When national debt grows too large, an economy enters "fiscal dominance." The central bank loses its ability to manage the economy, as raising rates causes hyperinflation to cover debt payments while lowering them creates massive asset bubbles, leaving no good options.

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.

A condition called "fiscal dominance," where massive government debt exists, prevents the central bank from raising interest rates to cool speculation. This forces a flood of cheap money into the market, which seeks high returns in narrative-driven assets like AI because safer options can't keep pace with inflation.

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 rise of electronic and portfolio trading has made public credit markets as liquid as equity markets. This 'equitification' has compressed spreads by eliminating the historical illiquidity premium, forcing investors into private markets like private credit to find comparable yield.

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 expected wave of M&A and LBOs has not materialized, leaving the deal pipeline thin. This lack of new debt supply provides a strong supportive backdrop for credit spreads, allowing the market to absorb geopolitical volatility more easily than fundamentals would otherwise suggest.

Lacking demand for long-term bonds, the Treasury issues massive short-term debt. This requires a larger cash balance (TGA) to avoid failed auctions, draining liquidity from the very markets needed to finance this debt, creating a self-reinforcing crisis dynamic.

The massive increase in government debt held privately has broken the monetary policy transmission mechanism. When the Fed raises rates, the private sector's interest income from Treasury holdings now rises significantly, creating a stimulus that counteracts the tightening effect on borrowing costs.