Why

The U.S. neutral interest rate (which neither stimulates nor constricts the economy) has risen in the post-pandemic period.   Consensus has moved the post-pandemic U.S. neutral interest rate to around 3%—from around 2.5% prior to the pandemic. The higher U.S. neutral rate mainly reflects two factors. First, the artificial intelligence (AI) boom and continued commitment to the energy transition spurred a productivity boom and raised investment. Because interest rates equate to investment and savings, this implies that interest rates should rise. Second, U.S. government debt continues to climb—implying that a higher interest rate is needed to entice agents to buy and hold U.S. debt.

A Trump victory increases risks that inflation and interest rates will rise.   While the Trump economic program aims to stimulate potential growth, a more likely outcome is higher inflation. Supply side measures—such as reducing regulations and increasing efficiency—should help spur growth, but their impact might be limited because potential U.S. growth recently increased by 40 bps-50 bps (to around 2.25%). Tax cuts are unlikely to boost growth by much because the economy is already operating above potential. Tariffs will raise inflation pressures, particularly if there are second-round effects following the initial rise in the level of import prices. And deportation will reduce the labor supply and therefore put upward pressure on wages and prices. Each of these developments is likely to raise inflation.

Long-term rates could ultimately remain higher than levels seen in recent years globally, even while still declining.   Corporations, governments, and individuals fund most of their debt based on long-term interest rates, and these do not always move in lockstep with more short-term policy rates. Long rates may rise or fall ahead of policy rates in anticipation of moves by central banks. On the other hand, moves in long rates may be delayed relative to policy rates if markets are less convinced of central banks' commitments to move rates.

Upwardly revised expectations for interest rates in 2025 may not pose a burden, so long as growth remains solid.   The experience of 2024 has proved the resilience of corporations and governments in the face of higher interest rates, with an overall improvement in relative credit quality, sustained positive earnings, and falling defaults (with a majority of those being less-punitive distressed exchanges). Perhaps the major contributor has been the indefatigability of economic growth, particularly in the U.S. Positive corporate earnings have provided firms with room to deal with higher interest rates, although this has been driven by cost-controls more than sales growth.

But dynamics are rarely this simple.   Our base case for 2025 calls for falling interest rates and a soft-landing for most economies—and experience has shown that higher interest rates can be a manageable headwind, if a consequence of above-trend growth. Still, the year ahead may be facing increased risks to this baseline. Nonfinancial corporations and financial institutions globally have faced higher borrowing costs post-pandemic than at any time in at least the past 10 years, and current coupon rates are roughly 150 bps to 200 bps above those for maturing debt. The interest rate gap has been manageable for most borrowers thus far--but could become more challenging the longer it persists.

What Could Change

If inflation pressures reemerge, central banks will halt the rate cutting cycle.   Led by the Fed, this would also include other countries—especially emerging markets. Should the pressures from the Trump administration's likely inflationary economic program reverse the recent fall in core inflation, the U.S. central bank is likely to end its rate cutting cycle earlier than previously thought on the rationale that tighter-than-expected financial conditions would be needed to ensure that the Fed achieves its 2% inflation target. Indeed, the October 2025 fed funds rates expectation rose by 100 bps in the past two months, taking the anticipated weighted average rates to around 3.9% from 2.9%. Dollar-dependent emerging markets are likely to mirror the Fed's moves.

Bond market quiescence could end, forcing longer-term rates to rise sharply.   Long-term U.S. government bond yields have already moved up in recent months, rising 80 bps from mid-September to almost 4.5%. This move initially showed the market factoring in a higher probability of Trump winning—reflecting a higher trajectory for the deficit compared with candidate Kamala Harris' plan—and has continued post-election. While the rise has been orderly so far, we foresee a risk from the potential for market participants to go on a "buyer's strike." In this disorderly scenario, yields would jump, volatility would rise, and liquidity and market access could dry up for some borrowers. While intervention by the Fed in such a scenario cannot be ruled out, the government would ultimately need to commit to some form of fiscal restraint to calm markets.

A sustained period of elevated rates could force borrowers to adapt.   The current interest rate gap may persist for some time, even if it tightens in 2025—considering our expectations for cuts in U.S. Treasury and other benchmark rates ahead, which are more modest than our expectations for cuts to policy rates. This elevated cost gap is nothing new to corporations but may have arguably influenced funding decisions (given its presence over the last two years). Issuance in 2024 has been dominated by refinancing activity as many issuers have finally come to grips with higher-than-desired rates. As 2025 unfolds, many more borrowers may face this reality, pushing up all-in costs of debt. This could force companies to adjust costs in other areas to compensate—such as via adjusting investment and labor-related decisions, shareholder rewards, or simply via lower profit margins.

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• After Trump's Win, What's Next For The U.S. Economy?, Nov. 7, 2024