Q2 2025 Credit Research Outlook Clear Eyes, Full Hearts, Can’t Lose

The credit markets have remained resilient despite global rate hikes since 2022, supported by strong consumer and corporate credit. However, risks are rising in 2025 due to inflation, policy uncertainty and potential disruptions from tariff and fiscal policies.

I have been waiting to quote the fictional high-school football coach from my favorite network TV drama series Friday Night Lights: “Clear Eyes, Full Hearts, Can’t Lose”. With the significant increase in uncertainty in market conditions and economic forecasts, it seems fitting.

In our 2025 Credit Research Outlook, we noted that the timing and scope of the Trump administration’s immigration, trade, fiscal and regulatory policies would be critical to the 2025 macroeconomic outlook.

So far, they have introduced more near-term downside risk to the US and global economies than anticipated at the end of 2024. The focus on tariffs has been front-loaded, with an increased probability that the size and scope will exceed initial expectations.

Additionally, the suspension of some federal outlays and spreading layoffs has added a near-term contractionary impulse to fiscal policy, while the prospects for the more “pro-growth” policy goals of the administration, such as tax cuts and deregulation, are expected to take longer to materialize.

The US Federal Reserve (Fed) may use monetary policy easing to support the US economy and credit markets if either weaken materially in the near term due to Trump’s policy implementation. However, the policy agenda makes this calculus more complicated from the Fed’s perspective.

Following the March Federal Open Market Committee Meeting (FOMC), the Fed’s policymakers revised up its projections for inflation in 2025 while revising down its projections for gross domestic product (GDP), consistent with the story of mild stagflation brought on by the policy sequencing.

The persistence of above-target inflation could make it more challenging for the Fed to justify interest rate cuts in 2025 to preempt an economic slowdown and/or support the credit markets.

Ever since the significant global rate hike cycle commenced in 2022 (with over 500 bp of hikes in the US!), the credit markets have remained vibrant and accommodative. Consumer credit has been supported by the persistence of a strong labor market, and corporate credit markets have been supported by historically healthy profitability and debt capital markets that have been consistently open to corporate issuers across the risk spectrum.

The risk that this balance may be disrupted has increased over the first few months of 2025, but quantifying the risk is challenging.

As of this writing, there is still much uncertainty regarding Trump’s tariffs. While he has identified 2 April as the start date for so-called “reciprocal tariffs,” there is little detail, at this time, on what the measures will entail. Further, there is still lack of clarity on the previously announced tariffs, including the conditions under which any tariffs could be removed or reduced. So, while economists widely believe that tariffs will be a tailwind for inflation, and a headwind to growth, the degrees remain highly uncertain. This, combined with the labor supply effects from immigration limitations, leads us to conclude that there will be some near-term cost to the economic transition that is being pursued by the administration.

We also see a risk that stagflationary conditions become a “self-fulfilling prophecy” due to sentiment. Various readings of consumer and business sentiment have deteriorated recently, especially in the US. Readings such as these suggest that consumers and businesses may begin to hold back spending decisions.

As an example, we point to Bloomberg’s Global Economic Policy Uncertainty Index (gross-domestic-product-weighted) — which tracks the state of global economies (weighted by country GDP) as it relates to business conditions — and includes economy-wide and industry-specific data points:

The index also demonstrates the degree to which US policy is impacting sentiment in the world’s other economies. Indeed, readings are now similar to those recorded at the onset of the COVID-19 pandemic in 2020.

Prolonged periods of uncertainty risk perpetuating a cycle where hiring and capex plans are delayed or altered, and perhaps businesses even begin cutting workforce. In this scenario, the support for this credit cycle — strong labor markets and business profitability — are undermined.

In addition to consulting with SSGA’s own economics team, we also monitor the forecasts of several third-party economic vendors, as well as a variety of economists from the sell-side firms.

In summary, the majority of the economists we follow have downgraded US growth forecasts, and upgraded US inflation forecasts by 0.5% to 1% for 2025, with a lot of variability and uncertainty embedded in current forecasts.

Global Cash Investment Universe

In our 2025 Credit Research Outlook, we highlighted the broadly stable outlook for the fundamental credit profiles of the majority of our investment universe. That stability going into the year gives us confidence that the credit profiles of banks on our approval list would be able to absorb a marked downshift in economic growth without immediate impact to their respective credit profiles.

Still, as we continuously analyze the details of policy developments and macroeconomic scenarios, there may be instances when we adjust maturity restrictions downward for investment counterparties to mitigate the amount and types of credit risks we are taking in the evolving environment.

For example, we recently made a modest downward adjustment to the maturity restrictions for the Canadian banks on our credit approval list. Given the materiality of the trade relationship between the US and Canada, and the specifics regarding the tariffs being threatened, any form of a US–Canada trade war would have significant, negative impact on the Canadian economy.

The Bank of Canada sees a –3.0% impact to real GDP in the first year and –1.5% in the second year, or a “severe” outcome, if tariffs are fully implemented and permanent, as threatened.

Given the strength and soundness of the Canadian banks on our credit approval, we believe that credit profiles would be quite resilient in this type of recession. However, our objectives as an investment team continue to be conservative as it pertains to the credit risks we are taking in our funds. As such, we believe it made sense to reduce the duration of our credit risk to Canadian banks.

As downside risks have increased for global economies, we continue to focus with “clear eyes” on investment counterparties best equipped to maintain their fundamental credit profiles through a variety of macroeconomic scenarios.

However, investment counterparty selection and duration considerations will continue to be important during any credit cycle or economic downturn. As long as we stay disciplined in that approach, we “can’t lose,” regardless of how the landscape plays out over the next quarter.