A new report from Fitch Ratings lists a number of key credit risks that treasurers need to factor into their forecasts over the next two years. These range from asset valuations and interest rates through to changing demographics and cyberwar.
According to Fitch, the macro credit story for the first half of 2023 was more positive than expected, with headline inflation falling in both the US and eurozone along with easing supply chain constraints. That said, Fitch suggests that a stubborn inflationary environment remains, with strong labour markets ensuring inflation remains ‘sticky’. As a result, Fitch anticipates further interest rate rises before the end of 2023.
Shallow recession
“As such, the underlying macro picture, including tighter lending conditions and still hawkish Fed policy, continues to point to cyclical deceleration,” the ratings agency says. “We forecast a shallow recession in the US beginning later this year, a limited growth recovery in the eurozone and China’s recovery fading into 2024.”
So, what are the key risks that Fitch highlights for the coming two years? It points to four immediate risks and a further four long-term risks.
- Funding, asset valuations and financial stability
Rising nominal and real interest rates have created conditions in which hidden leverage and financial vulnerabilities are much more likely to be revealed. Weaker corporates with capital structures predicated on low interest rates are most vulnerable to experience an increase in default rates.
- Inflation and interest rates
If core inflation remains materially above central bank targets and leads to increased terminal policy rate expectations, this would increase the risk of a hard landing. Macroeconomic and political pressures from costs of living, higher costs of capital, and tensions between monetary and economic policies would raise credit risks across several sectors especially if they delay a recovery from the cyclical downturn.
- Geopolitics, governance and policy risks
Long-term geostrategic tension between China and the US has resulted in material policy implications for certain sectors such as semiconductors and the beginnings of structural economic realignments. Domestic policy mis-steps resulting from sustained high cost-of-living increases and political divisions in certain countries have elevated governance and policy risks that can threaten long-term macroeconomic underperformance.
- Commercial real estate
The focus on funding and liquidity pressures on US regional banks in March brought renewed attention to the structural and cyclical challenges facing CRE in some developed markets. The combination of shifting work patterns, weak market conditions and fall in lender and equity investor confidence has raised risks to office valuations and CRE refinancing.
- Climate risk
Changing regulatory requirements, consumption trends, disruption from physical climate change, and investor-driven ‘green’ capital allocation decisions are pressuring issuers to adopt more sustainable operating models. The risks of severe climate-related events have risen, affecting insurability and the potential for operational events to reduce creditworthiness.
- Demographics
Long-term demographic change fundamentally will alter a wide range of economic, corporate, workforce, consumption and taxation patterns. Labour shortages, changing demographic patterns in regions and communities, increased health expenditures, and growing social security programmes are putting pressure on fiscal accounts over the long term at both the national and sub-national level for certain jurisdictions.
- Cyberwar
Sustained cyber-attacks, likely sponsored by a state actor, lead to systemic failure of critical infrastructure over an extended period. The growth or idiosyncratic cyber-attacks exposes vulnerabilities for many institutions, raising cyber-defence costs.
- AI
The rapid rollout of consumer-friendly Al interfaces based on large language models is a once-in-a-generation technological disruption. This opens space for large established players in many sectors to be vulnerable to competitive displacement as well as potential for unforeseen risks as the technology and use-cases evolve.
More details can be found here.
