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.
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Trillion-dollar tech companies are issuing massive bonds to fund AI CapEx, attracting immense demand from yield-hungry institutions. This 'hoovers' up available capital, making it harder and more expensive for smaller, middle-market businesses to secure financing and deepening the K-shaped economic divide.
The massive ~$1.5 trillion in debt financing required for AI infrastructure will create a supply glut in the investment-grade (IG) bond market. This technical pressure, despite solid company fundamentals, makes IG bonds less attractive. High-yield (HY) bonds are favored as they don't face this supply headwind and default rates are expected to fall.
A primary market risk is a sudden stop in the AI investment cycle. While this would clearly pressure equities, it could counter-intuitively benefit investment-grade credit by reducing new bond issuance—the main factor forecast to widen spreads.
The AI boom's funding is pivoting from free cash flow to massive bond issuances. This hands control to credit investors who, unlike vision-driven equity investors, have shorter time horizons and lower risk appetites. Their demand for tangible near-term impact will now dictate the market's risk perception for AI companies.
Instead of an imminent collapse, the credit market is likely poised for a final surge in risk-taking. A combination of AI enthusiasm, Fed easing, and fiscal spending will probably drive markets higher and fuel more corporate debt issuance. This growth in leverage will sow the seeds for the eventual downturn.
Tech giants are no longer funding AI capital expenditures solely with their massive free cash flow. They are increasingly turning to debt issuance, which fundamentally alters their risk profile. This introduces default risk and requires a repricing of their credit spreads and equity valuations.
The modern high-yield market is structurally different from its past. It's now composed of higher-quality issuers and has a shorter duration profile. While this limits potential upside returns compared to historical cycles, it also provides a cushion, capping the potential downside risk for investors.
Barclays forecasts a 40% jump in net investment-grade debt supply in 2026, driven by tech sector CapEx and renewed M&A activity. This massive influx of new bonds will test market demand and could lead to wider credit spreads, even if economic fundamentals remain stable.
A surge in investment-grade bond issuance to fund AI capital expenditures will insulate the high-yield market. This technical factor is expected to drive high-yield bond outperformance versus higher-quality corporate bonds, which will face supply pressure.
The gap between high-yield and investment-grade credit is shrinking. The average high-yield rating is now BB, while investment-grade is BBB—the closest they've ever been. This fundamental convergence in quality helps explain why the yield spread between the two asset classes is also at a historical low, reflecting market efficiency rather than just irrational exuberance.