The Curious Calm of Credit Markets

Andrew Sheets · Morgan Stanley

Heavy AI-related tech bond issuance has lifted yields and spreads, with issuers pricing cheaply for their ratings.

Technology is a relatively new sector with very low weight in credit indices, which are dominated by slower-growing banks, utilities and telecom. Heavy supply of tech bonds has pushed up both yields and spreads. These issuers have often been willing to price their debt cheaply relative to their ratings, so new highly rated AI-linked bonds come at a significant discount. This discount is part of why current conditions are attractive for investors.

“Heavy supply from this relatively new sector, technology, has pushed up both yields and spreads, especially because these issuers have often been willing to price their debt pretty cheaply relative to the rating.”at 1:36

Andrew Sheets · Morgan Stanley

Rising credit dispersion strengthens the case for active credit management over indexing.

The case for active credit management depends on credit performance differing across issuers, which a skilled analyst can capture. Dispersion between credits has increased, because higher borrowing costs hit lower-rated, more leveraged, slower-growing issuers harder while large tech companies are not slowed. Investors who had wanted dispersion now have it, which supports active management. If everything moved together, investors would be better off buying the index, so the current dispersion is a positive for active managers.

“The case for active credit management relies on the idea that there are differences in credit performance that a skilled analyst can capture. If everything just moves together, well, just buy the index. We got our wish.”at 3:15

Andrew Sheets · Morgan Stanley

Credit conditions check investors' boxes and are healthy; he is less frightened of the credit story.

Investment grade credit now yields close to 6% in the US and over 4% in Europe, so yields are high. Spreads have widened, and with no central bank intervention distorting prices, the widening reflects market conditions. The AI boom is bringing record supply of highly rated bonds from a new sector, often at a significant discount for the rating, and that is driving dispersion. Current conditions match what credit investors had long wished for, which he sees as a good, healthy development. He notes the path will not be straightforward but says the market is less frightening than the headlines suggest.

“The fact that current conditions check so many boxes of what investors were looking for and address so many underlying needs is a good, healthy thing in our view. The path is hardly straightforward. But for now, we're less frightened of the story.”at 4:04

Andrew Sheets · Morgan Stanley

Morgan Stanley expects hyperscaler capex to reach about $1.5 trillion next year.

Morgan Stanley estimates close to $900 billion of capex this year, roughly double last year and triple 2024 levels. It expects growth to continue, with hyperscaler capex reaching about $1.5 trillion next year, almost the size of the entire US defense budget. This spending requires financing, and credit markets have been a key source of it, which is why the buildout matters for bond supply.

“And we think this growth continues with hyperscaler capital expenditures reaching about $1,500,000,000,000 next year, almost the size of The entire US defense budget.”at 1:19