Global Credit Outlook
November 2018: Unresolved trade frictions are pressuring global supply chains and with economic headwinds also slowing growth, some borrowers -- especially in emerging markets -- are vulnerable to a financing squeeze from volatile debt, equity and commodities markets.
Published: November 1, 2018
Signs The Cycle Is Topping Out
"Although financial stress is likely to remain low, North America’s aging credit cycle could move closer to a turning point in 2019." - David C. Tesher
Published: November 1, 2018
Tough Fixtures Home And Away
“Weaker commodity price expectations and significant fiscal challenges could squeeze credit conditions, adding to pressures from rising U.S. interest rates, volatile capital flows and weaker currencies.” - Jose M. Perez-Gorozpe
Published: November 1, 2018
Bracing For Turbulence
“The credit impulse is decelerating, political relations in Europe are more confrontational and the potential for confidence shocks to accumulate is large, amid rising Brexit uncertainties.” - Paul Watters, CFA
Published: November 1, 2018
Cold Wind Blowing
“Escalating U.S.-China trade tensions have had small direct effects -- still financial stability risks have moved Chinese authorities to loosen monetary policy and deliver a moderate fiscal expansion.” - Terry E Chan, CFA
Published: November 1, 2018
Global Highlights
Growth is also gearing down for the Eurozone, where mainstream political parties continue to be challenged from all sides, and political relations are becoming more confrontational as Europe tries to avoid a disruptive Brexit. Slower global growth is weighting on commodity price expectations and emerging market vulnerabilities -- notably in Latin America -- are being exposed by fragile investor sentiment, as well as episodes of capital outflow pressures which are putting a strain on currencies. China’s past policy tightening combined with a more uncertain external environment, has slowed activity a bit more than expected. Policymakers are taking moderate steps to boost activity, bank funding costs are down but lending rates remain stubbornly steady and credit growth continues to fall. Although volatile equity markets suggest investor concerns about a disruptive deleveraging are ratcheting up, China still has policy space to guide for a gradual growth slow down.
Credit risk may increase as synchronized growth for the global economy fades away and financing conditions threaten to become more challenging.
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North America Highlights
The New Year will likely ring in a new record for the U.S. expansion, but could it be a last hurrah? Although financial stress is likely to remain low, North America’s aging credit cycle could move closer to a turning point in 2019.
Credit conditions are generally satisfactory, amid prospects for more modest growth, further increase in borrowing costs, and continued trade worries. The current cycle has a good chance of becoming the longest ever. But the risk of recession for the U.S. has risen and growth will likely slow even if the U.S.-China tariff dispute doesn't escalate into a trade war.
Key Takeaways
- What’s changed: We increased our view of risk of U.S. recession in the next 12 months to 15%-20%, from 10%-15%, largely because of volatility in equity markets and capital markets. Our quantitative assessment of U.S. recession risk rose to 16% from 12% in August.
- Risks and imbalances: Along with trade risk coming from disputes between China and the U.S., we see the biggest risks to North American credit conditions as a possible turn in the credit cycle, continued monetary policy normalization, and housing imbalances in Canada.
- Macroeconomic conditions: S&P Global Ratings expects U.S. real GDP growth to be 2.9% in 2018 and 2.3% in 2019, which is a tad above average for current expansion. Growth will likely be constrained by a combination of supply-side limitations and monetary policy tightening.
Latin America Highlights
Don’t push the panic button on emerging market sovereigns. Weaker commodity price expectations and significant fiscal challenges could squeeze credit conditions, adding to pressures from rising U.S. interest rates, volatile capital flows and weaker currencies.
We expect challenging credit conditions in Latin America to continue in 2019. Several factors will continue influencing investors' decisions over the coming year, including trade tensions between the U.S. and China, continued rate hikes in the U.S., and commodity price trends. Domestic factors will also be relevant, since although political risks have dissipated in some countries, challenges remain for the new administrations. Additionally, tighter financing conditions and significant fiscal challenges in many countries will result in sluggish economic growth over the next two years.
Key Takeaways
- What’s changed: Elections are over, but political challenges remain. In Brazil, Bolsonaro’s victory boosted investor sentiment; nevertheless, the new president still must deal with Brazil’s weak fiscal position and pass reforms that are needed to improve government finances. A highly divided Congress will challenge Bolsonaro's ability to pass such reforms. In Mexico, the incoming administration has announced various early decisions and changes, which have weakened investor sentiment and increased volatility. The new administration will present its budget sometime before Dec. 15, which will be a key signal for the markets. In Colombia, investors remain in wait-and-see mode after the new administration announced that it intends to present a new fiscal reform. In Argentina, an economic recession and high inflation will probably weight in 2019 elections.
