2025 Credit Research Outlook Soft Landing or No Landing?

As we look ahead to 2025, credit markets are poised to remain resilient despite elevated interest rates and fiscal challenges. However, sectors like real estate, private credit, and sovereign debt may face increased pressure if conditions tighten further.

Over the past two years, global growth and financial conditions have shown resilience despite concerns surrounding inflation, central banks and elections. This resilience has continued to support credit markets globally. Looking ahead to 2025, our credit research team notes a general consensus among global economic forecasters that economic and financial conditions should remain favorable for credit markets, even if global growth moderates. Ironically, the conformity of this consensus is somewhat unsettling. We continue to view ourselves as credit risk managers for our Global Cash clients and are closely monitoring various risk factors that could impact credit markets and the investment universe for our Global Cash funds — which largely consists of issues from systemically important banks and financial institutions.

Like many market observers, we will be closely monitoring policy changes in the US brought about by the Trump administration. We expect that evolving immigration, trade, fiscal and regulatory policies will have global impacts, and could be inflationary — assuming Trump follows through on the intentions articulated during his campaign. However, the degree to which these policies contribute to inflation remains uncertain, given the potential variability in their scope and timing.

The announcement of changes is less important than the speed at which the changes are implemented, at least in terms of our 2025 outlook. Faster implementation could heighten “stagflationary” risks, particularly if a tit-for-tat trade war develops between the US and its trade partners, while draconian immigration curbs materially restrict the US labor supply. That said, this scenario is not our base case. There is a list of potentially mitigating factors that could impact the growth and inflation outlook in the opposite direction (i.e. disinflation and higher growth), such as a normalizing labor market and the potential for tax cut extensions and deregulation across various parts of the economy.

While credit markets largely withstood a significant global rate hike cycle in 2022–2023 (over 500 bps in the US!) without “breaking,” certain segments of the market still remain vulnerable to higher-for-longer interest rates — particularly commercial real estate, high-yield corporates, leveraged loans, and private credit. In the near term, we are more concerned about fiscal policy as a catalyst for fixed-income market volatility than we are about US tariff or immigration policy.

The public finances of most major global economies continue to deteriorate. In advanced economies, the debt-to-GDP ratio is on an upward trajectory in every country except Germany1. Global fixed-income markets have reacted to these trends by driving interest rates higher during certain periods in recent quarters, despite the expectation of rate cuts in the near-future.

Recently, market have been focused on France’s fiscal position, but several advanced economies have experienced bouts of volatility in their sovereign debt yields. These episodes are usually triggered when governments signal or imply a weakening commitment to long-term fiscal discipline or push for additional deficit-financed tax cuts or spending increases.

While politically popular, such actions prompt quick and severe reactions in bond markets. The Trump administration could trigger this type of reaction if it pursues further tax cuts financed by higher borrowing. Sharp rises in bond yields often lead to tightening of financial conditions, which carry significant macroeconomic consequences by raising the cost of debt capital across public and private credit markets.

The Global Cash Investment Universe in 2025

Several large French banks are relevant in our investment universe, and their debt issuers underperformed global bank peers towards the end of 2024, as political instability in the country reduced the likelihood of near-term deficit reduction. While we do not foresee France facing a sovereign debt spiral similar to Greece’s more than a decade ago (the fundamentals of its economy are much stronger), the debt market volatility, along with its sovereign rating downgrade by Moody’s (December 17, 2024), underscores how persistent fiscal weakening can impair financial conditions within a major economy.

These conditions will continue to pose a threat to the fundamental credit profiles of French banks in the medium term. We are closely monitoring the situation with regard to French issuers and using it as a guide for other issuer jurisdictions in our coverage universe that are grappling with fiscal responsibility concerns.

Aside from French banks, most of key bank investment counterparties in our investment universe enter 2025 with a stable outlook for their respective credit profiles. In developed markets, banks’ financial performance has been supported by persistently low unemployment rates and strong income growth for consumers and businesses. There is general optimism for bank profitability in 2025, with limited concerns about asset quality — continuing trends from the previous years.

Even within global commercial real estate (CRE) loan portfolios, credit degradation has been modest, and exposure levels remain manageable in terms of capital and loan loss reserves. Banks on our credit approval list continue to report balance sheet strength with historically high levels of liquidity and capital.

In the US, the potential for de-regulation across both the economy and the banking system is perceived to be a tailwind for the US banks during the second Trump presidency. However, while a pro-growth agenda could drive activity levels higher, a subsequent rise in interest rates might dampen sentiment and negatively impact loan credit quality, especially if debt markets react unfavorably to any lack of deficit progress.

