S&P Global Ratings' credit cycle indicator, a forward-looking measure of credit conditions, continues to signal a potential credit recovery in 2025. However, challenges in the rest of 2024 point to a bumpy path to a divergent recovery.

Global

A Divergent Credit Recovery Could Come In 2025

Our global CCI continues to signal a credit recovery in 2025 (see chart 1). So far, economic growth and corporate earnings have demonstrated resilience. Markets have remained supportive and borrowers are able to tap into liquidity.

However, the financial situation and economic growth across income cohorts and sectors is uneven, pointing to a divergent recovery. Furthermore, macro uncertainties could hurt business and household confidence, pushing out the potential recovery.

We expect the Federal Reserve to delay policy rate cuts to end-2024, and some central banks elsewhere to follow suit. Higher-for-longer interest rates will keep debt costly, adding refinancing stresses to highly leveraged and weak borrowers. In addition, slowing revenue due to macro uncertainties and a high cost base could narrow margins, exacerbating credit stresses.

Costlier mortgages and sticky inflation are diluting households' purchasing power. To cope, households could pull back on spending, thus slowing demand. Already, signs of stress are already showing up in some places, e.g., in rising credit card delinquency rates, as consumers run down savings they built up during the pandemic. As individuals seek to economize on their spending, some consumer-related sectors will be hit. Cash flow and liquidity pressures could mount for some corporate borrowers.

The divergent recovery could prompt lenders to review credit lines to affected sectors and households. The risk of higher nonperforming loans and delinquencies could weigh on credit conditions for the rest of 2024.

For more details about our proprietary CCI, see "White Paper: Introducing Our Credit Cycle Indicator," published on RatingsDirect, June 27, 2022.

Chart 1

Asia

Asia's Nuanced Credit Recovery In 2025 Further Divides Winners And Losers

The Asia ex-China, ex-Japan CCI has continued to climb out of a trough since the first quarter of 2023 (see chart 2). A credit recovery could take shape in 2025, but it is becoming increasingly nuanced. The divide between winners and losers in the region could further deepen. In our view, India and Southeast Asia should lead the region's growth; this could spur credit appetite as corporates in these markets seek to expand and invest. On the other hand, persistent property challenges in China are squeezing credit conditions.

Although the region is poised for a credit recovery, the lagged resumption of financing availability and still-soft domestic currencies could delay or soften the pickup. Most Asian central banks will be cautious in cutting policy rates, in hopes of averting further downward pressure on their currencies. Amid higher-for-longer interest rates, interest burdens will intensify for borrowers, as maturing debt comes due for refinancing. Should domestic currencies weaken further, borrowers with substantial offshore debt obligations would be squeezed more. Given the dominance of bank financing here, banks' lending appetite remains crucial in supporting financing access. Meanwhile, the slowing economic backdrop could keep households cautious about spending, and limit demand.

Chart 2

China:  China's credit recovery is under pressure. The earlier uptick in the country's CCI has reversed (see chart 3), driven by a decline in nonfinancial corporate and household leverage. Recently, authorities have rolled out measures to support the country's weak property sector. However, household confidence remains weak, and households are increasingly ramping up savings.

We estimate the Chinese government will increase borrowing the most in 2024, compared with other governments in the region, to support the economic recovery via fiscal transfers to weaker local governments. However, authorities will continue to tighten oversight over corporate leverage in troubled sectors, in our view. In turn, banks may control lending to those weaker local governments, and associated state-owned enterprises and local government financial vehicles, in this space. For instance, we believe banks will remain cautious about lending to the property sector; we expect the nonperforming loan ratio for property lending by Chinese banks to peak higher and later in 2025. These factors combined could further delay China's credit recovery.

Chart 3

Japan:  The Japan CCI is bucking the global trend (see chart 4), underlining the risk of a deepening credit correction. As the Bank of Japan cautiously exits from negative rates, higher interest costs will strain borrowers. This is compounded by high inflation. Given the pinch to consumer pockets, households could limit spending.

The impact of the weak Japanese yen is mixed across corporates: exporting firms tend to reap the benefits, while domestic manufacturers and importers see higher input costs. Although some businesses have been passing on costs to customers, softening household purchasing power could test this ability. The risk of higher currency volatility entails steeper hedging costs, further eroding margins.

Chart 4

Emerging Markets

The CCI Still Points To A Credit Recovery In 2025

Our CCI for emerging markets ex-China foresees improved household and corporate credit quality in 2025. The CCI now reads -0.5 standard deviations, after a progressive descent to its trough at -1.5 standard deviations in the fourth quarter of 2022 (see chart 5). A potential credit recovery could take place in 2025. The narrowing of corporate spreads to historical lows has buoyed issuance year-to-date both from a sovereign and corporate perspective. However, the descent of borrowing costs has halted over the past couple of months on levels that remain high from an historical perspective. Interest rates remains sensitive to geopolitical risks, political electoral results, and the Fed policy rate normalization policy, which will likely dampen monetary easing by emerging-market central banks. The latest data shows the indicator's trend is mimicked across all countries, except for South Africa and Turkiye, which are easing.

