S&P Global Inc. (SPGI) Earnings Call Transcript & Summary

Hello, and a very warm welcome to S&P Global Friday Credit focus webinar. I'm Alexandra Dimitrijevic, Global Head of Research and Development, and I will be hosting this webinar for you today. As every quarter, we will be sharing with you the conclusions of our credit conditions committees. These committees are very important for us at S&P Global Rating as they define a house base case which underpins the rating forecast and as well identify the key risks which we are monitoring and could derail our base case. Let me start by a few housekeeping notes. You have a Q&A chat box that I will be checking through the webinar. So please don't hesitate to submit your questions at any time. We'll address as many as we can and answer the others via e-mail. You have also a lot of material at your disposal in the resource widget. You have the slides from the webinar as well as the macroeconomic and credit conditions report that we've published both at the global and regional level and other articles and the speakers bio. And lastly, if you could please take a couple of minutes at the end of the webinar to provide your feedback that would be hugely helpful. Now just before I introduce the speakers, I was reflecting a -- so we actually created this Friday Credit Webinar in April 2020 at the beginning of the pandemic as a way to be able to share with you our analysis of credit global risk and their potential implications on rating. And I'd like to thank you personally for being with us today and through that period. Today, unfortunately, we seem to be back to a period of heightened uncertainties with the war in Ukraine and its escalation, particularly on the energy front with the closure of Nord Stream 1 at the end of August leading to soaring energy prices, particularly in Europe and also, of course, persistently high inflation that is leading large central banks across the globe to accelerate their monetary tightening. And the Fed, in particular, which is pushing the USD to new heights. In China, we have China grappling with the Zero-COVID policy and challenges in the property sector. And really one difference with the situation we had during the pandemic is that Central Bank don't have the same ability to provide support as they are also fighting to pull back inflation and government on their side had a step-up in public debt during COVID and they also have more limited margins of move up. But not everything is negative. And it's really important to remember that we're entering this new phase of heightened uncertainty with some very positive tailwind from the strong post-COVID economic rebound and also 2 years of very cheap liquidity that has enabled a lot of the public sector and private sector players to refinance their debt and push out maturities. So in the webinar today is we are looking -- we are going to look at this balance between the positive tailwind and the heightened uncertainties ahead and their implication at the macro and at the credit level. To do so, I'm delighted to be joined today by our speakers. We'll first have our Global Chief Economist, Paul Gruenwald, who will provide an update on the macro forecast. We will then have Nick Kraemer, who will cover the global credit trends and credit conditions. I've also invited Emmanuel Dubois-Pelerin to provide us with insight on the energy sector, particularly at the European level. And then we'll go around with the share of the credit conditions committees at the regional level starting with Paul Watters for Europe, then David Tesher for North America, Eunice Tan for Asia Pacific, and Jose Perez-Gorozpe for emerging markets. I've also invited my colleague, Roberto Sifon-Arevalo, Chief Analytical Officer for Sovereign Ratings, who will be with us for the Q&A session at the end. Now let me start straight with you, Paul. So Paul, you titled your macro update this quarter, Many Routes To The Bottom. So could you please give us an overview of your latest macroeconomic forecast and the very divergent or different stories at the regional level? And as part of the pre-submitted question from the audience, like you also to answer one. So have we seen before a global environment where most large central banks adopt tight monitory policy and could this exacerbate the depth of the current cycle? And another question, are we headed for a global recession? Now over to you, Paul.

