Q3 2025 Credit Research Outlook Resilience amid risk
Despite persistent macro risks—tariffs, inflation, and geopolitical tensions—financial conditions remain stable. Credit markets show resilience, but high rates and policy uncertainty continue to challenge growth, especially in higher-risk segments.
We had hoped that much of the uncertainty surrounding market conditions and economic forecasts at the end of the Q1 2025—as highlighted in our Q2 2025 Credit Research Outlook— would have eased by the close of Q2. While those hopes were not met, there is still some reassurance in the continued resilience of the economy and credit markets.
This resilience is underpinned by several factors: global household deleveraging following the financial crisis, a balanced dynamic between labor and capital markets, and the ongoing—albeit waning—impacts from post-pandemic fiscal policies. Encouragingly, debt servicing burdens and bank non-performing loans remain historically low in the economies most important to our investment universe.
At the start of Q2, concerns about a potential US and global recession intensified following the Trump Administration’s “Liberation Day” tariff announcements, which threatened to disrupt global trade more severely than many had anticipated. Fortunately, the proposed tariff levels were later scaled back—albeit perhaps only temporarily.
While there remains a risk that US tariffs could rise again for certain countries if trade negotiations stall, there is broad consensus that the period of “peak tariff risk” has passed. Nonetheless, as of this writing, the average US tariff rate is at its highest level in nearly ninety years. If these tariffs persist, they are likely to have lasting effects on both the US and global economies.
Although the probability of a recession has declined, economic forecasts suggest that both US and global growth may slow in the second half of 2025. Recent “hard” economic data—particularly from the US—has shown signs of weakening. In response, officials from the US Federal Reserve have revised their growth projections downward for the year, while raising their forecasts for both unemployment and inflation.
While similar stagflationary pressures may be less pronounced in other developed markets, adverse shifts in US tariff policy during the latter half of the year could pose challenges for relatively resilient economies such as those in Europe and Japan.
In addition to tariff-related volatility, several other risk factors contributed to periods of heightened market turbulence during the quarter. These included the threat of regional conflict in the Middle East—driven by escalating tensions between Israel and Iran—as well as episodic financial market stress linked to US government fiscal challenges, underscored by a sovereign credit rating downgrade from Moody’s.
Despite these developments and intermittent volatility, financial and credit market conditions remained stable quarter over quarter. The Bloomberg Financial Conditions Index—which tracks financial stress across US money, bond, and equity markets and serves as a gauge of credit availability and cost—remained in positive territory, indicating accommodative conditions. While the index briefly turned restrictive following the “Liberation Day” tariff announcements, it quickly rebounded as the scope of the tariffs was scaled back.
It’s important to note that, as of this writing, financial conditions are more accommodative than during much of the Federal Reserve’s interest rate hiking cycle between 2022 and 2023. This is particularly noteworthy as we assess the likelihood of a “higher-for-longer” interest rate environment. Such a scenario would likely continue to challenge specific segments of the credit markets—most notably commercial real estate, non-investment-grade corporate credit, and leveraged loans.
Despite the range of macroeconomic risks outlined, we believe credit risk remains relatively expensive. While expansionary conditions can be sustained through well-calibrated trade, fiscal, and monetary policies, the overall environment remains fragile.
We are particularly focused on US interest rates, anticipating that monetary policy support may be required over the next two quarters to mitigate the risk of recession. However, for the Federal Reserve to ease policy, inflation must remain under control. Both inflation trends and market sentiment surrounding US fiscal policy will influence the Fed’s ability to lower interest rates and provide support to the broader economy and credit markets.
Should recessionary conditions emerge in the US, they would almost certainly trigger negative economic momentum in other key global economies within our investment universe.
As cash investors, we consistently assess investment counterparties with a conservative approach. However, prevailing market conditions have led us to increasingly recognize value in high-quality assets.
Despite the mounting challenges posed by a prolonged period of elevated interest rates—particularly for higher-risk segments of the credit market—we have constructed a focused investment universe designed to shield our funds from material direct and indirect exposure to these vulnerable areas.
Global banks on our credit approval list continue to exhibit strong balance sheet fundamentals, characterized by historically high levels of liquidity and capital. Their exposure—both direct and indirect—to credit market segments most susceptible to elevated nominal interest rates remains limited, reinforcing our confidence in their resilience.