Thoughts on the Growth of Private Credit

As mentioned earlier, we see private credit as a segment of the credit markets that could be vulnerable if interest rates remain elevated in 2025. The evolution of global bank regulations following the Global Financial Crisis (GFC) encouraged the disintermediation of lending from banks to capital markets. The rapid growth of the private credit markets is certainly a direct result of this regulatory shift, and its growth has accelerated even more explosively since 2020.

According to a recent Federal Reserve report, total private credit has grown to nearly $1.7 trillion, comparable to the leveraged loan market ($1.4 trillion) and high-yield bond markets ($1.3 trillion)2. However, it is worth noting that the study included direct lending assets-under-management (AuM) from private credit asset managers and mostly captured corporate debt. These figures likely undercount the totality of private credit markets, particularly in areas like privately placed debt within the asset-backed consumer and infrastructure segments.

Apollo Global Management estimates that the potential universe of private credit investments could be as large as $40 trillion when factoring the entire asset-backed finance universe3. Pension funds and insurance companies remain the largest buyers of private credit funds.

While this explosion in financing has occurred outside of the banking sector, the private credit markets do have implications for our investment universe of approved bank and financial institution issuers. Historically, banks have provided lines of credit to private credit funds. Most recently, banks in our investment universe began partnering with private credit managers in joint ventures. Over the past year, Citigroup, JP Morgan, BNP Paribas, PNC, Wells Fargo, and Societe Generale have all announced sizable partnerships with direct lenders in the private credit space.

These partnerships allow banks to offer private financing options to their clients without significantly utilizing their own balance sheets. Additionally, banks can recapture syndicated loan underwriting fees through these partnerships, enhancing profitability without taking on additional risk.

Using data from Bloomberg, we can observe the degree to which “private credit” is mentioned in the transcripts, presentation and earnings reports of major banks and financial institutions. Particularly notable is the material increase in frequency over the past year.

The rapid growth of private credit certainly has systemic implications for broad credit conditions and credit markets. In many cases, borrowers are accessing private financing that they would not be unavailable from traditional banks — raising overall leverage in the financial sector. Another risk is that private credit Investors’ committed capital is subject to calls by fund managers. This could intensify liquidity periods stress in the financial system if capital calls increase materially over a short period of time. The illiquid nature of these funds could also pose challenges for insurance companies if they misestimate their own liquidity needs.

Moreover, during a crisis, banks tends to deleverage but still roll-over loans and provide credit to borrowers. Private credit lenders, however, are less likely or able to do the same, potentially worsening liquidity and funding problems for the companies they finance. In fact, the Bank for International Settlements (BIS) finds that private credit flows are more sensitive to monetary policy surprises than private equity4.

As a result, we view the risk of credit crunch as materially higher in a higher-for-longer interest rate environment. While the fundamental credit profiles of major global banks are more resilient due to post-GFC regulation — since less credit risk remains on their balance sheets — the systemic risk of future credit crunches persists.

There are several mitigating factors to consider alongside these risks. The BIS has reported that private credit markets remain relatively small in size, with a low share in investors’ portfolios, low liquidity risks and low fund-level leverage4 . Additionally, private credit funds are generally closed-end vehicles with lock-up periods, which should minimize the risk of ‘runs’ or forced selling.

It is worth noting that funding and leverage from banks to private credit funds are currently at low levels, according to the latest reporting. For example, while the newly announced partnerships between JP Morgan and Citigroup with private credit managers made headlines for their size, the banks’ balance sheet involvement in these partnership will be very minimal relative to their respective sizes.

In Closing

We are cognizant of risks related to higher-for-longer interest rates, both for on economies and, more indirectly, for the fundamental credit profiles of the banks and financial institutions on our credit approval list. In many ways, our current outlook is similar to what we anticipated at the end of 2024. Funding conditions during 2024 were quite favorable for all types of credit instruments, so issuers in “higher risk” segments of the credit markets — such as CRE, private debt, HY corporates, leveraged loans —successfully refinanced a significant amount of debt, mitigating some of those risks for 2025.

However, as we outlined above, certain market segments will become increasingly challenged in 2025 if interest rates remain elevated, or increase further. While the global economic outlook is expected to be supportive of credit markets, as it was in 2024, our credit research team remains prepared for an economic backdrop that is more challenging. This involves continuing to select cash investment counterparties that are best-equipped to maintain their fundamental credit profiles through a variety of macroeconomic scenarios, including a higher-for-longer interest rate environment and tighter financial conditions.