Great. Thank you very much, Alexandra and hi, everyone. As always, it's a great pleasure to present to you today. Just as a warning. I'm in the Singapore Airport, so I apologize for any public service announcements that interrupt my presentation. Yes, let's start with this slide on the screen. The global slowdown is here. As Alexandra mentioned, we issued all of our updated global forecast this week, the regional levels as well as the global level. It's important for us to recognize that the slowdown we're seeing globally is different across the 3 major regions. We would classify the slowdown in the U.S. as more of a sort of classic overheating problem. There is too much fiscal stimulus in the system, monetary policy was too easy for too long, and now the economy is overheating. The economy is running a bit above potential. The unemployment rate is below the sustainable rate. So the job of the Central Bank is to raise rates and tighten monetary conditions and bring the economy back on a stable path. For Europe, we have less of a macro disequilibrium in the U.S. but again, as Alexandra mentioned, there is heightened political uncertainty overhanging the continent, which is pulling down sentiment and growth that may last a bit longer. It's highly uncertain, but it will not be a classical downturn and rebound like the U.S. And then finally, in China, it's more of a policy choice around health policy and lockdowns and vaccination, et cetera. We know that the Zero-COVID policy has pulled down Chinese growth. Overhanging all of this is a large rise in inflation. You can see the heat map here on this chart. This shows the G20 over the last 10 years. The way to read this chart is to read it from left to right, the advanced economies are on the top, the emerging markets are on the bottom. You can see over the past year or so, we've gone very red, which means inflation is well above trend. There's more red in the top half of the chart with the exception of Japan. For emerging markets on the bottom, we've got more of a mixed picture with China, India and Indonesia, not too far off of a trend. But the major challenge is to get inflation under control. So let's go to the next slide. This one shows the policy rate hikes year-to-date of the major Central Banks. These are the advanced economy Central Banks in the G20, and the way we constructed this chart is to put the rate hikes by quarter. So the light blue is Q1, the dark blue is Q2 and the yellow is Q3. You can see that rate hikes have been accelerated. The U.S. and Canada have raised rates by 300 basis points this year. And you can read the other Central Banks off the chart. The last 3 Fed hikes, as we know, have been 75 basis points. So maybe we can call 75%, the new 25%. Inflation has been quite high because of the effects of COVID, energy prices. But now it looks like some of the supply-side inflation measures are starting to level off, and it's becoming more of a demand story. So the Fed is also getting ahead of the other central banks, this is causing the dollar to be at very high levels and it's complicating monetary policies for other central banks in the world. So the USD appreciating as the Central Bank is raising rates, which is what is supposed to happen, but other central banks have the challenge of a depreciating currency, which means everything else constant, they will need to do more to get inflation under control in their economies. Let's go to the next slide, please. As Alexandra mentioned, it's not all bad news and one tailwind almost everywhere is the strength of the labor market. So on this chart, we've got the U.S., Eurozone, U.K. and Australia for economies that we follow quite closely. And as you can see from the chart, unemployment is at or near a multi-decade low. This is providing some support to consumer spending. In the U.S., in particular, we're seeing strong wage growth because of the low unemployment rates. We are identifying labor markets as the key variable to watch as we go into the coming quarters. We know that growth has started to slow. We know that central banks have raised interest rates, and we know that monetary policy works with a lag. So over the next couple of quarters, we'll be watching labor markets closely to see if they really start to go south. If we have a gradual rise in unemployment rates, that would be consistent with a slowdown. But if we see a sharp rise in unemployment, that's a signal that we're probably going into a recession scenario. Let's go to the next slide, please. So we've just released our latest growth forecast. So you can see them on the table here for the major economies. The new numbers are on the left and the right is the change since our previous credit conditions around in June. Green is obviously up. Red is down. If you look at the 2022 column, you see a lot of green there for Europe. That's because Europe had a stronger first half of the year than anticipated on good consumer spending and tourism spending due to the unlocking of -- or lowering of COVID restrictions. The U.S. had a weaker first half. So that's red. But if you go to 2023, we are almost uniformly red and lower, 1.25 percentage points for the U.S., Eurozone about 1.5% with Germany in recession. We're also calling for a moderate recession in the U.S. economy in early 2023. World growth as a whole has been marked down about 1 percentage point. So we're looking at, again, something close to 0 for U.S. and Europe next year, but weakness definitely in the first half of the year and then some recovery coming out of that. A few emerging economies are doing reasonably well. Again, if they are energy exporters and experiencing positive terms of trade shock. We are seeing some positive growth in those EMs, as well as EMs with large domestic economies and reasonably good balance sheets, that would be India and Indonesia. So let's go to the last slide, please, and look at what we are watching. The balance of risks is currently on the downside for our forecast. We're looking at the pace of activity. Economies are clearly slowing. And again, the labor market is the key variable to watch. Inflation and monetary policy are front and center. We think central banks will continue to raise rates aggressively. We're not back in 25 land yet. We've got the U.S. Fed going another 100 basis points. We've got the ECB peaking at about 2% and central banks generally should be leaning higher. EM central banks are a little bit more advanced than the advanced market central banks, so they could be easing earlier. And then geopolitics, we've mentioned already is front and center. And finally, China and COVID. Maybe just to conclude, China, we don't see a lot of downside risks. Actually, there is an upside risk to growth. If the authorities lift the Zero-COVID policy, we could see Chinese growth climbing back towards 4.5% to 5% rather than 2.7%, which is where we have growth this year. In terms of the global recession question, Alexandra, that's kind of hard to define. But again, we've got a recession in the U.S. We've got a recession in Germany. We have China running 2-plus percentage points below trend growth. So that may be a global recession already depending on the definition. And again, we think there will be significant weakening across the board in the next couple of quarters. So back to you.

Thank you very much, Paul. So all eyes on employment in the months to come. Let us move to Nick. So Nick, I have 2 sets of questions for you, one on rating trends. So far, we -- rating seems to have been quite resilient given the current environment. So why is that? And how do you see default tracking year-to-date? And where do you see them going in 2023? And second set of questions, Nick, on market conditions. How fast have market conditions deteriorated and how much worse could it get? Over to you, Nick.

