a man on a precipice

With higher interest rates expected to linger, economic growth will slow in the year ahead, weighing on asset prices, says Moody’s Investors Service.

In a new report, the rating agency detailed its outlook for 2024, which is headlined by the impact of central banks keeping interest rates elevated to combat persistent inflation.

This will continue to tighten financial conditions and serve as a drag on economic growth, potentially revealing pockets of risk, it said.

“This higher-for-longer expectation is already feeding through to the bond market and will keep long-term yields above levels seen in recent years. We also forecast high-yield spreads to widen next year,” it said.

Against this backdrop, the global default rate is expected to peak at around 4.5%-5% in the first quarter of next year, Moody’s said, noting that default rates are expected to remain well below the levels of the global financial crisis and the pandemic.

At the same time, high rates will boost lenders’ asset risk and “expose leverage-driven investment strategies,” Moody’s said. “They will also test the resilience and depth of private credit and direct lending markets.”

Ongoing uncertainty about the rate environment will also spur financial market volatility “and could lead to stress in parts of the financial system as we saw in March 2023,” the report said.

Continued stress in real estate markets will remain a negative for some residential mortgage-backed securities (RMBS), as well as for borrowers and lenders, it said.

And commercial real estate will continue to absorb permanent shifts to post-pandemic work models, “which will pose asset risks for some banks and securitizations.”

Other key trends for the credit outlook include the impacts of climate change and the carbon transition.

“Tightening emissions regulations and declining costs for alternative technologies like battery electric vehicles and renewables are already transforming business models and investment strategies in the automotive and power sectors,” the report said, and providing growth opportunities for clean energy manufacturers.

Additionally, the growth in sustainable finance will help some sectors accelerate their decarbonization efforts, it said.

The increased frequency and severity of extreme weather events, meanwhile, will impose rising costs on debt issuers, the report said.

Moody’s also predicted that financial sector regulation will tighten in 2024, “driven by stress in parts of the banking sector earlier this year and warnings from regulators about risks in market-based finance.”

The digital finance sector will also attract regulators’ attention, “given an acceleration in digital bond and stablecoin issuance, AI, crypto losses and fraud, and increasing cyber risks,” the report said.

“More broadly, geopolitical tensions and realignment will make policy less predictable and hamper international cooperation on issues such as trade, climate and debt relief, and the role of international institutions.”

Moody’s noted that there’s a heavy calendar of elections in 2024, including in the U.S., U.K., India, Indonesia, Mexico and South Africa.

“The U.S. presidential election next year will provide greater clarity on whether we are likely to see policies to address the sovereign’s growing fiscal pressures,” it said.