Risk-off mode! Morgan Stanley: The market is starting to buy U.S. Treasuries.
As cracks appear in the narrative of AI investment returns, investors are choosing to retreat and embrace U.S. Treasuries instead.
According to the Chasing Wind Trading Desk, Morgan Stanley’s U.S. Rate Strategy team published a report on February 13th showing that the market's wind vane has shifted. Faced with the ever-expanding AI investment frenzy and lofty market valuations, investors are exiting risk assets and turning to U.S. Treasuries for safety.
In the report, Morgan Stanley raised its 2026 U.S. real GDP growth forecast from 2.4% to 2.6%, reasoning that capital expenditures by “hyperscale cloud providers” will drive growth, but its team of economists simultaneously issued stern risk warnings.
Morgan Stanley points out that this growth does not come without a cost. The logic is very clear:
“The more AI-related capital expenditure cycles boost economic activity, the greater the risk if the investment returns ultimately fail to materialize, resulting in an over-investment cycle.”
The market has clearly understood this logic. Investors are increasingly sensitive to the negative spillover effects (externalities) of the AI investment cycle and are no longer blindly chasing high valuations. As Morgan Stanley strategists put it:
“Investors are fatigued by new narratives attempting to justify extremely high risk asset valuations, which has led to a spread in market style and a shift toward U.S. Treasuries, pushing yields lower since the start of the year.”
AI Narrative Weakens, SaaS and Private Credit Under Pressure
Cracks are already visible in the market. Although the S&P 500 Index has continued to set new highs, companies whose business models are being “disrupted” by the AI application wave (AI Disrupted Stocks) have long begun to collapse.
Morgan Stanley constructed a basket containing 108 stocks impacted by AI. Data shows that these stocks had already decoupled from the broader market at the end of last year and continued to drop even as the broader market hit new highs.
This divergence releases a dangerous signal: the narrative surrounding optimism in AI may have peaked.
Aside from directly damaged stocks, the Software-as-a-Service (SaaS) sector is also facing great pressure, and the more hidden risk lies in Private Credit. Morgan Stanley warns that since the fundamental indicators of private credit portfolios are opaque and lagging, the share performance in public markets of alternative asset management companies with exposure to private credit serves as a real-time risk barometer.
Data shows that a basket containing seven key alternative asset management companies endured significant downward pressure at the start of this year. The market is voting with its feet, avoiding the credit default risks possibly caused by AI over-investment.
The “Rich” Are Panicking: Warning of Asset Bubble Burst?
The stock market’s weakness is transmitting to the confidence in the real economy, especially among high-income groups.
Morgan Stanley observes that the upper-income segment (annual income over $100,000), the main force of consumption, has seen a significant change in their view of the current economic situation since the beginning of this year.
“Although the starting level is better than late 2021, this shift in sentiment looks very similar to early 2022—when the U.S. economy subsequently slipped into two quarters of negative growth.”
Why has high-income confidence declined? The reason points directly to asset price volatility. Morgan Stanley economists believe, “The bursting of asset investment bubbles will pose a greater risk to the economy.”
When the wealthy start tightening their belts, it is usually the best leading indicator of economic recession. In this environment, U.S. Treasuries have again become the best asset class for hedging recession risks. Morgan Stanley’s strategy team bluntly says:
“We believe that as the market-implied policy rate still barely prices in downside risk premium, U.S. Treasuries as a hedging tool look particularly attractive.”
Inflation Unexpectedly Falls, U.S. Treasuries Become the Best Hedge
If concern about the AI bubble is the long-term logic for buying U.S. Treasuries, then the latest inflation data is the direct catalyst.
January’s CPI data was well below expectations, hitting hard at the thesis of stubborn inflation:
- Overall CPI month-on-month growth was 0.17%, lower than economists’ expected 0.27%.
- Core CPI month-on-month growth was 0.30%, also slightly below the expected 0.31%.
More noteworthy is the underlying data excluding extreme volatility. The Cleveland Fed’s Trimmed Mean CPI and Median CPI both only rose 0.19% in January.
“These readings are the lowest values for the same period since 2021. Given that January is usually the strongest month for sequential calendar year data, we believe this unexpected drop will weigh heavily when investors consider inflation data for the full year.”
Weak inflation data directly reshaped the Fed's policy expectations. The market responded quickly, with traders pricing in a lower terminal rate. Current market pricing suggests that by the June meeting, there will be a 21 basis point cut, and by the end of 2026, cumulative cuts will total 62 basis points.
Morgan Stanley believes that declining inflation expectations will allow the Fed to further loosen policy to prevent real rates from becoming excessively restrictive. This means there is further room for U.S. Treasury yields to fall.
Meanwhile, the Fed’s note purchase operations are also providing liquidity support to the market. In the past 14 operations, the Fed has purchased $109.2 billion in notes, and each operation has reached the maximum scale (100% absorption rate), maintaining a loose financing environment and further benefiting short-term Treasuries.
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