Okay. Thanks, Alexandra. So to start off in terms of how bad has it been? And I think you've alluded to this already as well. I just want to lay the groundwork or at least at a very high level of starting point for where credit momentum has been and to maybe start to look at where it could go with at least -- I'll leave the other headwinds to my colleagues here, but just to talk about financing conditions briefly. What we have seen so far, and this goes back to 2021. But on the left, we're looking at monthly rating actions globally. So upgrades and downgrades and the line there, the gold line is the net cumulative upgrades and downgrades. So you can see there were a lot of downgrades in March, and that was largely because of the conflict in Russia and the impact on issuers because of that. It was still positive through the first quarter. But where we are now, we're starting to see this build up in momentum on the negative side and bringing the net downgrades into negative territory through September. On the right, looking forward, is this is our outlook -- our ratings bias based on the proportion of negative outlooks and credit watches. That is very low. So that's the good starting point as well but it is starting to tick up in most regions. And given the headwinds that we're elaborating here, this is the starting point. We're calling it an inflection point in credit, at least in the post-COVID period. So with the momentum that we're starting to see and with some of the indicators for looking forward, we expect downgrades and defaults to pick up moving forward. Let's jump to the next slide. Market conditions, it's the year of yield essentially, rising yields. On the left, we're just looking at that pace over the course of the last 2 years, and you can see the increase began and just really at the start of 2022 within the first week. That was when the Fed's December meeting minutes were released, and there was talk for the first time about QT happening and yields have just been on an upward lurch since then. And the sovereign yields I'm showing here really mirror what we've also seen within corporates. A little bit of a reprieve over the summer, maybe some bets that the Fed might pivot or inflation might come down. That has, obviously, since reversed course. This has been, I would argue, in terms of issuance, back to that question, the primary constraint so far this year, and issuers have been able to be more interest rate sensitive as well. They've built up a lot of buffers, cash buffers in the last 2 years as we've seen a great -- a tremendous amount of issuance in '20 and '21, and they pushed out maturities further. So there's less of a pressure to repay principal as much as historically. But execution risk, too. This is on the right, just looking at the average 5-day change in the 10-year treasury yield. This observation also applies for investment-grade corporates. So far, this has been the year, at least back to 40 years or so, where we've seen the largest average to approximate a weekly increase in yield. What's -- what you can maybe see here, and if I were to set this up chronologically, what we do typically find may be a bright spot is that in years when yields increase by this much on average in short periods of time, it's typically followed by years where they decline by either a large amount or maybe we'll get a couple of years in a row with less pronounced declines, but still declines. It's rare to see 2 years in a row of marked increases to this extent, but we are coming off of a very low base level. Please jump to the next slide. Because of those benchmarks, what we're seeing with spreads is that they're relatively subdued. On the left-hand side, in Europe, they're higher, perhaps unsurprisingly because of the additional stressor, the conflict. But for the most part, they have been tracking with each other relatively in parallel. Asia might be a bit of an outlier there. It's not much higher the emerging market, Asia spread, not much higher than where it was at the beginning of the year. The impact on issuance, no -- probably don't need much reminders, but just to put it into start display using U.S. spec rate as an example here, down almost 80% in the year-to-date. That lower bar on the top is through September. Leveraged loans have fared a little bit better but those are -- that gap is widening over the course of this year. If I just jump to the next slide, and what Paul mentioned, an additional burden for emerging markets and just the global economy generally, the strengthening dollar. The top currencies here that have chosen on the left are really the ones that we've seen be the largest contributors to non-U.S. issuance in terms of denomination -- currency of denomination. And on the right, if you think about that decline that I showed earlier in the U.S., this is looking at spec rate issuance for emerging markets, which is down about close to 90% because primary markets have been relatively closed. Issuers and investors really averse to it in such a rising rate environment, but look at how much of that is dollar-denominated as well. About 90% of the last 5 to 6 years has been all dollar denominated. And if you have these spec rate issuers with revenue coming in, in their domestic currency, this could obviously present an additional headwind. I'll just finish quickly looking at the default forecast on the next slide. As I've said, we are expecting them to increase through middle of next year to about 3.5% in the U.S. as a base case and 3% in Europe. But I think in summary, when we think about what is driving financing conditions, what could continue to, it's really been the Fed. The Fed has been in the driver's seat. It is a car full of risk and to extend it even further the -- it's inflation boulevard that they're navigating. So I think until that starts showing signs of subsiding interest rates, we should expect will probably continue to increase. Market expectations are reflecting that as well in terms of where the Fed is going through the year-end, another 5 quarter point increases and maybe with some more even by mid of next year. So with that, I'll hand over the keys back to you, Alexandra.

Thank you very much, Nick. And we will come back in more details on the potential rating actions or the sectors or geographies more impacted as we go later through the 4 regions with the credit conditions committee chairs for the regions. But before we do that, I'm very pleased to be joined today by Emmanuel Dubois-Pelerin who will provide us with an overview of the situation in the energy sector, particularly in Europe. And Emmanuel, I have 2 questions for you. The first question is what is the risk of energy shortages and monetary cut in gas consumptions for corporate and household in Europe for this winter and the next? And the second question is, how do you think European governments are going to address simultaneously the question of affordability, demand reduction and energy transition? So Emmanuel, over to you.

