As 2025 gets underway, the macroeconomic outlook remains uncertain, and volatility lingers. S&P Global Ratings investigates five questions that could affect liquidity and volatility in the global credit markets in 2025.

1 – Will the Fed's path to neutral rates be bumpier and longer?

Tensions between the Fed's dual targets of maximum employment and price stability raises the risk that the Fed could allow interest rates to remain higher for longer. That, combined with policy uncertainty, is likely to make 2025 a challenging year for the Fed.

The Fed's monetary stance hasn't changed much since 2024 (at least not yet).  It remains in "wait and see" mode, with an underlying bias toward easing that is conditional on the evolution of the balance of risks around its dual mandate (price stability and maximum employment). The arrival of the new administration has, however, changed the government's policy stance and increased the probability of disruption to the Fed's easing bias.

The U.S. economy is at full employment and characterized by a lingering tendency to excess inflation. That is in stark contrast to 2017, when President Donald Trump's first term commenced against a backdrop of slack in the U.S. economy. The Fed is committed to removing the excess inflationary impulse without further weakening the labor market. However, President Trump's second term promises a policy mix, including tariffs, immigration curbs, and tax cuts, all of which tend to be inflationary. That could mean milder easing of Fed rates (which may remain on hold for longer) or even a temporary reversal of policy direction.

The journey to a neutral policy rate may be detoured.   In late 2024, we had anticipated that the Fed would reach an inflation-neutral policy rate by the end of 2026 (see "Economic Outlook U.S. Q1 2025: Steady Growth, Significant Policy Uncertainty," Nov. 26, 2024). We updated our assumption for reaching neutral in January, and now expect one rate cut of 25 basis points in the first half of 2025 followed by a long pause, then renewed easing beginning in the second half of 2026 that reaches neutral in 2027 (see "The Fed Is In Limbo," Jan. 20, 2025). Yet progress along that path could be troubled by a brewing short-term conflict (between the Fed's inflation and employment mandate) that could create market liquidity and financial issues.

A delicate dance may be about to commence.   Inflationary increase in the price of goods and services, due to tariffs and labor shortage (as well as expected fiscal stimulus in 2026), could push the Fed to choose between accepting temporarily-stronger inflation or higher interest rates--which should cool economic activity and increase unemployment. We suspect that the Fed is now more sensitive to the risk that inflation expectations become unmoored, particularly given the experience of the post-pandemic inflation surge. That increases the likelihood of higher interest rates, likely accompanied by lower economic growth, which is a mix that is not conducive to investor returns. Either way, it promises to be another challenging year for Fed policymakers who will have to second-guess President Trump's policies in order to front-run Fed actions.

Chart 1

Quantitative Tightening (QT) may soon reach its natural end.  QT will stop at a point when the Fed deems the sum of banks' reserves and reverse repurchasing agreements (repos) (i.e. the total amount of money available to the banks on short notice) is ample but not abundant. Identifying the transition point from abundant to ample reserves is challenging, but the Fed telegraphed last year that it could further slow the cadence of asset runoffs as bank reserves approach 10% of GDP (compared with 10.9% currently) and stop it altogether somewhere between 8%-10% of GDP. This will likely happen by the end of 2025, when the so-called "financial sector liquidity" (bank reserves) will begin expanding again at the pace of GDP growth to keep the Fed's operational control running smoothly.

Chart 2

2 – Will China's Struggle To Contain Outflows Have Wider Implications

We expect China's muted economy and its large interest-rate gap to the U.S. to prompt net financial outflows and to weigh on the renminbi (RMB). China's policymakers are taking measures to resist this pressure. They, and possibly their peers elsewhere, will be tested if the foreign exchange pressure intensifies.

Amid a muted economic outlook, monetary policy is likely to be loose in 2025.  We expect China to experience: soft 'organic' domestic demand; effects from U.S. tariffs on Chinese exports; and more downward pressure on prices. Against that backdrop, policymakers at the December Central Economic Work Conference committed to "moderately loose" monetary policy for the first time since 2011, and to cuts in interest rates and reserve requirement ratios. Our forecast is that the policy rate will be cut by another 40 basis points (bps) this year, and we expect significant fiscal policy expansion.

