Global Market Strategist
Global Market Strategist
In Brief
- Despite geopolitical tensions and political noise in January, corporate bond markets remained calm, and IG spreads tightened further.
- IG spreads would need to widen by at least 72 bps to cause capital losses—a magnitude of widening historically seen during crises, not during benign economic expansion.
- AI-driven issuance may pose a challenge to valuations and diversification; prioritize active security selection and income generation over price appreciation.
Are credit spreads now “too tight?”
Investors have had to contend with a lot in January—military action in Venezuela, further threats to U.S. Federal Reserve (Fed) independence, and an escalation in tariff threats. Despite these market-moving events, credit spreads tightened further during the month. U.S. investment-grade (IG) spreads narrowed to the lowest level since 1998.
Despite concerns over tight spreads and high supply, the bond math works in investors’ favor. High starting yields provide a significant cushion against mark-to-market losses.
From the current historical tights, spreads would need to widen by approximately 72 basis points (bps) on U.S IG to wipe out the yield income, and 237 bps on U.S. HY to offset current carry and result in capital losses. Exhibit 1 compares the current “breakeven spread” (blue line) against historical spread widening events (diamonds) across global credit markets. The gray bars illustrate the historical extremes of quarterly volatility, bracketing the range between the sharpest spread widening events (market stress) and the most dramatic tightening periods (market recovery).
Spread widening of a magnitude at the blue line is rare. It typically only occurs during periods of severe economic contraction or external shocks, such as the 2008 Global Financial Crisis or the onset of the pandemic in 2020. Absent a hard landing or a deep recession, which is not the base case, the carry offered by the asset class creates high barriers to negative returns.
Is there a risk from AI-driven issuance?
The most significant recent shift is the anticipated surge in supply driven by the “AI arms race.” The capital expenditure required for data centers, energy infrastructure, and hardware is immense, and outside of operating cash flows, debt markets will be the primary funding source. While the technology sector currently represents less than 10% of the IG index, 14.5% of IG debt is now tied to sectors involved in artificial intelligence (AI) capex, which is larger than U.S. banks1.
IG issuance specifically tied to AI capital expenditure is expected to grow exponentially, rising from USD 44billion in the first 11 months of 2025 to an estimated USD 300billion in 20261.
U.S. IG spreads are currently trading at tight levels across sectors. Notably, despite the anticipated issuance headwinds, the technology sector continues to trade at flat or tighter than the broader IG index. This reflects the sector’s historically strong balance sheets and high cash reserves.
The risk is that a flood of new issuances challenges this dynamic. If the market struggles to digest the new supply, the tight spread differential between technology and the broader index could erode. The rising tide of AI issuance is likely to create dispersion in corporate performance, and investors must distinguish between companies borrowing to fund highly productive growth and those that are materially re-levering to defend or grab market share. Close monitoring is required to determine if investors will eventually demand a higher premium to hold this growing portion of the market.
Will demand remain strong?
Demand for income-generating assets, as well as the ‘up-in-quality’ bias, has supported corporate bonds, and we expect this to continue as investors seek yield stability and remain wary of the risks associated with holding excessive government debt.
Steeper yield curves suggest that investors are demanding additional compensation for extending government bond duration. Fiscal concerns, central bank independence, lingering inflation concerns, and the possibility of de-dollarization (not our base case) all add upward pressure on bond yields and contribute to a more volatile bond market.
The additional spread offered by high-quality corporates provides a necessary buffer against rate volatility, even at tighter spreads, making the asset class a more efficient vehicle for income generation in this period of the cycle.
For foreign investors, shifts in hedging costs may also add to the appeal of U.S. credit. For example, the cost of hedging a U.S. dollar investment back to the Japanese yen is currently 3%, and while this is still above the 15-year average of 1.9%, it has declined sharply as forward rate differentials have narrowed.
Investment implications
Tighter spreads naturally constrain the potential for capital appreciation, and there is little scope for further tightening, but all-in yields on corporate bonds remain attractive by historical standards, which is likely to support demand.
Concerns around elevated bond issuance, heightened geopolitical concerns, the trajectory of Fed policy, and broader economic conditions could lead to spread widening in risk-off moves. However, the base case of continued global economic expansion suggests a “stable yield” environment where the heavy lifting for portfolio returns comes from income rather than price appreciation.
Like any asset class, higher valuations reduce the margin for error, necessitating a focus on active security selection. Ultimately, while valuations appear full, the combination of robust corporate fundamentals and a substantial yield cushion supports a constructive, if selective, position in credit.