Thank you, Alexandra. Hi, everyone. We think this summer marked turning point in Europe's energy markets. Governments realized they must intervene on several fronts to support very nervous physical and futures markets for both power and gas. Indeed, as we speak, the U.S. meeting to discuss key proposals from the commission to effectively redesign energy markets. A first key point, in our base case, significant gas rationing. Your question Alexandra does not occur this winter. Significant downside risk around this scenario mean that prices, anyway, will remain very high and volatile. And for power too, since for now, gas acts here as a price set up of power. As we'll see in the next 2 slides, looking 2 winters out, we believe high volatile prices will persist for a couple of years. Government, especially in the EU, need to balance 3 objectives, which are not easy to reconcile supporting affordability and inflation containment, enhancing security of supply now via reduced consumption, and accelerating the energy transition. Plus in resolving this trilemma, governments face 3 constraints. Time, they need to decide to implement fast; second, having several levels of decision and implementation, EU, national and local; and third, solving for various degrees of gas dependency, power mixes and financial firepower across [ different ] states. The U.K. faces different priorities and constraints. We see various national and EU-level initiatives with some of the largest countries, focusing a lot on direct affordability measures as the U.K., France and yesterday, Germany unveiled. We believe the more structural initiatives may at some point, have a stabilizing impact on power and gas markets, notably around decoupling power prices from gas and then in the nearest term around supporting liquidity on futures exchanges. From a credit perspective. Among corporate losers are, on the one side, energy producers and suppliers facing physical shortfalls. And on the other side, energy-intensive industries, like fertilizers, glass, metal, paper and others. This is unless these industries can easily switch fuel, raise imports or demonstrate sufficient pricing power. Otherwise, by pausing and winding down production, this demand destruction helps the European gas balance. Beyond Europe, impact of [indiscernible] for utility space soaring spot energy prices. Next slide, please. This slide shows wholesale gas prices over 2019 to '25 for easy read. We show them in both USD per BTU and EUR per megawatt hour. Double blue arrow is our approximation of the gas price equivalent of the EU's proposed per price cap. Since last summer you can see, i.e., before the war of Ukraine, prices have been steadily increasing and being volatile. Relative to the pre-pandemic 2019 average, in September, the gas price has been multiplied by an astounding 14x and year-on-year by 3x, plus Q4 liquidity monitoring is that at its August 26 peak, gas was 20x or the equivalent of $550 per barrel of oil, considerably trading liquidity on power future exchanges and of some utilities handing on them. This prompted the emergency responses by the U.K., Swedish and Finnish governments which set up massive government liquidity schemes, as Germany had done in the spring. Last month, we raised our European gas price assumption significantly from the yellow line up to the black line. And even so, we see upside risk to these assumptions. As you can see, they remain below what futures markets indicate today. As you can see, the European Commission's proposal also for EUR 180 per megawatt hour power cap balances pretty well, we think currently extreme prices with the prices enjoyed until mid-2021, that is -- those on which investment decisions to add renewable capacity were taken. Next slide, please. So as we saw, we believe prices will be high and volatile for the next couple of years. But why so? It's notably because the second winter out constitutes yet another challenge for Europe's physical gas balance and why so? Because exiting this winter, stocks likely will be fairly low. And because sustained January to May 2022, Russian supplies need to be offset because it would have [ disappear ]. This is the challenge the left graph illustrates. It shows our view of the 12-month gas balance from [indiscernible] for Europe, including the U.K., assuming demand decline accelerated to a sustained 12% as well as sustained LNG and pipe imports. Even with the new LNG floating terminals, a deficit is plausible. This is possibly why futures markets today remain nervous and continue to price gas very high until summer 2024. Risk around this scenario are primarily around too slow a reduction of residential demand and harsh winter, which could raise annual demand by up to 7%. But let's end on a ray of hope. And the right-hand graph calibrates the benefits of the energy transition from a gas supply perspective. It shows the gas savings that would result from a 1:1 substitution of additional renewable power generation blue for gas fired in brown. We estimate that every year, new renewable capacity may substitute some 3% of European gas demand. So the tunnel is 2 year long, but this is one of several reasons to see an end to it at some point. Thank you. Back to Alexandra.

All right. Thank you, Emmanuel. So 3 years -- 2 years to go. So after we've set the scene now at the macro level, financing conditions, energy, which are all critical for credit, and we're going now to move on to credit and ratings trend at the regional level, starting with Paul Watters for Europe. And Paul, I'd like you maybe to first start by talking about the implication of the conflict in Ukraine on -- from a credit perspective and also given the environment that we've just described, in which sectors and countries do you expect most vulnerability in terms of credit quality? And how high do you think interest rates could go in Europe? And is that a concern from a financing perspective? Over to you, Paul.

Thank you very much, Alexandra. And yes, thank you, Emmanuel, for sort of laying out the energy story so well. So look, yes, this conflict in Ukraine is clearly another major geopolitical shock. And after the recent advances by Ukraine, Russia's reaction, as we know, it's been to signal an escalation of its military and economic conflict, both with the Ukraine but also with the West. So unfortunately, that means high uncertainty, significant downside risk. And from our point of view, no real visibility on how and when this conflict will end. So in terms of the implications, Emmanuel has already talked a bit about this, but obviously, Russia has weaponized gas supplies to Europe, and that represents a huge negative terms of trade shock. Over 3% of Euro area GDP basically arising from just the loss of Nord Stream 1 on its own. And don't forget Russia is still supplying 35 billion cubic meters a year through Ukraine south stream as well as, obviously, LNG. And that is still potentially in a downside scenario, quite significantly at risk. Emmanuel has talked about the pricing. I mean that's going to stay well even through '23, '24 winter still stay very high. So in terms of credit implications, clearly, I think we expect to see downside credit pressures building as buffers start to be eroded in this sort of more high inflationary environment, and in particular, we're watching how consumers are responding to falling disposal incomes as well as implications for sales volumes from a corporate perspective in the slowing growth environment. How margins are developing and you can see on the chart on the left, that many sectors are starting to see margin erosion in 2022 versus 2019, and that's below the line. After many had a record year in 2021, if you look at then the right-hand side of the chart. Liquidity, always important, particularly at the moment. Managing working capital and inventories is a key focus for corporates right now. M&A and investments, not quite so much, apart from obviously on the renewable side. From a banking perspective, asset quality remains key, and we're watching SMEs and consumer lending. Those are the 2 portfolios that perhaps will see some early signs of deterioration, and we expect to see that perhaps during the course of 2023. In terms of sector vulnerability, Alexandra, I mean, obviously, cyclical capital and energy-intensive sectors are in the spotlight here. So capital goods, building materials, chemicals, autos and glass. And Emmanuel mentioned glass, fertilizers and paper packaging sectors as well. Consumer discretionary sectors. Clearly, retail, travel, leisure, media and entertainment. And I would point out that leisure and travel benefited from the delayed sort of bounce back post pandemic. But we don't think that's going to last. Real estate. Yes, I mean, we factored in some lower occupancy assumptions on real estate but margins are still under pressure, particularly where landlords are not able to pass through inflation through indexation provisions. Utilities, well, Emmanuel is the best person to talk about that. But typically investment grade. The sector is under close surveillance due to liquidity pressures caused by the high prices and extreme volatility in energy markets. Stand-alone credit profiles have come onto some downward pressure, although mitigated in several recent high-profile cases by the provision of extraordinary government support. Leverage finance, still -- we still have around 30% of speculative great companies B- and below. And concerns are really centered on those that are unable to generate free operating cash flow. If you look at the chart on the right, a recent study that we did highlights the vulnerability of cash flows of many BB and B rated credits to a fully fledged recession. Around 40% of B+ and even BB credits could become free operating cash flow negative as shown in the chart on the right, in a full-fledged recession scenario. To finish on this, country-wise. Countries highly dependent on natural gas and gas for power generation, so Italy, Germany, 2 countries, but also consumer-driven economies like the U.K. that have a particularly higher share of B- and CCC-rated companies. And in this context, actually, I would just highlight -- point out that we did revise to negative our trend for economic risk faced by the German banking system in July. If we go to the next slide, yes, in terms of the financing question, how high do we think interest rates will go, and is that a concern? I think there's 2 points to make from the rate side. I mean, central banks, as Paul has already described, having to accelerate our front-load there at the tightening given the macro environment that we're experiencing. So we now see ECB raising the refi rate to 2.5%. So that's top end of the neutral range by Q1 '23, and the Bank of England raising their rates to 3.5% by Q1 '23. And so that's above the neutral rate that we think is around 2.5% to 2.75%, but both are still quite well below market-implied levels, as you can see on this chart on the left here. But actually, let's not forget the quantitative tightening is also very important part of the story is that will raise risk premiums and yields further when that really kicks in. Bank of England has pushed back the start date for the QT program to the end of October, reducing their balance sheet by EUR 80 billion over the next year. But the ECB hasn't even -- is still reinvesting their maturities. So they haven't even laid out a timetable yet when they will start stopping reinvestment, let alone shrinking their balance sheet. So is this a concern? Just to finish. Clearly, much tighter financing conditions than we've seen for many years. That's what we should expect. And from our perspective, we think that's more of a problem, an issue for speculative grade than investment-grade companies. I mean cost is important, but market access is critical. And we expect speculative grade refinancing really to become a more pressing through 2023 as 2024 maturities come on to the horizon, given the maturities being pushed out. And one final fact, 11% of the EUR 750 billion due to be refinanced next year is speculative grade. So that's really quite low compared to over 20% of maturities that we typically see will need refinancing in a normal year. And that's not going to kick in till more like '25 or '26. So back to you, Alexandra.

