Fixed income

What’s next for the credit cycle?

April 09, 2025 - 9 min read

by the Loomis Sayles Macro Strategies Team

Key Takeaways

We view the US tariff shock as monumental, upending generations of trade liberalization and global economic integration. It is a major shock with significant uncertainty on economic and financial outcomes.
Tariffs are a tax paid by either importers, suppliers or consumers. The tariffs represent a huge fiscal tightening that we believe will hit demand and disrupt supply chains globally.
We expect countries around the world to raise their own tariffs or implement other trade barriers.
Unfortunately, we think these policy decisions raise the risk that the credit cycle shifts toward a downturn.
We believe profits are the key indicator to watch going forward. If profits become negative, we would view it as a red flag that a downturn may be approaching.

Graphic Source: Loomis Sayles. Views as of 7 April 2025. The graphic presented is shown for illustrative purposes only. Some or all of the information on this chart may be dated, and, therefore, should not be the basis to purchase or sell any securities. Any opinions or forecasts contained herein reflect the current subjective judgments and assumptions of the authors only, and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. This information is subject to change at any time without notice.

Late-Cycle Dynamics

In our view, the US economy is still in late cycle because both profits and the labor market have remained strong, supporting consumer spending. Imports, after all, are 15% of US GDP.¹ However, we see significant economic headwinds. Huge uncertainty and massive supply disruptions from the tariff shock will likely cause companies to hold back on investment spending, in our view. Most economic models we look at show that retaliation from trade partners will be another blow to economic prospects. We also expect tariffs to crimp housing supply as costs increase. The Federal Reserve has paused its cutting cycle in response to recent stickier inflation data and policy has remained restrictive.

Going forward, we will be watching corporate health very closely. Our most recent survey of Loomis Sayles’ credit analysts (our Credit Analyst Diffusion Indices, or CANDIs) indicated a positive outlook for corporate health, but noted rising input costs. The Loomis Sayles Credit Health Index (CHIN) is currently at a healthy level consistent with late cycle.

We believe profits are one of the most important indicators to watch because they drive the cycle. If declining demand or increased costs hit margins and profits turn negative, then companies are likely to start shedding labor. A rise in unemployment is a key signal for the downturn phase of the credit cycle.

A Closer Look

Credit cycle analysis involves measuring the changing factors that influence a cycle’s movement and tracking the complex interactions between credit and asset prices. We use our credit cycle framework to interpret data and shape our views on where a country, sector or issuer may be in the cycle. We keep in mind the variability of indicators since they can shift in large and small ways and undermine or bolster market sentiment and valuations.

Interpreting the Cycle
The key economic indicators in the following table tend to behave differently in each phase of the credit cycle. Currently, most of these indicators display expansion/late cycle characteristics. However, we do not interpret indicators at face value and make a conclusion. Our determinations incorporate art and nuance.² Our analysis indicates late-cycle dynamics with serious headwinds on the horizon that could tip us into downturn if profits collapse and leverage increases. At this stage of the cycle, investors tend to focus on capital preservation and moving up in quality.

The economy went through a period in late 2022 and early 2023 when the threat of downturn was also elevated. Excess consumer savings, pent-up demand and post-pandemic "revenge spending" were a powerful engine of growth through the shallow profits recession of 2023. The economy may be less resilient this time, as excess savings have now been depleted and consumer delinquencies are on the rise.

Table Source: Loomis Sayles. Views as of 7 April 2025. Highlighted cells represent attributes we’re currently observing. Green represents our current view. Bright blue represents the previous view (if different from the current view). Arrows indicate the direction of change in view where applicable. The table presented is shown for illustrative purposes only. Some or all of the information on this chart may be dated, and therefore, should not be the basis to purchase or sell any securities.

What's Next?

Because macroeconomic factors don’t always behave as expected, we prepare scenarios for the path of the US credit cycle over the next six months. Here, we outline three potential scenarios and indicators to watch:

Late Cycle/Stallflation

Stagflation gets talked about a lot, but we believe that term implies a 1970s scenario with a much more bearish shading to inflation, unemployment and asset prices than what we currently anticipate. We prefer “stallflation” for this scenario because we see trade war uncertainty slowing real GDP growth toward “stall speed,” around 1%. Tariffs push inflation sharply higher, but the jump is temporary as opposed to persistent inflationary pressure.
The Fed may be delayed in responding to slower growth and unemployment drifting higher but inflation should prove to be “transitory” as demand weakens, eventually allowing for easier Fed policy.
The unemployment rate drifts higher toward 4.5%, opening the door for the Fed to respond to its full employment mandate and resume rate cuts.
Markets are volatile and valuations become more favorable. The Fed provides liquidity, helping to avert bear markets in credit spreads and equities.

