The primary threat to today's tight credit spreads is not weakening demand but a sustained surge in supply, particularly from AI 'hyperscalers'. The concern is how this new debt is employed, as it could fundamentally deteriorate the issuers' balance sheets over time.

The credit market appears healthy based on tight average spreads, but this is misleading. A strong top 90% of the market pulls the average down, while the bottom 10% faces severe distress, with loans "dropping like a stone." The weight of prolonged high borrowing costs is creating a clear divide between healthy and struggling companies.

While default risk exists, the more pressing problem for credit investors is a severe supply-demand imbalance. A shortage of new M&A and corporate issuance, combined with massive sideline capital (e.g., $8T in money markets), keeps spreads historically tight and makes finding attractive opportunities the main challenge.

The ABCP market's composition has shifted, with independent-sponsored programs growing to 42% of the total, up from 30% two years ago. This change is driven by dealers using these off-balance-sheet structures to finance collateral more efficiently, especially as equity financing costs rise, thereby gaining potential accounting advantages.

Unlike equities, credit markets face a growing risk from the AI boom. As companies increasingly use debt instead of cash to finance AI and data center expansion, the rising supply of corporate bonds could pressure credit spreads to widen, even in a strong economy, echoing dynamics from the late 1990s tech bubble.

Hyperscalers could theoretically add $2 trillion in debt and remain investment grade. However, the true bottleneck is the US investment-grade market's ability to absorb this supply without violating concentration norms. Analysts estimate the market's practical capacity is closer to an incremental $510 billion, using US banks as a benchmark for maximum issuer size.

Despite forecasting a massive surge in bond issuance to fund AI and M&A, Morgan Stanley expects credit spreads to widen only modestly. This is because high-quality, highly-rated companies will lead the issuance, and continued demand from yield-focused buyers should help anchor spreads.

Demand for long-duration AI-related debt is waning. In early 2026, a typical 30-year bond deal from a hyperscaler would attract around 15 insurance clients with large orders. By mid-2026, that number was cut in half, providing a concrete sign that key real-money investors are reaching their concentration limits and becoming more cautious.

Enormous government borrowing is absorbing so much capital that it's crowding out corporate debt issuance, particularly for smaller businesses. This lack of new corporate supply leads to ironically tight credit spreads for large borrowers. This dynamic mirrors the intense concentration seen in public equity markets.