Global Credit Outlook: 3Q2024

Key takeaways

• With progress on inflation becoming clearer, and the downside risks to growth more pronounced, central banks in the U.S., Europe and the U.K. have increasingly discussed (or started) rate cuts.
• Our base case calls for gradual and “shallow” rate cutting cycles, however. This means that consumer, corporate, and commercial real estate borrowers are unlikely to see material, near-term interest rate relief on their debt costs – at least not in 2H2024.
• For investors in corporate credit (liquid and private markets), the interaction between higher rates and economic activity will be paramount. Supportive growth would help mitigate the headwind from persistently elevated debt service costs, while preserving the fundamental resilience of the past few quarters. That said, we expect dispersion on a multitude of fronts (i.e., asset class, sector, issuer, manager, vintage).
• With rates elevated – at least by the standards of the post-financial crisis era – we expect to see incremental demand from yield-based buyers for subsets of corporate credit. This will likely keep IG and HY credit spreads range-bound in aggregate (and may even support tightening, as issuance slows through the summer).
• The inverted yield curve should continue to favor shorter- and intermediate-duration exposures, relative to the long-end. Capital allocated to corporate credit should be based on carry and income, in our view (as opposed to total return).

Monetary policy: Normalizing, not easing

After swift and compressed rate hiking cycles in the U.S., Europe, and U.K. from 2022-2023, market participants have turned their attention toward the start of rate cuts. For 2H2024, we see potential for the start of monetary policy normalization in these regions_,_ but not widespread easing.

The European Central Bank (ECB) was first to move (in June) with a 25bp rate cut. That said, the Governing Council expressed a desire to preserve optionality regarding the pace of any additional actions beyond that point, due in part to a “bumpy” path for domestic services inflation (driven by elevated wages).

As ECB Executive Board Member Isabel Schnabel highlighted in a May 17th interview with Nikkei, the current policy cycle is unique “in the sense that rate cuts are not meant to counter a looming recession, but rather to gradually withdraw restriction without reigniting inflation.” Uncertainty related to where the “natural rate” of interest is in “real time” further underscores the need for a cautious approach, according to Schnabel.

Adding to the call for a patient approach: ECB Chief Economist Philip Lane said that the “bumpy and gradual” improvement on domestic services inflation means that the ECB will “need to be restrictive all year long,” such that “firms will think twice about trying to pass on cost increases” (referencing the potential for second-round inflationary effects from elevated wages).

While the Bank of England (BoE) kept rates unchanged at its June meeting, the decision to hold vs. cut was “finely balanced” for some members of the Monetary Policy Committee (per the minutes). The minutes pointed to the August meeting’s forecasts to determine “how long Bank Rate should be maintained at its current level.”

Exhibit 1: We expect shallow rate cutting cycles, barring a sharp growth downturn
Monetary policy rates for the European Central Bank, Federal Reserve, and Bank of England

We expect a shallow cutting cycle in the U.S.

Relative to Europe (and possibly the U.K.), the U.S. is farther behind in the start of a rate cutting cycle. As shown in Exhibit 2, the expectations for the first rate cut have shifted later as 2024 has progressed, driven by a combination of hotter-than-expected inflation in 1Q2024 and resilient economic data.

That said, after an in-line inflation reading for April, a better-than-expected print for May, and labor market rebalancing (Exhibit 6), we believe the groundwork is forming for at least one 25bp rate cut in 2024 (either in September, or in 4Q2024).

The onus will be on the next few months of inflation data to continue this recent (favorable) pattern, such that the FOMC receives the “greater confidence” it desires before starting to normalize monetary policy.

As we have highlighted previously, the reason for eventual rate cuts is more important than the timing. Rate cuts in response to improving inflation are much more supportive for risk sentiment compared to rate cuts in response to a sharp deterioration in economic activity (or the labor market).

So long as U.S. growth remains at or above trend (note: 2Q2024 real GDP is tracking well above trend, at 3.0% per the Atlanta Fed GDPNow as of June 20th), we continue to expect a “shallow” rate cutting cycle. This makes the prospect of significant, near-term interest rate relief (on consumer and corporate borrowers’ debt service costs) unlikely.

But it will also leave “all-in” yields elevated for a range of investors seeking to deploy capital into the corporate credit markets. This will likely keep IG and HY credit spreads range-bound in aggregate (and may even support tightening, as issuance slows through the summer).

Exhibit 2: The U.S. rate market pricing has shifted to reflect “high for longer”
The U.S. policy rate implied by Fed Funds Futures, through early 2025

Restrictive vs. sufficiently restrictive

Given the resilience of economic activity in the U.S., we expect policymakers (and market participants) to remain focused on the transmission of monetary policy, as well as the degree of restrictiveness embedded in the current stance (Exhibit 3).

The “longer run” Federal Funds rate is now 2.8% per the median “dot” in the June 2024 Summary of Economic Projections (SEP) – up from 2.6% as of March 2024, and 2.5% as of December 2023. While Chair Powell pushed back (in the June FOMC press conference) against the relevance of the long-term neutral rate for setting near-term monetary policy, he acknowledged that this drift higher reflects a “view that rates are less likely to go down to their pre-pandemic levels” which were low by historical standards.

Chair Powell also reiterated his prior messaging that while he views the current stance of monetary policy as “restrictive,” the question of whether policy is “sufficiently restrictive” is one that will be known over time.

Other Federal Reserve officials, such as Minneapolis Fed President Neel Kashkari, have also questioned the degree of restrictiveness in the current stance of U.S. monetary policy. President Kashkari has pointed, for example, to the resilience of the U.S. housing market.

A large subset of corporate borrowers have also demonstrated resilience to the rate hiking cycles in the U.S. (and Europe). We attribute this to three factors: (1) the supportive growth backdrop, especially in the U.S.; (2) the proactive liquidity raising done in 2020-2021, when rates were very low; and (3) the emergence of the private debt funding channel as another viable option for corporates’ borrowing needs, which we view as a positive for financial stability..

Exhibit 3: Financial conditions have eased from local tights in April 2024
Goldman Sachs U.S. Financial Conditions Index

Past commentary

• 2Q2024 
• 1Q2024