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Credit Cycle Indicator Q4 2023: Risks Could Intensify Before The Cycle Turns


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This Month In Credit: 2023 Data Companion

Credit Cycle Indicator Q4 2023: Risks Could Intensify Before The Cycle Turns

Editor's note: This article is a compilation of the five Credit Cycle Indicator sidebars from our Q4 2023 Credit Conditions reports (see Related Research).

S&P Global Ratings' Credit Cycle Indicator, a forward-looking measure of credit conditions, continues to show a credit correction. That said, some regions are beginning to show tentative signs of reaching a trough.

Risks remain, given the extent of the cyclical buildup of credit as shown in our CCI in early 2021, and the lagged nature of the credit markets' responses to cycle turning points. As such, we may see further increases in nonperforming loans (NPLs) and defaults in the coming quarters.


The Global Credit Cycle Indicator Highlights Risks As The Credit Correction Continues

The Global CCI continued to trend down from its second quarter of 2021 peak, indicating an ongoing credit correction. Peaks in the CCI have historically tended to lead periods of credit stress by six to 10 quarters. Defaults have started to pick up, but the tailwinds from the COVID pandemic, years of cheap money, and economic resilience appear to have pushed the peak in credit stress into 2024.

So far, broad and sustained turbulence in credit markets has not materialized. Nonetheless, the risks remain, given the extent of the cyclical buildup until 2021. As the credit correction progresses with increasingly selective lending, higher funding costs, and downward pressure on asset prices, it could affect NPLs and defaults in the coming quarters.

Already, we expect speculative-grade default rates in the U.S. and Europe to rise by more than three percentage points from early-2022 troughs to the third quarter of 2024 (see "The U.S. Speculative-Grade Corporate Default Rate Could Rise To 4.5% by June 2024," published on RatingsDirect on Aug. 17, 2023; and "The European Speculative-Grade Corporate Default Rate Could Rise to 3.75% By June 2024," published Aug. 19, 2023).

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

Chart 1



Turning Point: Asia-Pacific Credit Conditions Could See An Upturn In 2025

While our CCI for Asia ex-China, ex-Japan is showing early signs of a trough, we expect an upturn only in 2025. Meanwhile, headwinds from a slower China and lagged effects of rapid rate hikes could prolong the ongoing credit correction into 2024. Concurrently, with interest rates poised to stay "higher for longer," borrowing costs look to remain elevated. There could be pockets of funding selectivity as lenders turn more cautious and differentiate credit. With mortgage rates staying high (outside China), an upturn could remain elusive amid still-weak market sentiment.

Chart 2


China  The China CCI is seeing a pronounced inflection, largely driven by a rise in the corporate sub-indicator. The country's corporate debt has increased upon its exit from COVID lockdowns. That said, credit demand may soften amid China's slower economic growth and subdued business confidence (see "Corporate China Hits A Turning Point On Leverage," published June 26, 2023).

Meanwhile, China's ongoing property crisis is dampening the propensity for households to spend, as reflected in the declining household sub-indicator. Recent credit events in the property sector are exacerbating the confidence crisis, spilling into weaker employment and constraining consumption.

Risks around China's corporate leverage remain pronounced, including the low productivity and high indebtedness of state-owned enterprises (SOEs) (see "Global Debt Leverage: China's SOEs Are Stuck In A Debt Trap," published Sept. 20, 2022). Systemic stability is a priority for the central government, even as authorities look to contain high leverage among local government-controlled nonfinancial SOEs (see "What Are China's Options To Resolve Local-Government SOE Debt Risk?," published Aug. 3, 2023). We do not anticipate significant stimulus by the central government.

Chart 3


Japan  The Japan CCI continues to decline from its peak of three standard deviations in the first quarter of 2021, reflecting the broad downward trend in both the corporate and household sub-indicators.

The pace of Japan's gross nonfinancial corporate debt build-up has slowed, following the sharp uptick seen during the onset of COVID. With global economic conditions softening and U.S. interest rates staying higher for longer, corporates may seek more onshore debt (given prevailing interest rate differentials) to prefinance maturing debt and build cash positions.

We expect the Bank of Japan to embark on a mild policy rate increase in 2024 (see "Economic Outlook Asia-Pacific Q4 2023: Resilient Growth Amid China Slowdown," published Sept. 25, 2023). The country's economic growth remains supportive, but domestic currency weakness could entail higher imported inflation, particularly around energy.

For rated corporates, their revenue growth could cushion the impact of higher interest rates and persistent inflation (see "Global Debt Leverage: Japan Corporates Can Tolerate Higher Rates And Inflation," published April 11, 2023). However, rising interest rates and input costs would cause pain for small and midsized enterprises (SMEs; mostly unrated) seeking to refinance.

Chart 4


Emerging Markets

Signs Of Decreasing Momentum For The Credit Correction

In the four quarters after the first quarter of 2020, the emerging market (EM) ex-China CCI trended upward, reaching a peak of 2.3 standard deviations in the first quarter of 2021. This suggests potentially greater credit stress from late 2022 through all of 2023. The aggregate indicator seems to be near an inflection point, with some countries--such as Mexico, India, and South Africa--appearing to have reached their CCI troughs and with many countries close to their own troughs; we expect credit conditions in very few countries (namely, Chile and Poland) to ease further in the next six to 10 quarters.

