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 same uncertainty AI injects into equity valuations also affects credit. While a four-year bond for a major software company seems safe, a 30-year bond is far riskier, as the company could be disrupted. This dynamic could lead to structurally steeper credit curves in the future.

While AI will increase prepayment risk from efficient servicers, it also presents an opportunity for investors. AI can be used to identify and bundle loans with specific desirable characteristics into new 'specified pools,' allowing for more precise risk targeting and alpha generation in the MBS market.

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.

AI tools will drive higher refinancing volumes, increasing the total market size for mortgage originators. However, by making it effortless for consumers to compare offers, AI will also intensify competition. This price transparency will pressure the "gain on sale" margins lenders earn on each loan, pitting the benefit of higher volume against lower per-unit profitability.

AI data center financing is built on a dangerous "temporal mismatch." The core collateral—GPUs—has a useful life of just 18-24 months due to intense use, while being financed by long-term debt. This creates a constant, high-stakes refinancing risk.

The rise of powerful AI tools threatens the business models of many software-as-a-service (SaaS) companies. This jeopardizes their future revenue, making it difficult to refinance loans originated at near-zero interest rates. This is a fundamental, technology-driven risk to a large segment of private credit.

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.

Investment-grade technology bonds now trade at a wider spread to the overall corporate index, a reversal of historical trends. This isn't due to increased credit risk or downgrades, but is a technical market effect caused by the sheer volume of debt being issued by hyperscalers to fund AI capital expenditures.