BofA Hartnett: The "best trade" for 2026 is "shorting big cloud company bonds," and the market is unlikely to "stop going long stocks" before May next year.
Is the AI frenzy about to peak?
Bank of America strategist Michael Hartnett has made a bold prediction in his latest report: the “best trade” going into 2026 will be shorting the corporate bonds of “hyperscalers” that have invested heavily in AI. He believes that debt pressures triggered by AI will become the tech giants’ new “Achilles’ heel.”
Hartnett’s view is based on a central judgment: the loose financial conditions supporting the AI boom are reaching a turning point. Despite 167 rate cuts by central banks globally over the past 12 months, the number of expected cuts over the next year is forecast to tumble to 81. This weakening liquidity momentum means the low point in credit spreads is behind us, which is bad news for industries needing massive financing.
Even though cracks are appearing in the credit market, Hartnett believes this does not mean the stock market party will end immediately. He expects that, supported by factors including the “Fed put” and the “Trump put,” asset allocators will still generally hold long equity positions as the market heads into 2026.
Hartnett marks a key time for the market: May 15 next year, when the new Federal Reserve Chair will be appointed. He thinks that until then, there is not likely to be a major “risk-off” signal triggered by bank stocks or credit spreads. In other words, the long equity trade seems safe until next May.
The Debt Risk of AI: Why Short the Cloud Giants
Hartnett’s core bearish logic is rooted in changes to financial conditions (FCI). He highlights that the “secret sauce” for risk assets in 2025 is “massive easing,” with 167 global central bank rate cuts in the past 12 months. However, this momentum is fading, with only 81 rate cuts expected over the next 12 months.
Hartnett argues that the main part of the easing cycle is past. As liquidity tightens, worries about cracks in credit and financing the capital expenditure boom are mounting.
The direct result is pressure on the credit market. Hartnett observes that the peak of financial easing usually coincides with the bottom in credit spreads. Currently, the technology sector’s large-scale capital expenditure for the AI “arms race” is outpacing available cash flow, causing bond spreads and credit default swap (CDS) prices to widen. He describes this as “Trouble in Parade.”
For example, Oracle’s CDS surged above 100 basis points in recent days, after media reports pointed to its poor credit profile in early October.
He even quoted a market saying to stress his point: “When the Fed next implements quantitative easing (QE), you’ll know they’re buying AI cloud giant bonds.”
Unaffordable Borrowing Costs
BofA’s Hartnett sharply points out a core contradiction in the current US economy. He directly cites data, saying massive easing has brought prosperity to Wall Street, but the borrowing costs for Main Street (the US government) are still ‘unaffordable.’
He lists a set of stark rate contrasts: “US government borrowing cost is 4%, investment grade (IG) corporate 5%, mortgage rates over 6%, small business credit lines at 7%, home equity loans at 8%, used car loans at 13%, SBA loans at 14%, and credit card APR as high as 20%.” Such huge disparities highlight the unbalanced transmission of monetary policy and the reality of a “K-shaped” recovery.
In the “Goldilocks” Story, Risk Appetite Continues Until Next May
Despite credit concerns, Hartnett thinks the macro narrative driving markets higher is still strong.
He summarizes it as a “Goldilocks” scenario: “lower rates/higher profits, the US government wants strong growth before the midterm elections, stock market performance equals economic performance and supports K-shaped consumer spending, and AI suppresses inflation by reducing some jobs and boosting productivity.”
Based on this, he judges that “the price movement for 2026 is likely to be priced in ahead of time.” Asset allocators will stay long equities until bank stocks or credit spreads flash a clear risk signal. That signal “is unlikely to come before next May.”
This date is not casually chosen. May 15, 2026, is when the new Federal Reserve Chair will be sworn in. The market widely expects a more “dovish” chair at that time.
Before then, expectations built on the “Fed put, Trump put, and Gen Z put” will keep asset allocators favoring equities. In other words, the market is pricing in future policy easing, temporarily ignoring underlying credit cracks.
Beyond AI: Focus on PMI Acceleration and Cooling Inflation
Beyond risk warnings, Hartnett points out macro trading opportunities. He predicts that tax cuts, rate cuts, and US industry reshoring will drive the Purchasing Managers’ Index (PMI) up towards the expansion range of 55.
Within this “PMI trade” framework, Hartnett is bullish on commodities, global markets sensitive to PMI (such as China, Japan, Germany), and US small/mid-cap equities. He especially mentions “Doctor Copper,” seen as a barometer of the economy, as supporting this view.
Meanwhile, US small/mid-caps have lagged in 2025, and their valuations (14x PE) are far below the S&P 500 (23x PE), giving potential for catch-up gains.
However, Hartnett also warned: early-cycle sectors like real estate, construction, and retail are struggling to rebound, which may indicate AI is having a negative impact on jobs and job security, possibly hindering the rise of small/mid-cap and cyclical industrial stocks.
Hartnett also offers a “contrarian trade” on inflation. If the US core CPI drops to 2%, it will benefit long-term US Treasuries (like ZROZ). He ties this to politics: “Whoever wins the ‘affordability’ question wins the midterm election.”
He forecasts that to capture voters, the US government may intervene directly in prices to control costs in energy, healthcare, and housing, but this will hurt profit margins in those sectors. In such an environment, there is more upside room for the long US Treasuries trade.
However, this trade also comes with a clear “take profit” signal. Hartnett advises investors to “take profit before May 15,” that is, exit before the new Fed Chair is appointed to avoid potential policy uncertainty.
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