Corporations  The corporate sub-indicator overall continued to trend downward as corporate debt fell in the first quarter of this year, particularly in Latin American countries. The key driver is high funding costs--especially in international markets and notably for companies at the lower end of the rating spectrum. Equity prices decreased across the board (except in Mexico and South Africa), signaling that protracted macroeconomic strains are hurting corporate valuations. Sustained inflation, along with high interest rates and a slowing economy, will likely keep credit pressure on corporates.

Households  The household sub-indicator remained at the previous quarterly level of -1.2 standard deviations, tighter than its corporate counterpart. Household borrowing mildly decreased in EM Asia countries (except India), but it didn't fall in the emerging markets of Europe, Middle East, and Africa (EMEA) and Latin America, where inflation is biting the most. Property prices were mixed but tilted to the downside, signaling the ongoing strain of high mortgage rates on housing deals across EM.

Chart 5



Early Signs Of Decreasing Credit Stress, But Economic Resilience Will Be Tested Further

Our eurozone CCI reached a peak of 3.1 standard deviations in the second quarter of 2021. Based on statistical precedent, this points to potentially heightened credit stress six to 10 quarters later, meaning in the period from the fourth quarter of 2022 to the fourth quarter of 2023. Yet, material credit stress has been relatively limited in Europe, so far. The economy proved resilient, and inflation helped ease corporate and household debt burdens in real terms. Indeed, the recovery in the CCI over the past six quarters has been unprecedented in the relatively short history of this series.

Nonetheless, we remain cautious, given the softening economic outlook for the rest of 2023 and 2024, and because the full effect of high-for-longer nominal interest rates--and positive rates in real terms from 2024--is still uncertain.

Corporates  After peaking in the first quarter of 2021, the eurozone corporate sub-indicator descended rapidly from 2.4 standard deviations in the first quarter of 2021 to -1.2 at the start of this year. The economic and inflationary rebound from the pandemic spurred nominal growth across the eurozone and substantially helped reduce the corporate credit-to-GDP ratio to pre-pandemic levels. According to the Bank for International Settlements, the ratio was 101% in the first quarter of 2023, from a pandemic peak of 112% in the first quarter of 2021.

Although a declining CCI reading signals moderating stress going forward, higher rates, tougher financing conditions, and a stagnating economy may expose financial vulnerabilities in certain segments of the nonfinancial corporate sector in the near term.

Households  The household sub-indicator follows a trend that is similar to that of corporates in that a peak of 62% in the first quarter of 2021 preceded a significant decline through to the start of this year. Over that period, total credit to eurozone households as a percentage of GDP decreased to a pre-pandemic level of 56% by the first quarter of 2023. To some extent, this moderation reflects the benefits of a strong labor market and the lagged effect of higher rates feeding through to end users.

As the effect of rate rises on debt repayments materializes, households with minimal savings could struggle and face difficulty accessing credit, especially in the event of an economic downturn and rising unemployment.

Chart 6


North America

Credit Correction Likely To Continue Into 2024; Early Signs Of An Upturn In 2025

A slight uptick of the North American CCI ended the seven-quarter downward streak. However, the current credit correction seems yet to fully play out and could continue into next year. The impact on defaults and NPLs from the buildup of debt leverage and asset prices could linger, considering the confluence of risks that North American borrowers face (see 'Top North American Risks' section of "Credit Conditions North America Q4 2023: Shift To Low Gear," published Sept. 26, 2023).

Meanwhile, if the CCI trough firms up soon, we may see signs of a credit upturn around 2025, as historically the CCI tends to lead credit developments by six to 10 quarters.

Corporates  After a steady decline from the peak in the fourth quarter of 2020, the corporate sub-indicator increased to -1.6 standard deviations, mainly driven by higher equity prices. However, higher-for-longer borrowing costs in the face of looming maturity wall, along with more severe profit erosion amid demand and inflation headwinds could squeeze corporate credit further.

Companies at the lower end of the credit spectrum are particularly vulnerable: they face more debt-servicing difficulties and possible liquidity strains, given their higher reliance on floating-rate debt.

Households  The household sub-indicator continued to trend downward. While the resilience of consumers has been a bright spot of the economy, households' financial cushions are running thin as suggested by increasing credit card borrowings and rising auto loan and credit card delinquencies recently. Meanwhile, potential payment shocks for U.S. student loan holders (as the federal forbearance program has ended with payments resuming in October 2023) and many Canadian homeowners (as their shorter-term, floating-rate mortgages come up for renewal) are also a concern. Lower-income and younger cohorts could be particularly challenged in this context. In addition, any further correction of the U.S. and Canadian housing markets could dampen perceived household wealth and cause spillover effects across sectors.

Chart 7


Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Vincent R Conti, Singapore + 65 6216 1188;
Yucheng Zheng, New York + 1 (212) 438 4436;
Christine Ip, Hong Kong + 852 2532-8097;
Luca Rossi, Paris +33 6 2518 9258;
Secondary Contacts:Nick W Kraemer, FRM, New York + 1 (212) 438 1698;
Eunice Tan, Singapore +65-6530-6418;
Jose M Perez-Gorozpe, Madrid +34 914233212;
Paul Watters, CFA, London + 44 20 7176 3542;
Osman Sattar, FCA, London + 44 20 7176 7198;
David C Tesher, New York + 212-438-2618;
Terry E Chan, CFA, Melbourne + 61 3 9631 2174;

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