Thank you very much, Paul, for that deep overview on Europe. Let's move to the U.S. and with David Tesher, and David in light of the shallow recession and accelerated Fed tightening, where do you see the largest credit pressure? And could you please also speak about the trend in the U.S. real estate market? Over to you.

Thank you, Alexandra. Just so let me start with this graph that we have in front of us, which we've used in several of our last commentaries as well as in several publications, what it tries to capture is effectively cost pressure that's arising at the nonfinancial corporate front. So the vertical axis essentially is a question we've asked to our U.S. sectors. And I won't get into the details that Paul just alluded to. But the bottom line here is that you see the ability to pass on additional costs and you see the placement that our sectors have provided us every quarter here. The top vertical -- I'm sorry, the top horizontal access looks at EBITDA margins contrast in 2021 versus 2022. Let me focus on homebuilders as an example this quarter, which is in the bottom right quadrant. What you see here is a sector that is vulnerable to rising interest rates and obviously, recessionary pressures. And the last quarter, we actually had homebuilders looking at basically reflecting the ability to somewhat easily pass on additional costs to the end consumer. And their EBITDA margin was just going to fall a little. Now the actual homebuilder sector is more in a position where it's more somewhat difficult. And the EBITDA margin implication for 2022 is fall moderately versus falling a little. Now I would like to spend more time going into in terms of some of our stress sectors, retail and restaurants and the consumer product in particular. If you look at our outlook for retail on consumer credit has become increasingly negative since the spring. That's when we first started to see consumers pushing back from inflation. Today, weakening consumer sentiment, persistent inflation in freight, labor and logistics, and the ongoing stress in discretionary purchasing power have all contributed to the buildup of inventory levels. This has basically been further amplified by the just-in-case versus just-in-time inventory management that evolved in the post-pandemic environment. Bottom line, we now have a growing negative bias for our retail ratings, which factors in an increased inventory management risk, and that's going into the holiday season. This pain is even more pronounced in the consumer product sector where more than 1/3 of the credits we have rated have effectively a negative outlook. This is the most negative at the moment across all corporate sectors. In particular, smaller issues with vulnerability to discretionary sales and who have less financial flexibility or a particular risk. We've talked about the strong dollar, and that's been an issue that we've seen. But from a corporate credit perspective, it's good for imports because it tempers inflation. But at the same time, it may be headwinds for companies that have exposure to foreign markets. We've been cautioning at our top risk that a disorderly reversal could become problematic. So let me go to the next slide, if I could, to really address your question about the U.S. real estate market. This is an interesting graph on the left. It was extracted and you'll see the bottom footnote, it was extracted from an RMBS publication that came out in September 15. And what you see here is a chart that shows June of 1992 through June of 2022 data points. It's from 9 regional census divisions from the Federal Housing Finance Agency and the vertical bar spotlight when price declines were signaled by one of the regional census divisions. As of June 2022, the right side, 5 regional federal housing finance agencies are reporting home price to clients. That's the bar on the right. What I think you should look at is take your time and look at the contrast between 1992 and effectively 2022 at the June data points and check out of essentially the backdrop regarding what type of economic credit cycle we were in and what type of credit market environment we were in. It's interesting to look at this. The yellow line reflects annual home price appreciation. And I think an important point here is that we still see growth in 2022. However, it's decelerated to 15% now versus 20%, which was reflected in 2021. Again, directionally, it's going down. Regarding the commercial real estate sector, that's the bullet point on the right side, I'm not going to go into. But the refinancing risk that we've talked about, that Paul mentioned, yes, companies, in the case of nonfinancial corporates have pushed out the maturity issue and refinancing is not as prevalent, not as much of an issue. But in the commercial real estate market, it may be more challenging than in recent years, given the fact that benchmark rates are going up and some of the spaces that we effectively look at commercial real estate, in particular, may be more vulnerable to recessionary headwinds. With respect to some of the looming stress that we're seeing, office, retail and lodging, all of these sectors are essentially stressed and is contributing to declining valuations. But from an office space perspective, we believe that the Class A office space will outperform Class B in a period of an economic contraction. But note, there will be variances by property type and ultimately their market. Lastly, in terms of going to the next slide, if I could, on the top risk. I just wanted to effectively show that our top risk at the moment, we have this conversion of risks but the top risk that we are looking at right now is the U.S. sliding into a more deeper and a more protracted recession for 2023 versus the short and shallow base case recession forecast that Paul Gruenwald alluded to earlier. This is now our front and center risk. The risk that you see underneath are converging, and these are the risks that we can talk about in greater detail in our top risks in our report, so I encourage you to look at that. With that, I would like to go back to you, Alexandra.