The economic and monetary policy outlook is reflected in bond yields that are at record lows, despite policymakers' attempts to support them.  The 10-year government bond yield fell to 1.7% in January, suggesting that financial markets expect subdued growth, low inflation, and low policy rates (see chart 3), despite recent stimulus announcements. The People's Bank of China (PBOC) has tried to arrest the fall in bond yields, including by issuing window guidance and suspending its open-market purchases of government bonds. However, so far, those efforts have had little impact.

Chart 3

Net financial outflows and depreciation pressure will likely persist.  Having been mildly positive in the first half of 2024, China's net financial flows turned negative in the second half of the year amid weakening confidence and financial market expectations that an unfavorable interest rate gap to the U.S. will remain large. This has come alongside depreciation pressure on the RMB (see chart 4). With this configuration likely to be sustained this year, Chinese investors will likely remain keen on investment opportunities abroad.

We expect policymakers to intensify efforts to contain financial outflows and currency depreciation.  The PBOC, in January, committed to support the currency, if necessary. Open foreign exchange market intervention has been limited in recent years. But in January, the PBOC, at times, set the daily reference rate for its +/- 2% band strong, compared to the market rate of the previous day, signaling its intent to support the RMB. Policymakers have recently also made it easier to borrow from overseas and taken measures to mop up liquidity in the offshore RMB market, all in support of the currency.

Significant foreign exchange pressure could test policymakers in China and elsewhere.  China's foreign reserve coverage is solid. But a spike in depreciation pressure resulting in major foreign exchange (FX) market intervention could lead to large declines in reserves. That was the case in 2015-2016, when a badly handled currency devaluation led to massive capital outflows and a fall in foreign reserves of USD 1.3 trillion. In a repeat situation, China could opt to let the currency slide. That would have significant spill-over effect in other FX markets, especially in Asia. We consider that China's policymakers want to avoid a major currency slide and will be willing to take a range of measures to control outflows, if needed. But, in the event of significant pressure, substantial RMB weakening cannot be ruled out.

Chart 4

3 – Could the private credit market's growth provide new liquidity sources?

A lack of trading means the private credit market does not traditionally offer secondary market liquidity, yet the private credit market is quickly changing. Growth has encouraged new participants, given rise to new investing needs, and driven the provision of new financing tools, all of which could combine to transform the scope for private credit market liquidity.

The lack of trading and the absence of asset liquidity has arguably been part of the appeal of private credit.  Traditionally, private credit is an illiquid, buy-and-hold asset with little to no secondary-market trading. Loans are often more bespoke and smaller in size, compared to broadly syndicated loans, which makes them more difficult to scale efficiently for trading. However, these characteristics don't appear to have slowed the growth of private credit, which had grown to about 26% of the U.S. leveraged finance market at the beginning 2024, up from 14% in 2016. Some investors in alternative assets promote the advantages of greater price stability and infrequent asset valuations as factors they claim contribute to private credit's more appealing performance curve. Private credit assets under management (AUM) in the U.S. now exceed $1.1 trillion, more than double their value in 2019.

But sources of private credit market liquidity are likely to increase.  With the market growing and attracting investors with more diverse needs, the need for greater liquidity is likely to. Furthermore, M&A and IPOs have lagged in recent years, reducing the liquidity available to investment fund general partners (GPs). A slower rate of exits and the absence of liquidity at the asset level, if prompting GPs to turn to other options to facilitate trades and liquidity at the fund level. That has included asset sales to secondary funds, which have seen an uptick in formation over the past year. Fundraising for secondaries reached its second-highest annual level in 2024 (with near $88 billion raised through September) and was on track to surpass the record set in 2020, according to data from PitchBook, a provider of capital markets data. Those "secondaries" included private credit secondary funds, such as one from Ares Management, which raised close to $2 billion for its fund in the vehicle's first year.

