Delayed Fed Rate Cuts Raise Credit Risks and Spillover Concerns, S&P Global Warns

S&P Global has pushed back its forecast for the first Federal Reserve rate cut to December 2024, citing persistent inflation and unexpectedly strong economic data. This delay in easing monetary policy raises concerns about elevated credit risks in the US and potential spillover effects on other economies, particularly in Asia-Pacific and emerging markets.

In a report published on Thursday, S&P Global emphasizes that the Fed remains committed to a data-dependent approach, requiring "several months" of inflation near its 2% target before considering rate cuts. Recent economic indicators, while potentially overstating underlying inflationary pressures, have nonetheless dampened expectations for an early policy shift.

Elevated Credit Risks and Liquidity Concerns

S&P Global warns that prolonged high interest rates pose a significant risk to borrowers' liquidity, particularly for lower-rated entities facing upcoming debt maturities. "If interest rates remain elevated for even longer than we anticipate, the costs of debt service and/or refinancing could be overly burdensome—especially for lower-rated borrowers," states the report.

Challenging financing conditions could also lead to a decline in asset valuations, potentially triggering a housing slump or deepening the correction in the commercial real estate market. While improved financing conditions in the first quarter allowed some borrowers to refinance upcoming debt, the outlook for refinancing may become less favorable as investors temper their expectations for rate cuts and credit spreads widen.

Spillover Effects on Global Economies

The delay in Fed rate cuts is expected to have significant implications for monetary policy and exchange rates in other economies, particularly in Asia-Pacific and emerging markets, where central banks are sensitive to interest rate differentials with the US.

S&P Global anticipates that these central banks will likely delay and slow their own policy rate reductions to avoid further currency depreciation and maintain control over inflation. While the report does not expect the Fed's decision to significantly impact the timing of rate cuts in Europe, it acknowledges that upside risks to European long-term bond yields have increased.

Uncertainty and Potential Risks

Despite the revised forecast, S&P Global acknowledges the two-sided risks to the timing of the first Fed rate cut. A faster-than-expected weakening of the labor market could prompt the Fed to prioritize its employment mandate and begin easing sooner, even with inflation above target. Conversely, persistent inflation could lead to a further delay in rate cuts, potentially extending into 2025.

The report also highlights the risk of a US recession if the Fed waits too long to ease monetary policy. While consumer spending has remained resilient despite high borrowing costs, S&P Global believes that the strain from high rates is beginning to show, with consumers increasingly reliant on credit and dwindling savings.

"Excess savings are likely depleted for all but the highest-income households, and delinquency rates on credit cards and auto loans have risen beyond pre-pandemic levels," notes S&P Global.

From a credit perspective, continued high borrowing costs and the pressure they exert on borrowers’ liquidity remain the top risk, S&P Global warned.