Q4 2025 Credit Research Outlook Can Central Banks land the plane?
Central banks ease rates amid global uncertainty; US, Europe, Canada, Australia, and Japan banks show resilience. Credit markets remain open, but long-term yields and fiscal risks warrant close monitoring for investors.
We are somewhat encouraged by the modest decrease in policy uncertainty since our last quarterly update—Q3 2025 Credit Research Outlook, particularly as it pertains to US policy. US trade policy has seemingly reached a temporary equilibrium, and significant fiscal reforms appear improbable. Further, policy has become crystallized across sectors such as technology and manufacturing, where recent legislative acts and executive actions support domestic industry and supply chain security. Major global economies largely muddled through the quarter, even though there was clear evidence of slowing growth and weakening labor markets in the US and Canada. These developments provided the catalyst for a resumption of central bank easing biases. The US Fed delivered its first 25bp cut after a long pause as insurance to tackle its weakening labor market despite above target inflation.
Most economists that we follow are constructive on the economic outlook, given the expectation of additional rate cuts from many major central banks, as well as evidence that the global capex cycle is getting a sustained boost from AI-driven capital needs. These dynamics could drive economic growth rates higher into 2026, especially if the threat of policy uncertainty continues to diminish. Given the confluence of factors, there is much debate about how much further the Fed, the ECB, and other central banks will be inclined to ease policy.
In our quarterly updates we’ve often referred to the Bloomberg US Financial Conditions Index as a barometer for financial and credit market conditions. Leading up to, and after, the Fed’s rate cut on September 17th, financial conditions continued to be as accommodative as at any other point since the pandemic ended. The persistence of these conditions would suggest that the Fed is already providing an adequate amount of accommodation to assure the healthy transmission of credit and capital through the economy. Throughout this credit cycle, debt capital markets and lending markets have remained open to borrowers across the credit spectrum. The more leveraged parts of the credit markets (high-yield and leverage loan corporates, parts of the commercial real estate (CRE) market, subprime consumer lending markets), whose performance is most impacted by higher interest rates, have been continuously able to refinance, and get access to credit, allowing for the continuance of the cycle.
However, one corner of the fixed-income market that we are looking closely at, as it pertains to effectiveness of monetary policy, is the long end of the government bond curve. The selloff in government bonds of many of the world’s largest economies has taken 30-year yields to their highest levels in more than a decade.
It is notable that as policy rates at the respective central banks have come down over the last 12 months, short term rates in these countries have fallen (as expected), but longer-term yields on their government’s bonds have not. This could suggest decreasing confidence that central banks have the ability and willingness to push inflation to or below target levels. There is a term premium associated with demand for long term government debt, as the balance of risks around interest rates and inflation over the medium term have shifted in recent years. The shape of the yield curve plays a pivotal role in financial markets and materially influences credit conditions. Higher bond yields have not made credit conditions restrictive, to date, but many central banks may have a more difficult time delivering sustained lower yields than in the past. Fiscal concerns can cause sovereign term premium to rise, tighten financial conditions in the private sector, and negatively impact demand in the economy. This dynamic is not observed, at present, but it is a risk we are monitoring.
Our investment team continues to monitor our key investment counterparties that are headquartered in each of these jurisdictions. The fiscal situation in France has continued to be a focus for our credit research team and our clients, especially as it pertains to investment opportunities in major French banks. Fitch’s sovereign credit rating downgrade of France to A+, on September 12th, highlighted that France’s sovereign credit profile is on a long-term deteriorating path and its risk is increasing.
However, perspective should be kept. As an example, France’s fiscal challenges are not comparable to Greece’s past sovereign crisis. Several factors differentiate France from Greece and other European peripheral countries that were at the center of Europe’s sovereign debt crisis of the previous decade:
- France is the 7th largest economy in the world and part of a reserve currency (Euro).
- It has an above-average savings rate and household wealth.
- France hasn’t been in recession like Germany.
- France has valuable exports in pharma and aircraft.
- Its total debt average maturity is almost 9 years, limiting the impact of near-term increase in refinancing costs.
France’s fiscal problems stem from an unsustainable deficit, compounded by political fragmentation. Bringing down the deficit is not an impossible task because of the economic resources that the country has. However, the political will to implement tax increases and spending cuts continues to be absent and will likely only materialize if/when there is significant market pressure. In the near-term, we expect that any contagion from France’s government bond market to the rest of the euro-zone should be relatively muted unless France’s political crisis becomes more pronounced. The conditions for a systemic crisis in the eurozone are not currently in place. European institutions including the ECB now have tools to limit contagion.
Currently, negative sentiment and credit spread risk are the main concerns for French banks on our approval list. Credit fundamentals have held steady — asset quality is stable, capital levels are solid, and funding conditions are healthy. Maturity limits on our investments in French banks also reduce credit and duration risk in our funds. A more bearish outlook would require clear evidence of deteriorating loan quality or capital threats.