- Macroeconomic conditions: Political developments have been the focus of our macroeconomic assessment of Latin America since our last Credit Conditions Committee, amid a general election in Brazil and a controversial political decision about the construction of a new airport in Mexico. The outcome of these political events haven't materially changed our underlying macroeconomic assumptions for Brazil and Mexico, since they've only marginally affected our GDP growth forecast for those economies. However, next year there are many key risks that could affect our expected economic forecast.
EMEA Highlights
Countdown to Brexit: No deal moving into sight. The credit impulse is decelerating, political relations in Europe are more confrontational and the potential for confidence shocks to accumulate is large, amid rising Brexit uncertainties.
Credit rating trends remain relatively positive overall but are showing some signs of peaking now that global growth is slowing, rates are gradually rising, and the credit impulse is decelerating. Add in the need to plan for potential costly disruption arising from political decisions and regulatory changes (trade, Brexit, environment), then the scope for confidence shocks to accumulate is large.
Key Takeaways
- What's changed: Increased volatility in financial markets as investors adjust to a slowergrowth and higher-rate environment; escalating U.S.-China trade tensions that are starting to affect business strategy and performance; rising Brexit uncertainty ahead of the U.K.'s departure from the EU; and ahead of EU elections next year, the Italian government is challenging EU fiscal rules with negative implications for Italian bond yields and the cost of bank funding.
- Risks and imbalances: The highest risks in Europe likely to worsen over the next year concern a further escalation in trade tensions if the U.S. opens a new front with Europe on autos; and a no-deal Brexit in March 2019 that, while not our base case assumption, remains a meaningful likelihood in our view. The leveraged finance market is also moving up onto our watch list. In the Middle East, banks' dependence on foreign debt in Turkey and, to a lesser extent, in Qatar, remains a very high risk given the fickle nature of investors’ risk appetite.
- Macroeconomic conditions: While the domestic strength of the eurozone economy remains intact, uncertainty surrounding external demand remains high as the global economy slows. Risks lie to the downside: escalating trade tensions and their effects on business confidence, a no-deal Brexit, and growing turbulence in financial markets.
Asia-Pacific Highlights
Our investor poll suggests bumps ahead on China's long road to deleveraging. Escalating U.S.-China trade tensions have had small direct effects -- still financial stability risks have moved Chinese authorities to loosen monetary policy and deliver a moderate fiscal expansion.
We expect credit conditions in Asia-Pacific to tighten further in 2019. With U.S. interest rates rising and sentiment weaker, financing conditions are likely to constrict as macroeconomic indicators soften.
Key Takeaways
- What's changed: Market optimism is fading. Given that the U.S. economy is likely to slow down through 2019, investors are truning conservative, leading to credit tightening, capital flow volatility, and pressure on some emerging market currencies.
- Risks and imbalances: Corporate refinancing risk, U.S.-China strategic confrontation (most visibly over trade), asset repricing risk, and China's debt leverage are top risks for the region going into 2019. In particular, the first two risks are high and worsening.
- Macroeconomic conditions: The pace of the regional slowdown is the key uncertainty. Current data and economic policies are still supportive of a gradual and benign slowdown. We forecast China's GDP growth to ease to 6.3% in 2019 from 6.5% in 2018.
Financing Trends
Competition to lend is strong -- especially among European banks -- and many corporate borrowers are ahead of upcoming debt maturities, so refinancing risk is manageable. At some point, higher costs will bite nonfinancial borrowers as benchmark interest rates continue to climb toward historical norms.
Volatile emerging market capital flows, wider credit spreads (even in developed markets) and the challenge some speculative-grade borrowers face accessing domestic, or foreign currency funding from global bond markets, suggests investors are more risk averse. Other financing risks include a build-up in leveraged lending and growth in the speculative-grade universe, especially among borrowers rated ‘B-‘ or lower (now 25% of all rated issuers in the U.S.) -- a group that usually accounts for the majority of defaults in times of financial stress.
Some sectors will be more vulnerable than others when the cycle turns and scarce liquidity, or deteriorating credit fundamentals contribute to rising defaults.
Learn MoreEconomic Outlook
The U.S. is positioned to lead the slowdown. Chinese growth will moderate. Europe's growth will remain relatively low and stable.
We see the risks around our baseline on the downside. These include worries about the entrenchment and expansion of the U.S.-China dispute, as well as market turbulence related to the path of interest rate normalization by the U.S. Federal Reserve. Brexit and Italy's fiscal woes may have an impact, but remain regional risks for the most part.
All is not lost! Policymakers across the major economies can seize the opportunity to shed shibboleths and undertake bold (non-monetary) policy actions to mitigate the slowdown.
We expect the path of growth and policy normalization next year and beyond to be orderly for the most part; more an arrival of autumn than a coming of winter. This global slowdown is both necessary and healthy. It's not the beginning of another global financial crisis.
To advance this agenda, we also are leveraging the S&P Global Foundation to distribute grants to nonprofit partners committed to help women thrive in today’s economy.
