US mid-market CLO rally "unlikely to last"

The recent rally in US mid-market collateralised loan obligations (CLOs) is unlikely to last, according to S&P Global Ratings analysis.

The market had a bumper first quarter of 2025, boosted by active issuance and growing demand for private credit.

Defaults fell amid improved market conditions, the report said. Rating performance remained resilient during the first quarter, with downgrades slowing to the lowest level since 2023.

However, US President Donald Trump’s tariff announcements since early April have sparked widespread market volatility, with changing policies prompting a period of prolonged uncertainty.

“The primary impact of tariffs on the credit estimated companies in S&P Global Ratings’ middle-market CLO universe has thus far been limited, given the portfolio’s concentration in service-oriented sectors including software, health care, and professional services,” the report said.

“But second-order effects could weigh more heavily on middle-market borrower performance moving forward.

“Broader economic trends will influence not only growth and consumption, but also cost of funding for the middle market, where loans are predominantly secured floating-rate instruments tied to benchmark rates set by the Federal Reserve.

“We expect tariff-driven price increases will lift core inflation, and this may result in fewer interest rate cuts this year than investors had expected. Borrowers whose cash flows are already strained by elevated interest charges would experience exacerbated difficulties.”

However, the analysis went on to say that the repercussions of tariffs “may be tempered” on the middle market, as many CLOs are focused on less-effected sectors such as software and healthcare, that are not directly disrupted in global supply chains.