Downturn

We believe the risks of a full-fledged downturn are rising and are about equal to the slightly less-disruptive stallflation scenario. Fed policy is restrictive while economic and policy uncertainty are elevated.
We believe profits are the most important variable to watch. In this scenario, profits go negative or undershoot consensus expectations by 10% to 15%, leading to layoffs and a sharply higher unemployment rate. The rise in the unemployment rate is a lagging indicator, but it defines a recession.
The trade war is expected to upend generations of supply-side integration. The increase in tariff levels stick and cause both a supply shock and demand shock.
The trade war becomes even worse as other countries retaliate. It becomes a race to the bottom reminiscent of the beggar-thy-neighbor polices of the 1930s, when countries sought to boost their economies with protectionist trade measures at the expense of their trade partners.

Late Cycle/Resilience

In this low-probability scenario, the economy continues to chug along with approximately 2% annual real GDP growth. Profits and the consumer remain resilient. Tariffs keep prices high, but companies have no problem passing on the costs. Some companies may even pad their margins further, keeping profits resilient.
Less migration keeps the labor market tight and wages healthy, enabling consumer spending.
The consumer substitutes imports for domestic goods and local travel. An improving trade balance supports GDP growth.
The Fed’s hands are tied with a strong economy, labor market and stubborn inflation; no rate cuts on the horizon and fears of further hikes could start to creep into the market. This scenario acknowledges the potential for bond yields to push toward 5%.

Macro themes in a flash

Our views on key topics that can influence the credit cycle.

The US Consumer

Our view: Overall consumer spending in the US is slowing from very elevated levels. The consumer is still a positive driver of economic growth.

The details: Higher-income households continue to spend at favorable rates. Lower-income households, a much smaller segment of total spending, are showing weakness.

Global Growth

Our view: Global growth has experienced a massive negative shock. Encouragingly, many countries are able to respond with increased fiscal spending to become more resilient without the US driving consumer demand.

The details: We expect countries to forge new trade relationships and reroute supply chains. We might be surprised at how fast these can develop. The US may become vulnerable as the US importer or consumer bears the brunt of the tariff burden. The weaker US dollar may be reflecting these shifts.

US Monetary Policy

Our view: While the timing is uncertain, we expect further rate cuts.

The details: We expect that inflation will continue its disinflationary trend after a temporary jump from tariffs. We think the Fed probably has enough confidence in the disinflationary trend that it would respond to a rise in the unemployment rate with further rate cuts.

US Corporate Profits

Our view: 2024 was a very strong year for earnings. Consensus expectations for 2025 are gradually drifting lower but high-single-digit growth is still expected.

The details: We believe bottom-up consensus expectations for US corporate profit growth are likely to slip from the current +10% rate. Consumers and businesses are pulling back on consumption and investment in the face of tariff uncertainty, which will hit earnings. Nevertheless, we still believe 6% to 7% earnings growth is achievable in 2025.

US Credit Risk Premium/Risk Appetite

Our view: Credit spreads were very tight at the start of 2025 and now offer more value as volatility has increased.

The details: Tight credit spreads have led us to look for value in other segments of the fixed income markets. We would view further spread widening as an opportunity because all-in yield remains attractive.

Inflation

Our view: Tariffs should interrupt the disinflation trend.

The details: We are seeing a cooling labor market, which could contribute to softening wage growth. If the unemployment rate moves higher as we expect, we expect inflation to resume its downward trend, allowing the Fed to lower interest rates.

The US Dollar

Our view: We believe the US dollar is overvalued and it appears the US administration would welcome a weaker dollar.

The details: We are seeing consensus growth expectations for the US get marked down relative to other countries. Many countries may fear capital barriers are next and may decide to bring their capital home, which would have a weakening effect on the US dollar.

China

Our view: The enormous tariff increase is a major shock, coming on top of a protracted property market downturn and subdued consumer spending that have weighed on the economy's recovery.

The details: Exports have been one of the few growth drivers for China lately. Many other countries may start to erect their own trade barriers as China has a lot of excess capacity and will be looking for new export markets, potentially undercutting domestic suppliers.

Geopolitics

Our view: As hot wars cool down in Ukraine and the Middle East, trade wars are now exploding onto the scene.

The details: We think hotel rooms will be scarce in the Washington, D.C., area as global policymakers make their way to the US capital to negotiate deals to alleviate tariff penalties.

¹ Source: World Bank, based on 2023 data.

² Unlocking the Credit Cycle (loomissayles.com)

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