Chart 5

New funding options are coming to the fore.  Some fund managers are sourcing liquidity for their funds through fund financing options, such as net asset value (NAV) loans and subscription lines, which provide fund managers with options for alternative sources of cash. Liquidity from fund financing does not make the underlying private credit assets more liquid, but it offers a way for the fund to help manage liquidity or FX risk. In recent years, such financing has occasionally been used to finance distributions to funds' limited partners (LPs).

Exchange traded funds (ETFs) will play an increasing role.  ETFs are already expanding their footprint in the leveraged loan and private markets. For example, collateralized loan obligations (CLO) ETFs are seeing rapid AUM growth--having already grown to over $19 billion in November 2024 from $120 million in 2020. Notably, new CLO ETFs include not just broadly syndicated loan (BSL) CLOs, but also private credit CLOs comprised of middle-market loans. Asset managers are also proposing to launch new ETFs dedicated to private credit that could lead to new demand for liquidity for private credit assets. Private credit ETFs will be challenged by the stark contrast between the liquidity of the ETF and the illiquidity of its underlying assets, but market participants are working to provide solutions. They include establishing trading-desks to provide liquidity in the underlying private credit assets for a proposed ETF, or reserving a portion of the portfolio for more liquid assets, such as broadly syndicated loans or investment-grade debt. Interestingly, more frequent trading of private credit ETFs could lead to price discovery that results in the ETF trading at a discount (or premium) to the fund's NAV.

4 – Will European banks reprioritize liquidity management as quantitative tightening continues?

As the European Central Bank (ECB) and the Bank of England (BoE) make slow but real progress in their quantitative tightening (QT) programs, they have announced their intention to maintain an ample stock of central bank reserves and to mainly use standard bank refinancing operations to deploy these reserves.

Central banks will play a significant role in banks' funding and liquidity risk management going forward.  The ECB's and BoE's new operational framework for banks outlines how central banks expect banks to make routine use of the refinancing facilities to cover their permanent need for reserves. Notably, these facilities are distinct and do not replace more traditional emergency liquidity measures that the central banks provided as lenders of last resort, such as the emergency liquidity assistance under the Eurosystem framework.

Chart 6

The ECB refinancing facilities are flexible.  There are refinancing facilities for one week (the main refinancing operations (MROs)); three months (the long-term refinancing operations (LTROs)); and overnight funding (the marginal lending facility (MLF)). The ECB will continue with full allotment procedures for all these facilities, meaning that it will not set a limit on the amount that banks can borrow against adequate collateral. Importantly, the ECB changed the relative pricing of the MROs and LTROs, which dropped to 15 bps, from 50 bps, above the deposit facility rate--the rate at which the ECB remunerates banks' reserves--from Sept. 18, 2024. The ECB intends this narrowing of the spread to incentivize banks' use of the facilities.

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There are clear risks to banks stemming from central banks plan to rely on repo lending to maintain ample reserves.  The ECB and BofE need to ensure that banks can fully express their demand for these reserves via refinancing operations without putting themselves at risk. The first obstacle in that regard is the market stigma that can surround accessing central bank facilities. Yet we see such market stigma as likely to be limited in practice because the ECB's targeted longer-term refinancing operations and the BoE's term funding scheme for small and midsize enterprises showed that banks were able to access standard refinancing operations without being penalized, whilst the frameworks will form a core part of central banks' operating models and will therefore become standard and permanent, and this should reduce the market's negative perceptions.

Central banks also have their own risks.  Central banks have their own challenges to face in relation to their operational readiness. For instance, in the Eurosystem, the assessment of banks' credit claims eligible for repo funding can be potentially cumbersome and slow if banks have not prepositioned their collateral, especially in times of crisis. Furthermore, this assessment is left to national central banks, which have different operational capacities. Additionally, central banks need to ensure that their willingness to allow banks to hold less liquidity reserves on-balance sheet and rely more on contingency facilities does not run counter to expectations from bank supervisors. Indeed, bank supervisors assess banks' resistance to liquidity stress and set expectations as to how much liquidity banks need to hold. If a bank supervisor disregards the availability of central banks' contingency funding in their assessment they could put contradictory injunctions on banks.

