Fitch Warns of Elevated Credit Risks as "No-Landing" Scenario Gains Traction

Fitch Ratings has issued a warning about increased credit risks in the US market as the likelihood of a "no-landing" scenario, where economic growth and interest rates remain largely unchanged, gains traction. This shift in expectations is driven by persistent inflation, which has cast doubt on the timing and extent of future rate cuts by the Federal Reserve.

The first quarter of 2024 was characterized by robust domestic demand, improved market liquidity, and a surge in bond issuance. However, sticky inflation has renewed uncertainty about the Fed's monetary policy path, potentially leading to elevated credit risks for rate-sensitive asset classes such as real estate, high-yield corporate debt, certain financial institutions, and subprime consumer securitizations.

"The likelihood of a no-landing scenario, in which growth and interest rates remain largely unchanged, has increased, elevating credit risks for rate-sensitive asset classes," states Fitch in its latest US quarterly credit brief.

This scenario could result in higher-than-anticipated delinquencies and defaults in commercial real estate, lower credit quality consumer loans, and corporate debt. The report notes that the recent increase in risk appetite and investor confidence was predicated on expectations of more aggressive rate cuts by the Fed, which now appear less likely. As a result, credit spreads and other risk assets have begun to reverse some of their earlier gains.

Despite these concerns, Fitch maintains a relatively benign base case scenario for individual sectors, forecasting broad ratings stability across asset classes. This reflects the current strength of the US economy, robust ratings cushions, and structural protections.

On a more positive note, Fitch revised its forecast for US economic growth in 2024, raising it from 1.2% in December to 2.1% in March. However, they still warn of a slowdown later this year, with growth falling below typical levels.

The report also highlights the higher percentage of sub-investment-grade ratings with Negative Outlooks compared to investment-grade ratings. This indicates the ongoing pressures faced by lower-rated entities due to higher leverage, refinancing risks, and deteriorating asset quality.

"This could cause commercial real estate and lower credit quality consumer loan delinquencies and corporate defaults to rise more than currently anticipated," warns Fitch.