Morgan Stanley: AI is a capital expenditure black hole, risks spreading to the credit market

Morgan Stanley points out that artificial intelligence is shifting from being merely a hot topic in capital markets to becoming a real variable that induces structural pressure in credit markets. Vishwanath Tirupattur, Head of North American Fixed Income Research at the bank, believes that market perceptions of AI are showing significant divergence: on one hand, tech giants are continuously burning cash for infrastructure, while on the other, the software sector is facing large-scale sell-offs. This divergence reflects investors’ growing alertness that AI represents not only growth opportunities but also existential threats to existing business models.

According to Chase Trade Desk, the bank has sharply raised its capital expenditure forecasts for hyperscale cloud service providers, projecting related spending to reach $740 billion by 2026. Driven by AI investment demands and a rebound in M&A activity, the bank expects US investment-grade bond issuance to hit a historic high of $2.25 trillion in 2026.

Against this backdrop, two key features are noteworthy. First, the investment landscape remains vast. By 2028, AI-related investment is expected to see an accumulated growth of 20%, but actual investment so far is less than 20% of this scale. This means the vast majority of investment opportunities still lie ahead.

Second, financing structures are undergoing change. Unlike the spend phases up to 2025, the next stage of build-out will rely more heavily on diversified credit markets, including secured and unsecured financing, securitization and structured products, as well as joint venture models. The upcoming capital expenditure is so massive that equity financing alone will no longer suffice, and credit will play a central role in systematic financing.

Currently, stock market weakness has spilled over to the credit market. Year to date, the S&P Software Index has fallen 23%. This pressure is especially pronounced in the credit space, particularly in sectors with significant software exposure such as leveraged loans and business development companies (BDCs).

Morgan Stanley warns that sentiment in these sectors may remain sluggish, and credit investors may have to wait for a longer period or a larger price correction before they return. Although current default rates remain low, as AI applications accelerate and uncertainty persists, credit market price declines may broaden and deepen.

AI Investment Commitments Upgrade and Reshape Financing Landscape

The latest financial reports from large hyperscale cloud service providers confirm that investment commitments in AI infrastructure are being rapidly realized. Morgan Stanley internet equity analyst Brian Nowak points out that leading platforms with the richest data resources and strongest investment capability are expanding their competitive advantage at unprecedented speed, far outpacing expectations from just a few weeks ago.

Based on the latest guidance, Morgan Stanley’s equity team has significantly raised forecasts, estimating hyperscale cloud providers’ capital expenditure in 2026 will reach $740 billion, a surge from the $570 billion predicted earlier this year. The core logic remains firm: computing power demand continues to massively outpace supply.

This financing demand is profoundly reshaping the bond market. Morgan Stanley expects that, driven by AI capital spending and a rebound in M&A activity, US investment-grade bond issuance will soar to a record $2.25 trillion in 2026. The increase in supply may cause investment-grade credit spreads to widen slightly by year-end. However, the bank notes that current market conditions resemble those of 1997-98 or 2005, namely credit spreads widen against a backdrop of rising equity markets, which does not mean a “cycle end.”

Software Sector Faces Disruptive Shockwaves

Concerns about the disruptive risks of artificial intelligence are intensifying in the market. This anxiety is not due to skepticism about the technology’s prospects, but rather a growing awareness that AI’s transformative power is real, and enormous capital expenditure is rapidly turning this potential into reality. Recent reports indicate that advanced AI models are close to being able to perform most software engineering tasks, ringing alarm bells for investors and prompting the market to reassess two core questions: the speed at which the software industry will be disrupted, and the breadth of disruptive effects spreading outward.

On the equity side, the software sector has become a hard-hit area. Year to date, the S&P Software Index has plummeted 23%, whereas the S&P 500 Index has remained basically flat over the same period. This notable divergence clearly outlines the market’s pricing logic for AI disruption risk.

Stock market weakness is spreading to credit markets, with pressure first concentrated in areas most exposed to the software sector. Data shows that US software leveraged loans have fallen about 3.4% year to date, dragging the overall leveraged loan performance from positive to negative, with a 0.4% decline. In contrast, high-yield bonds with less software exposure still posted positive returns, indicating that the risks have not yet fully spread.

Credit Markets Face Continued Pressure

Morgan Stanley adopts a cautious outlook on current market prospects. The bank believes that sentiment in software and related sectors may remain depressed, and it is still unclear what the next catalyst for reversing the downturn will be. Credit investors may have to wait longer or for a larger price correction before re-entering.

Although default rates currently remain low, as AI applications accelerate and uncertainty continues to loom, it becomes difficult to distinguish which companies truly face existential risks, and price declines in the credit market may broaden and deepen further. Morgan Stanley warns that when default rates eventually rise, given that these companies are generally asset-light, their default recovery rates may fall far below historical averages.

From a more macro perspective, the bank notes that although the surge in supply may push investment-grade credit spreads wider, current market conditions resemble historical phases when credit and equity markets diverged, but not the end of a cycle. As credit strategists, Morgan Stanley remains keenly attentive to the mounting internal pressure within credit markets, and their core view is: the future engines of productivity are catalyzing today’s market pains.

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The above highlights are from Chase Trade Desk.

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