What’s Next for the Credit Cycle?

Key Takeaways

• We believe the credit cycle will remain in the expansion phase, despite a number of macroeconomic headwinds. We expect solid growth supported by healthy risk appetite, strong corporate health, easy financial conditions and fiscal policy.
• The war in the Middle East has a wide range of potential outcomes. However, the US economy entered the conflict with a broadly supportive economic, monetary and fiscal backdrop, and we believe it will remain resilient through the volatility. If oil prices surge toward $150/barrel and are sustained for a prolonged period, then economic risks would rise, in our view.
• We expect energy prices to add inflationary pressure, but we don’t anticipate a period of sustained wage/price inflation because the labor market is soft. Recall that even with some tariff-induced inflation in 2025, the US saw continued disinflation that allowed the Federal Reserve (Fed) to cut interest rates. 
• Despite cooling labor market data, we are not expecting a massive wave in layoffs. We view corporate health as the linchpin behind the labor market, and corporate earnings have been strong.
• Energy-induced inflation has many central banks (and the markets) rethinking the path of policy rates. The new Fed Chair incoming in May 2026 will likely have to walk a tightrope with a soft labor market and energy-induced inflation picking up, in our view.

Middle East War/Oil

Our view: We entered the conflict with a broadly supportive economic backdrop. We would need to see persistently high oil prices to increase our odds of a downturn materially.

The details: There are a wide range of potential outcomes in this war. We think the most likely scenario is a persistent, low-intensity conflict that could last months. In our view, oil prices are likely to range between $85-$100 in the near term, with occasional spikes higher. Markets are likely to react to newsflow, but we believe the overall impact on the credit cycle will be contained thanks to a solid macroeconomic backdrop and corporate health.

The US Consumer

Our view: The consumer still appears fairly healthy in aggregate.

The details: Higher- and lower-income consumers have been spending at healthy levels.ⁱ Elevated tax refunds this year should help support consumption. We’ll be watching the wealth effect closely—it has been a large factor propping up spending over the past few years.

Global Growth

Our view: Global economies are typically more exposed to large energy shocks compared to the US. We would expect the global economy to slow marginally given the rise in energy costs, but we are not expecting a recessionary environment. Global growth was looking more synchronized coming into 2026, supported by interest rate cuts in 2025. Countries have the ability to increase fiscal spending to support their economies if needed.

The details: In our view, the risk of a sustained rise in energy prices causing a widespread recession is a tail risk for now. We have seen stronger manufacturing PMI data, which suggests some positive cyclical momentum for the global economy. China is exiting deflation. Europe appears to be in the early stages of the credit cycle, driven by interest rate cuts, improving financial conditions and substantial and iterative fiscal stimulus. External risks remain relevant on a global scale, especially with elevated geopolitical tension, but there is more resilience globally compared to the energy shock that followed the beginning of the Russia/Ukraine war.ⁱⁱ

US Monetary Policy

Our view: We think the Fed will resume cutting interest rates but the timing is more uncertain. We had anticipated a couple of “fine-tuning” interest rate cuts by the summer of 2026, but now we think those cuts may be pushed out to late 2026. A lot hinges on the soft labor market balanced with the potential for energy prices to pass through to goods inflation. 

The details: We think a softer labor market and a resumption of disinflation should pave the way for additional interest rate cuts by the end of the year. New Fed leadership may push for an easier bias, looking to take a forward view on potential productivity, but it’s unclear if the Federal Open Market Committee would be on board with that stance. For the Fed to cut 100 basis points or more, we believe it would likely want to see accelerating disinflation and weaker non-farm payrolls data.

US Corporate Profits

Our view: Corporate earnings growth has been very strong, handily beating expectations. We expect equity earnings-per-share (EPS) growth to remain solid through 2026, though consensus forecasts already appear bullish.

The details: We believe earnings growth can broaden out this year, and large-cap earnings could potentially achieve double-digit growth rates.

US Credit Risk Premium/Risk Appetite

Our view: Credit spreads were very tight at the start of 2026, but widened marginally since early March. Wider spreads seem more associated with the increased risk of downgrades and defaults stemming from software/AI disruption than the threats from the war in the Middle East. Given how solid corporate fundamentals have been, we think a widening of credit spreads would present a more compelling opportunity to add credit risk compared to what was on offer in 2025.

The details: Credit fundamentals still look solid and the technical backdrop has helped keep spreads contained. Compressed credit spreads have led us to look for value in other segments of the fixed income markets, such as mortgage-backed securities and other securitized debts. We would view further corporate credit spread widening as an opportunity because all-in yield remains attractive and aggregate credit fundamentals still look relatively healthy.

Inflation

Our view: We expect US inflation to drift gradually down to the Fed’s 2% target, though the energy-induced spike in headline inflation may delay that process until the back half of the year.

The details: We expect inflation to taper off and hit the Fed’s target in 2027 as energy costs and tariffs fade into the background. Businesses appear to be passing along tariff hikes gradually. Goods inflation pressure has subsided, shelter inflation should continue to cool and wage pressure has softened.ⁱⁱⁱ

Artificial Intelligence (AI)

Our view: AI spending can help support the economy. We think it is likely to drive further productivity gains, though the process will be somewhat gradual and uneven. AI is still in its early innings.

The details: The global economy has seen some productivity gains (even without the introduction of AI) after a very weak period following the Great Financial Crisis. We expect productivity gains to continue, though the magnitude and timing are uncertain. Labor market disruptions have been mostly concentrated thus far; we don’t anticipate significant near-term displacement under our base case scenario. Capital expenditures have been immense and are expected to continue. AI spending has been largely funded by cash flows so far, but we are seeing increased debt issuance. Most hyperscalers are healthy, profitable companies, in our view.^iv

Our view: We believe the potential for a US dollar bull market remains low, especially if the Fed cuts interest rates later this year while other central banks hold or tighten policy.

The details: The US dollar tends to trade with a firm tone when international developments pose risk to overall financial market stability. We still believe non-US-dollar assets can perform well as the expansion progresses, but ongoing Middle East conflict has lowered our optimism and expectations. When global growth expectations begin to stabilize or even improve, a more bullish stance for owning non-US-dollar assets will return quickly, in our view.

China

Our view: Inflation in China appears to be moving out of negative territory after three years of deep deflation. 

The details: We believe higher inflation in China could serve as a catalyst for broader economic improvement. The People’s Bank of China is likely to continue easing with small and gradual interest rate cuts. We think the temporary US-China tariff truce will hold, and we anticipate non-US demand to support China’s trade surplus in 2026. Overall, we anticipate real GDP growth of approximately 4.5%-5.0% in 2026.