Thank you, David. And indeed, there's a lot more in all of the reports, if you want to go deeper at a regional level or in the global report. And you have our top 3 stable both at the global and regional level in the slide deck and in the report. We have 2 more regional presentation, and then we'll go to the Q&A. I see some questions coming in that we will address during the Q&A. I'd like to move to Eunice, and Eunice starting with China, looking at the credit implications of the Zero-COVID policy, challenges in the real estate sector and the geopolitical situation. And then outside of China, looking at the implication of the domestic currency depreciation. Over to you, Eunice.

Thank you, Alexandra. Yes, a slower China coupled with the fears of protracted recession in the U.S. and Europe are putting the brakes on business and consumer confidence. While lower Chinese demand will help ease inflationary pressures, corporate revenues, particularly the downstream could see contraction. Now these are posing significant headwinds for Asia Pacific. As Paul Gruenwald has mentioned in his economic presentation, China's slower growth momentum is mainly attributed to 2 areas: the country's Zero-COVID policy and the ongoing real estate challenges. The country's COVID lockdowns have dented consumption and economic activities. Consumers are spending lesser, evident from the acceleration of deposits underlying the impacts to businesses and households. Now it is hard to predict when the Chinese government will adjust its overall COVID-19 stance. Now at this moment, within the analytic practice, we assume a meaningful lifting of restrictions will happen after 2023 first quarter. However, this easing will most likely be gradual. So this means the deployment of mass testing and containment measures to limit COVID outbreaks will continue to drag on fiscal strength of local and regional governments in China and also hurt mobility dependent sectors, such as leisure and retail. Now meanwhile, the lingering real estate growth is impacting market confidence, low new home sales and declining home prices persist, now despite the introduction of stimulus by the authorities. These weak sentiments will continue to hinder the overall economy in 2023. Now for Chinese issuers, financing access had also narrowed as the offshore bond market for high-yield issuers and the longer tenor onshore bond market for privately owned companies have shut. Now with liquidity squeeze, we could see more defaults. For global trade, the bigger area to watch would be geopolitical developments, the submarine tensions underlying increasing geopolitical polarization of Russia and China versus that of the U.S., Europe and their allies. Now this prolonged tensions could reverberate to the rest of APAC with spillovers to the global technology trade flows. Now in the case of the rising cross-trade tension between Taiwan and Mainland China, semiconductor companies could face the highest risk since the bulk of the capacity is located within Taiwan. Now while companies like TSMC are building fabrication plants in the U.S. and Japan, overseas capacity will remain limited over the next few years. Next slide, please. So I think, Alexandra, to your next question around the currency depreciation for Asia Pacific. Now except for China and Japan, the region's economies have embarked on rate hikes to match the Fed's profile. This is to stay for capital outflows and depend their currencies from depreciation. Now despite so, as you can see from the chart, most Asia Pacific currencies have cumbered against the USD of late. And this weakness could be set to assess a bit even further, should there be additional U.S. fed hikes. Now the region's emerging markets will fuel the currency pains more acutely. For Asia Pacific companies, the pain comes from multiple fronts. We continue to see inflation, borrowing costs and refinancing excess challenges to dominate our risk radar. Now with major commodities being priced in USD, the stronger dollar were a bigger windfall for commodity and energy exporting countries and sectors. However, for manufacturers, this could enter costlier imports and input costs. Now regional central banks could earn on the side of tightening should imported inflation worsens. Now so more select -- more selective discretionary spend, but consumers will make passing through of these higher input costs more challenging. Corporates may be required to cut unit volumes or costs. So at the same time, the Fed's accelerated rate hike and inflationary pressures could see investors demanding for much higher yields and risk premiums to compensate for taking on the risk and to beat inflation. So for the highly indebted and dependent on offshore financing issuers, all these conditions point to a much more downside for them. Back to you, Alexandra.

Thank you very much, Eunice. And we are going to end up the regional round with emerging markets with Jose. Jose, if you could please join us. In the past, dollar appreciation shock could often predict economic downturn in emerging markets. Based on your observation and analysis, which countries do you think are more vulnerable?

