The Curious Calm of Credit Markets

It appears that credit investors have gotten most of what they’ve wished for over the last decade. Our Global Head of Fixed Income Research Andrew Sheets considers whether there could be unintended consequences. Read more insights from Morgan Stanley.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley. Today, how spooked should we be about the credit markets? It's Friday, October 30th, at 2pm in London. I grew up watching The Simpsons, and I've always had a soft spot for their Halloween episodes. One in particular that's burrowed pretty deep in my memory involves a cursed monkey's paw. It technically granted wishes to whoever held it, but with unintended consequences. For example, Lisa wishes for world peace, the entire planet disarms; and then aliens invade and take over. That sort of thing. Keep that monkey's paw in mind. Credit markets are going through their own jittery episode. After a long period of support, central banks are raising rates and shrinking their balance sheets. Thanks in part to this shift, global yields have risen. And since bond prices move inversely to yields, they've driven negative total returns. Then there's the AI boom, maybe the defining economic story of 2026. Morgan Stanley estimates that close to $900 billion of CapEx will happen this year, roughly double what we saw last year and triple the levels of 2024. And we think this growth continues, with hyperscaler capital expenditures reaching about $1.5 trillion next year – almost the size of the entire U.S. defense budget. All that spending requires financing, and credit markets have been a key source of it. 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. These higher yields haven't slowed down the largest tech companies, given their considerable financial resources. But it has caused ripples further down the chain. Lower-rated credits with more leverage and slower growth are being more impacted by these higher borrowing costs. And the presence of these new technologies has increased fears of disruption to existing business models, especially in sectors like telecom. And as a result, the dispersion between credits has increased. Scary stuff. Or is it? If you'd spoken to a credit investor over the last 10 to 15 years, you would have heard a litany of wishes. If only central banks stopped intervening in markets, compressing credit risk premiums. If only yields weren't so low. If only the growth backdrop was better. These investors wish that the technology sector would finally issue bonds, given its extremely low weight in credit markets, which are heavily skewed towards slower-growing sectors like banks, utilities, and telecom. They wished for new bonds that were highly rated, yet also would have high spreads. They wished for a new issue premium, which had compressed sharply. And maybe, just maybe, in their wildest dreams, they hoped they could get it all. New bonds that were highly rated in a fast-growing sector issued at a large new issue premium. And hopefully a lot of it. They also from a business sense wanted dispersion. 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. Yields are high, with investment-grade credit yielding close to 6 percent in the U.S. and over 4 percent in Europe. Spreads have widened, and there's no central bank intervention to distort this. The AI boom is resulting in record levels of highly rated bond supply in a new sector, often at a significant discount for the rating. And all of this, and more, is driving significant dispersion. Granted, like the monkey's paw, the reality of this