5 – Can We Bid Farewell To Near-Term Refinancing Risk?

The surge in rated primary issuance over the last 18 months has materially reduced near-term refinancing risks. Despite a bright start to 2025, the macroeconomic and monetary policy outlooks seem increasingly fluid, which may prove problematic for lower rated issuers with residual maturities in 2025.

2024 proved a "sweet spot" for primary issuance.  Investors sought to lock in attractive yields as major central monetary policy easing began and issuers, against the backdrop of a resilient global economy, took advantage of strong demand to opportunistically access markets. Nowhere was this more evident than amongst speculative-grade (SG) issuers, which propelled leveraged loan issuance to $770 billion globally, more than double 2023's figure, while SG bond issuance rose almost 75% to $488 billion. Together, this marked the highest leverage finance issuance since 2021, and the second highest volume in seven years. That volume was largely fueled by refinancing, which accounted for about 70% of global SG issuance in 2024. The result has been a material reduction in near term refinancing risk, with 2025 nonfinancial corporate speculative grade maturities falling by nearly 51% over 2024.

Financing costs won't necessarily trend downward.  We still expect primary bond issuance to grow in 2025, though at a more modest 3%. The engine of that growth will be investment grade issuance, and financial services. The outlook for speculative-grade issuance is less clear. Refinancing is unlikely to remain as active in 2025, and the outlook for financing costs is increasingly uncertain. Credit spreads remain near record lows in the U.S. , but benchmark yields have been volatile since the start of the year due to the increasingly uncertain outlook for monetary policy easing, particularly in the U.S. In addition, issuers are typically refinancing low-cost debt (issued before the rapid rise in rates over 2022-2023). We estimate that the average yields on 'BB' bonds refinanced in 2025 could rise by about 180-200 bps, if refinanced at current new issue yields.

Idiosyncratic risk will (arguably) be a more important factor for remaining 2025 maturities.  Most issuers that had debt maturing in 2025 have already taken advantage of the past 18 months of constructive market demand to refinance. Speculative-grade rated maturities have correspondingly declined to 12% of total rated maturities in 2025, compared to about 40% in 2028. Some of the remaining 2025 maturities, particularly at the lower end of the ratings scale, may not have been refinanced due to idiosyncratic risk that limited demand over 2024. Those limitations are unlikely to ease given the uncertain macro backdrop and the risk that financing costs will rise in 2025.

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A brighter outlook for ratings performance is not a given for 2025.  Downgrades increased 28% in December 2024 contributing to a wider, end-of-year negative shift that left the trailing three-month downgrade ratio above 50% for the first time since January 2024. In addition, while net bias continued to improve through the end of 2024, negative bias for issuers rated 'B-' and below increased in December for a second month in a row--a sign that pressure may be returning at the lower end of the rating spectrum. The number of weakest links (issuers rated 'B-' and below with either a negative outlook or CreditWatch placement) has also risen, and defaults remain elevated, particularly in the U.S. and Europe, where the full year 2024 counts exceeded 2023's levels despite a marginal decline at the overall global level. We still expect the global speculative-grade corporate default rate to decline but clearly pockets of pressure remain.

Lower but more targeted refinancing risk will be a focus in 2025.  Rated refinancing risk has been materially pushed out, with peak maturities now occurring in 2028, but this does not mean near-term risk has disappeared. Remaining risk is materially lower but arguably more challenging as over 50% of remaining 2025 speculative grade non-financial corporate issuer maturities (as of Jan. 1, 2025) are rated 'B' or below with 16% in the 'CCC' category. U.S. speculative-grade sectors to watch due to their higher exposure to refinancing risk include media & entertainment, healthcare, and telecoms. While in Europe, the sectors to watch are automotive, telecoms, and healthcare.

Chart 9