Thanks, Alexandra. Let me begin by giving some brief context. First to understand what's going on with dollar appreciation. We must consider that the USD is the worst reserve currency, and it's used in trading commodities and many noncommodity goods between countries. Its strength, usually, is driven by either global risk appetite. So flight to safety will strengthen dollar. Global financial conditions, so tighter financing conditions also correlate with stronger dollar. And last but not least, the Fed's monetary policy tightening also implies a stronger dollar. So all 3 channels are active today. First, as you know, and we have described over these sessions today, the Russian and Ukraine conflict has triggered uncertainty and flight to safety. Second, there's ongoing monetary tightening worldwide, not only in the U.S., which has reversed accommodating financial conditions, and third, there's continued upside surprises in the consumer price inflation than in the U.S., which has turned the Fed decisively hawkish. The combination of these factors has meant that the dollar has strengthened against currencies in advanced economies as well as in emerging markets. You can see that on the chart on your left. And -- on the case of emerging markets, lower gains against emerging markets is partly reflected of the composition bias in the aggregate exchange rate index that we are comparing last year. But also on the chart on your left, you can see that in the first months after Russia invaded Ukraine, the dollar was relatively stable against emerging markets as rising commodity prices split emerging markets down in the middle which benefits commodity exporters but hurts commodity importers EMs. The balance shifted early in June as the Fed turned decisively hawkish, which caused emerging market currency to fall almost across the board, as you can see on the chart on your right. This highlights the key role of the Fed has played in driving emerging market sell-off. It's too early to tell if the worst of emerging markets currency weakening is behind us, given the unusually high uncertainty related to the supply-driven inflation dynamics. The war appears to be a drag on food and energy commodity prices and the strengthening dollar has made it even more expensive for emerging markets importers of these commodities, highlighting that dollar appreciation episodes are relevant for emerging markets in several fronts. Looking to these fronts, the first one, of course, is the potential cost pass-through on consumer price inflation, especially in countries that are net commodity importers. Food and energy inflation, as we have spread in past is particularly harmful for emerging markets as their households spent much more than in these goods relative to advanced economies. Therefore, high food and energy inflation has the potential to quickly erode emerging markets household purchasing capacity and living conditions. This, in turn, undermines domestic demand growth, which ultimately hurts corporation earnings and bank's asset quality which, of course, could lead to downgrades in these sectors. The second reason is that the pressure on the financial conditions via rising interest rates in the U.S. and other advanced economies tightens financing conditions in local markets from the resulting portfolio rebalancing and capital outflows. Tighter financing conditions usually lead to amplified refinancing risk and higher financing costs for overall EM issuers, especially those are the lower-rated spectrum. Now this particular appreciation cycle has many concerns compared to the past one. This time around, we have many compounding risk as more of my colleagues have already expressed. One key risk, if we go to the next slide, please, is that inflation remains high. We can see on the left chart, you can see the gap between the central bank's targets and our expected inflation for the end of the year. The gap is pretty wide, mostly across the board. There are a couple of emerging markets in APAC that are actual exceptions. Now we expect inflation will gradually come down during 2023. However, it -- right now, our expectations point towards higher inflation than we previously expected. And it would probably remain above central bank's targets for many emerging markets. In particular, we expect core inflation to stay above central bank targets across many EMs for the rest of the year and well into next year as past increases in energy prices and higher input prices from currency depreciation spillover to broader core items. On a sequential basis, inflation appears to have peaked in many EMs, but it will remain elevated owing to second round effects as higher energy and food prices are passed through services prices. Now higher inflation expectations, you can see this on the chart on your right, and the hawkish U.S. Fed and other major central banks will continue pressuring emerging market central bank to raise interest rates in the next few quarters, keeping inflation expectations anchored. And protecting capital flows will be top of mind for monetary policymakers in emerging markets. So we can expect interest rates to continue to be pressured over the next couple of months. There are some positive factors for EMs as well, and I would like to end my comments on a positive note. So something to consider is that some key emerging economies benefit from high commodity prices, countries such as Saudi Arabia, especially those that are net energy exporters are benefiting. Most emerging markets external accounts look better than in previous Fed tightening cycles. And also foreign exchange reserves are adequate in most of the emerging markets. And last but not least, exposure to foreign debt is lower in most key emerging markets with, of course, some notable exceptions that include Chile, Colombia and Turkey. Just to leave an out of the most fragile -- most fragile emerging markets have a combination of factors that include legacy weak fiscal flexibility and high deburden along with high exposure to foreign currency-denominated debt which is also relevant to look beyond sovereign accounts and into corporate and banking sectors since unhedged foreign currency exposure could also carry relevant risk for economies. On sovereign ratings, we capture all these risks. And when looking at creative emerging markets, the ones that are more vulnerable to weakening conditions include Argentina and Salvador, Ethiopia, Ghana, Mozambique and Pakistan. Other emerging market countries fundamentals might weaken, and we could expect increasing downgrades for the next quarters. I will end my comments there, Alexandra. Back to you.

Thank you very much, Jose.

And I'm now going to ask all the speakers to come on screen to address some of the last questions. We have one question, which is for Paul. Paul, given all of the headwinds prevailing in the slowdown today, have there been ever a similar setup where employment had not deteriorated?

Thanks, Alexandra. The short answer is no. Unemployment will always go up as the economy slows. That's something we call the fill-ups curve. But I think the question is really about can policymakers get inflation under control and only have a rise of unemployment to say the neutral rate, which would be 4.5% in the U.S.? That has been extremely rare. Given the size of the gap between current inflation and where it needs to go, which is around 2%, we have very few examples of central banks achieving that without causing a recession. That's why our U.S. team is now forecasting a moderate recession in the U.S., and we have downside risks across our global macro forecast. So back to you, Alexandra.

