The biggest tech companies are gearing up to spend even more on artificial intelligence than investors had anticipated, and money managers increasingly fear that whatever happens, credit markets will get hit.
Microsoft Corp., Oracle Corp. and other “hyperscalers” are in an arms race to invest in AI and beat competitors in a technology that could change vast parts of the economy. Google parent Alphabet Inc. said it’s poised to spend as much as $185 billion on data centers this year, more than it has invested in the past three years combined. Amazon.com Inc. promised an even bigger outlay: $200 billion.
A chunk of those investments will come from the high-grade corporate bond market, potentially resulting in more debt sales this year than investors had expected. But the more tech companies borrow, the greater the potential pressure on bond valuations. The securities are already expensive by historical standards, trading at close to their tightest spreads since the late 1990s.
“The AI spending bonanza is finding buyers today but leaves little upside and even less room for error,” said Alexander Morris, chief executive officer and co-founder of F/m Investments. “There is no asset class that can’t and won’t spoil.”
Those fears weighed on tech companies’ notes this week, which broadly weakened relative to Treasuries, including most of the $25 billion of debt that Oracle sold on Monday. In the broader market, high-grade corporate bond yield spreads edged about 0.02 percentage point wider this week.
Beyond supply and demand, intensifying worries around AI’s power to disrupt have sparked tremors in the market. As companies like Anthropic PBC release a steady stream of tools targeting professional services from finance to software development, investors are starting to price in the threat AI poses to entire businesses.
Software companies have seen their leveraged loan prices drop about 4% this year through Thursday, according to Bloomberg index data, amid fears that AI will leave many software products obsolete.
Publicly traded lenders known as business development companies also have extensive exposure to software, with the industry accounting for more than 20% of portfolios on average, according to a note from Barclays. A BDC equity index fell 4.6% this week.
In the high-grade and high-yield bond markets, software companies are comparatively less represented, accounting for around 3% of each, according to Barclays. Still, one factor that makes corporate bonds vulnerable to rising risks is valuations, which remain high even with recent weakening.
The average US high-grade corporate bond spread was 0.75 percentage point at Thursday’s close, according to Bloomberg index data.
“Tight valuations make credit susceptible to potential disruption,” Barclays strategists Brad Rogoff and Dominique Toublan wrote in a Friday note.
JPMorgan Chase & Co. in November forecast about $400 billion of high-grade US bond sales from the technology, media and telecom sector this year. But that figure could climb as companies’ spending plans increase.
For all the concerns around looming supply, it’s likely that, for now, current demand for investment-grade bonds is even greater. Money has been chasing deals this year even though spreads remain near their tightest in decades.
High-grade technicals — market parlance for the balance between supply and demand as revealed by data like dealer inventories and the cash balances of credit funds — have remained robust despite record-setting issuance in the US and across the globe. Funds that invest in high-grade bonds saw $6.44 billion of inflows in the week ended Feb. 4, according to LSEG Lipper, the biggest inflow in over five years.
But as these tech giants ramp up their spending plans and sell more debt to fund their AI projects, technicals should continue to weaken, according to Nathaniel Rosenbaum, head of US credit strategy at JPMorgan.
Prone to Shocks
New issues over the past 10 days have underperformed the JPMorgan US Liquid Index by 4 basis points, the largest such underperformance since October, Rosenbaum wrote in a note Friday. That’s even as dealer inventories remain near record lows.
“To the extent issuance picks back up again over the remainder of the month, as we believe it will, there is room for further technical weakness ahead,” Rosenbaum wrote.
It’s possible that investors could swoop in and buy bonds as they become cheaper, shifting from either money market funds or mortgage bonds that have generated big gains, said Andrzej Skiba, head of US fixed income at RBC Global Asset Management’s BlueBay Fixed Income, during a Bloomberg TV interview on Friday.
Still, the confluence of tech’s borrowing binge, tight spreads and rising credit risks tied to AI make for a potentially precarious environment for investors — and one easily prone to shocks.
“It doesn’t take too many adverse events to create a selloff and for the prices to collapse,” said Ali Meli, founder and CIO of Monachil Capital Partners. “While credit markets may appear very liquid when the markets are good, the buyers can quickly disappear.”