- Interest rate volatility and policy uncertainty have driven term premia higher
- A looming liquidity squeeze will tighten bank lending capacity
- Private credit gains traction as borrowers seek flexible financing
- Investors pursue high yields with floating-rate protection, fuelling demand for private credit
- Special opportunities strategy stands out; it captures excess returns during rate shocks
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A new market reality. Two forces are reshaping the global credit landscape. The first is a structural elevation of interest rate volatility which now moves in tandem with economic policy uncertainty. Since Trump’s inauguration, a deluge of executive orders culminating in the passage of the “One Big Beautiful Bill Act” (OBBBA) has increased unpredictability around fiscal discipline, inflation outlook, and monetary policy. This uncertainty has amplified the risk of adverse market movements, prompting market participants to demand higher compensation for duration risk, resulting in an upward repricing of term premia.
The second force is a looming liquidity crunch expected to materialise over the next quarter as a consequence of the passage of the aforementioned bill. With the debt ceiling lifted, the Treasury will soon begin to issue large volumes of securities to rebuild its Treasury General Account (TGA) toward a target of c.USD850bn by September. Historically, Treasury issuances drew liquidity from the Federal Reserve’s Overnight Reverse Repo Facility (ON RRP) which once saw balances at c.USD2tn at its peak. That buffer is now nearly depleted with balances around a mere USD35bn. As a result, new issuances now draw directly from bank reserves deposited with the central bank. Reserves are a critical component of the monetary “plumbing” system because they determine how much lending banks can provide to the private sector. With reserves now at risk of falling below USD3tn by the end of September, we believe a structural contraction in the supply of bank loans is imminent, accompanied by tighter loan terms.
This squeeze coincides with the implementation of Basel III “endgame” reforms, which raises capital requirements and obliges banks to hold more capital against risk-weighted assets. At the same time, the private sector faces a looming maturity wall of c.USD443bn in syndicated bank loans by 2028, with refinancing likely to become costlier and more challenging under traditional bank channels. The result is accelerating demand for alternative lending solutions.
Private credit has emerged as a natural choice amid these structural shifts. As banks face mounting constraints, borrowers are increasingly turning to private credit lenders for flexible and bespoke financing solutions that traditional channels can no longer provide. For investors, the appeal of private credit is amplified by the new market reality of elevated volatility and repriced term premia. Higher uncertainty around policy and rates has driven demand for assets that can deliver high premia, and private credit is uniquely positioned to offer both high illiquidity and complexity premia. Current yields average c.10–11% with stable spreads of c.200 bps across different rate cycles. Crucially, most private loans are floating-rate, providing a built-in hedge against rate uncertainty and helping preserve real yields in a “higher-for-longer” policy regime. These features have enabled private credit strategies to rebound faster and sharper from volatility shocks compared to public markets.
In a regime defined by volatility, adaptability is paramount. Diversification across private credit sub-strategies offers a practical path to adaptability. Specifically, it can help investors capture differentiated premia across a range of volatility scenarios. Our Monte Carlo studies on empirical private credit funds data suggest a combination of different private credit sub-strategies can ensure outperformance across various volatility shock scenarios.
Special opportunities funds stand out across the private credit spectrum, particularly in today’s environment of elevated rate volatility. These strategies thrive in complex, time-sensitive situations, often stepping in where traditional lenders are constrained. They operate across the capital structure — from unitranche loans with equity enhancements to structured preferred equity and transitional financing — without necessarily targeting distressed assets. Rather than pursuing control through restructuring, special opportunities funds focus on pricing risk dynamically and negotiating bespoke terms in liquidity-challenged scenarios. Quantitatively, they demonstrate strong outperformance potential and low loss probability during rate shocks. Funds launched in such periods consistently deliver superior distribution profiles — a “vintage effect” driven by attractive entry pricing when capital is scarce. Rate shocks create funding gaps and orphaned assets, enabling opportunistic lenders to command pricing power, tight covenants, and equity upside. For investors, this translates into faster cash returns, shallower J-curves, and enhanced multiple potential.
Markets are at an inflection point. For investors who can deploy patient, flexible capital, this is a regime that rewards preparation and conviction. Private credit offers the means to capture higher premia while maintaining structural protections. Within this universe, special opportunities funds deserve particular attention for its unique combination of flexibility, control, and ability to capture excess returns from market disruption.
Figure 1: Higher and more “policy sensitive” rate volatility will spike term premium
Source: Bloomberg, FRED, DBS
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