Thank you, Paul. I have a question for Roberto on Sovereign. COVID already led to a step up in sovereign debt. Now with the energy crisis in Europe, governments will likely have to provide massive fiscal packages. What does that mean for sovereign ratings?

Thank you, Alexandra. Well, in short, it means that negative bias is going to increase, and in some cases, it's going to increase a lot. I think my colleagues did an excellent job of explaining how difficult financing conditions are and will be for the next -- at least for the next year. If you think about one of the key features that governments could rely on during COVID, was the fact that they were able to put in massive fiscal stimulus, a record low cost of financing. Now the opposite is true. They had to again provide in many cases, as we've seen recently, some announcements in Europe significantly pretty heavy fiscal stimulus and the cost of financing that made us easily digestible and sustainable in the past is no longer there. Today, you have monetary policy and fiscal policy at odds in many ways. And unfortunately, it will take, as Paul was mentioning, many economists to go into recession for those to maybe start working in the same direction. The other feature here that I think puts a fair amount of pressure on sovereign ratings is the duration of this. If you compare, again, using COVID, we -- the world locked itself up until we were able to produce a vaccine. And there was kind of a horizon that we could all look at to say, okay, it's up to here and then we can reopen the economies. Many of the forces at play now that are behind this crisis. I mean, there's never a good time for a conflict, but definitely, the invasion of Russia in the Ukraine, it came at a terrible time in the global economy and monetary policy cannot control that, right? So how long are we looking? If we look at the presentation that Emmanuel made shows very clearly that the pressures on energy are not going away 2023, are likely to remain here in 2024, which means just to end that sovereigns will continue to need to do the heavy lifting, again, at a very high cost. So I think the outlook is, in general, if you look at the 137 sovereigns we have, you could say, stable. A lot of that is coming from the recovery that we saw during 2021 and early 2022 as many economies reopened. But as we look forward, I think the challenges are rather large.

All right. Thank you, Roberto. Next in line, and please all speakers, if you can look at the list of questions. The next in line is for Nick. Are corporate maintaining the cash buffer built in 2021 to hold them over as primary market activity slows down and what has been the uses of cash?

Okay. Yes. What -- it seems like that those cash buffers are indeed coming down, certainly from the levels that they were at in 2020. There can be a little bit of a lag with this data, but it is -- it has been falling -- in aggregate, it is still high, historically. But this has been coming down. It looks like median cash ratios are coming down. So liquidity, not may be as strong as it was last year, a year before. But it can, I think, depend on where you are in the rating spectrum. So there's still probably arguably a bit more on the investment grade side and these levels of cash have been coming down a bit on the spec rate side and some of our internal forecasts appear to be tempering themselves down as the year moves on. So -- this is something we'll be watching. I think other sources externally are starting to show the same thing that they're falling rather quickly, lately, this year, in particular. But again, I think it supports still from what I've seen the same argument that these declines aren't as -- aren't yet matching the increases in cash that we saw over the prior 2 years.

Thank you very much, Nick. So we have time for 2 very quick questions. One is for Jose. Can you talk about the difference in rate hikes and market implied interest? And then one last for Roberto and then we'll conclude. Jose, over to you.

Yes, I'll try to be very fast with this. So there's definitely a lot of interesting credit factors going on in the different interest rate hikes in emerging markets. I think one thing that is probably a positive factor is that we have these central banks that were very focused on anchoring inflation expectations early in the cycle. So they are -- some of them are not that behind and they were faster to actually tight interest rates as inflation came in. That definitely is driving a lot of the differentials that you're looking at now. But I think that's something that wasn't present when -- early in the year when inflationary pressures were the resulting of supply chain disruptions, it's the extra pressure from energy prices coming from the conflict. So right now, you have 2 extra pressures. The energy price is coming from the conflict and the Fed, much, much faster interest rate hike. So those 2 factors will definitely prevent central banks going forward to actually perhaps stop the hiking cycle and even going -- try to kind of ease the monetary tightening going forward. Our baseline is that we will continue to see interest rate hikes that the Fed will continue to pressure in most emerging markets going forward. Back to you, Alexandra.

Thank you, Jose. And the last question will go to Roberto. Roberto, we have a question on the situation in Sri Lanka and Pakistan and as well if this could spread the rest of it? Back over to you.

Thank you. Well, maybe start by the last question. I don't think this is something that could stay -- spread to the rest of Asia. As a matter of fact, I think especially Southeast Asia is an area where we look at and where you can find some good momentum and good activity, I think pretty -- relatively good balance sheets across governments. Both the situations in Pakistan and in Sri Lanka, I think they're the product of many decades of endemic problems. Sri Lanka, as you know, is on default, and currently, on talks with the IMF and trying to secure a package in order to be able to cure the default. In the case of Pakistan, still not in default, of course, facing serious pressures. We currently rate them at B- level, which is very low. The key feature is that Pakistan does have a fair amount of levers where -- from where you could still pull, are still receiving financing from China, financing from also Saudi Arabia, which Sri Lanka did not have. And also one other, which is a new development is also the fact that they have also started serious talks with the IMF as well to try to receive some type of support package. Having said that, of course, a lot of the rationale behind why the economic situation is what it is, it is because a lot of structural efficiencies that will need to be addressed and will not be easy to be addressed. So the situation will continue to be stressed in those 2 countries.

Thank you, Roberto. We have to conclude the webinar for today. We will address the other questions directly via e-mail. I would like to thank all of you for joining us today. And thank you to all the speakers and wishing everyone a nice weekend. This concludes our webcast for today. Bye.