Corporates:  The corporate sub-indicator hit a trough in the first quarter of 2023 at -1.7 standard deviations, and now reads -0.9 standard deviations. Corporate debt moved sideways in the fourth quarter of 2023, underpinned by the high cost of financing, while equity valuations were up strongly. Equity prices rose significantly across regions, as a relatively low default rate compared with advanced economies, and a manageable debt maturity wall bolstered the credit resiliency of emerging-market corporates. Such corporates, in most cases, have access to domestic financing options should funding in hard currency become too expensive.

Households:  The household sub-indicator increased to -0.6 standard deviations for the third consecutive month (-1.1 in the first quarter of 2023), increasing less than its corporate counterpart. Household debt plateaued, while property prices rose in Chile, Mexico, India, Thailand and Poland. The gains signal that high mortgage rates have not fully eroded real estate demand. On the other hand, property prices fell in South Africa, especially from the high-value segment, and in Turkiye, on tighter monetary policy since the second half of 2023.

Chart 5

Eurozone

Debt Levels Are Normalizing In Europe, Albeit With Variations Across Countries

Our eurozone CCI appears to be stabilizing at a low level (see chart 6). In essence, nominal GDP has grown, high interest rates have curtailed debt growth, and house prices have stalled. Barring any systemic shocks--especially geopolitical--our CCI is tentatively signaling a more positive credit environment ahead. This is borne out by our equity market factor that is back close to pre-COVID peaks, and even higher in some countries.

Going into country-level detail for some major countries across Europe, we see the following: the correction in household debt to GDP has taken this ratio back to 15-20 year lows in Italy, Spain and the Netherlands (and even the U.K.). And while household debt to GDP in Germany and France is not particularly high, the ratio has only retreated to pre-COVID levels.

A similar pattern is apparent across the major countries in Europe in relation to corporate debt to GDP. The ratio of corporate debt to GDP in Germany is typically stable and relatively low. Perhaps the combination of high inflation, slow real growth, and disrupted supply chains have put greater pressure on German corporates to maintain debt levels given the size of their industrial base. In France, while corporate debt to GDP has fallen, it remains relatively high at early 2019 levels. The caveat here is that BIS debt figures capture the unconsolidated debt position of corporates, and companies in France maintain a relatively high proportion of debt as intercompany loans.

Chart 6

North America

Persisting Risks Could Complicate Potential Credit Recovery

In our view, the trough in our North American CCI, which started to form in early 2023, supports a potential credit upturn in 2025 (see chart 7). While market conditions and asset prices have largely been improving in the region, U.S. corporate and household debt-to-GDP continued to decline. This has signaled more subdued debt accumulation relative to GDP growth in the face of high interest rates. We expect a first Fed rate cut in December. But further delays could keep borrowing costs high and weaken investor sentiment. That, along with lingering inflation pressures and geopolitical risks, remain pressures for credit quality, and could derail the potential recovery. Lower-income households and consumer-facing, highly leveraged corporates will likely fare worse.

Chart 7

Households:  The momentum in the household sub-indicator seems to be stalling. This points to underlying weakness in household financial health. New delinquencies of auto loans and credit cards have been surging since 2022 in the U.S., and Canada's debt-service ratio is at its historical high. We believe the pressure is likely more acute for lower-income households. According to analysis by the St. Louis Fed, lower-income households tend to have higher credit card debt (which are typically floating rate) relative to their monthly income. Coupled with high price levels that bite into purchasing power, a sharper-than-expected pullback in consumer spending could weigh more on the economy and lead to a jump in unemployment, causing more household fragility.

Corporates:  The corporate sub-indicator slightly reversed course recently. While first-quarter corporate results suggested generally positive sentiment in North America, earnings recovery has been uneven among sectors. Cash interest payments were still on the rise, weighing on liquidity (see "Corporate Results Roundup Q1 2024," May 22, 2024). Margin pressure may persist if input-cost inflation proves to be more stubborn, and/or passthrough becomes more difficult as demand dwindles. Highly leveraged entities, especially those sensitive to the health of the consumer, could be more at risk. All told, we expect the U.S. trailing-12-month speculative-grade default rate to remain close to its current level through early 2025, coming in at 4.5% next March (see "Resilient Growth, Resilient Yields, And Resilient Defaults To Bring The U.S. Speculative-Grade Corporate Default Rate To 4.5% By March 2025," May 16, 2024).

Related Research

• Corporate Results Roundup Q1 2024, May 22, 2024
• Default, Transition, and Recovery: The European Speculative-Grade Default Rate Should Level Out At 3.75% By March 2025, May 22, 2024
• Resilient Growth, Resilient Yields, And Resilient Defaults To Bring The U.S. Speculative-Grade Corporate Default Rate To 4.5% By March 2025, May 16, 2024
• White Paper: Introducing Our Credit Cycle Indicator, June 27, 2022