The “King of Short Selling” Muddy Waters shifts focus to credit bonds; CEO bets that AI will trigger widespread layoffs and a wave of defaults.

Short-selling firm Muddy Waters Capital has set its sights on the corporate credit bond market. Founder and CEO Carson Block believes that the accelerated adoption of artificial intelligence will trigger a massive wave of unemployment and ultimately lead to the deterioration of corporate financial conditions and wider credit spreads.

Block outlined this logic in a Bloomberg TV interview this Tuesday and said he has started shorting exchange-traded funds (ETFs) tracking corporate bonds, including BlackRock’s iShares iBoxx USD High Yield Corporate Bond ETF and iShares iBoxx USD Investment Grade Corporate Bond ETF.

He expects that the market’s reaction will precede the actual employment shock, meaning the shorting window may open before substantive deterioration in economic data.

The backdrop for this wager is that the market is already highly alert to potential risks in private credit; if a crisis emerges in that sector, the spillover effects will further impact publicly traded credit markets and resonate with Block’s bet.

The AI Replacement Wave Will Reshape Employment Patterns

Block holds an extremely aggressive view on the speed at which AI will replace human jobs. He predicts that, within the next three to five years, a large number of U.S. companies will substitute employees with some form of AI technology, and a single AI technology can replace up to seven jobs.

He cites the legal industry as an example: tasks previously requiring law firm commissions and bill payments he now completes himself using Anthropic’s Claude software. In his view, this transformation is accelerating across industries.

Block’s logical chain is: large-scale AI replacement of jobs will result in higher unemployment rates and a weakening economy, which will in turn erode corporate revenue and debt-servicing capabilities, ultimately pushing up credit spreads and triggering defaults.

Using Bear Put Spreads to Control Exposure

Given the unpredictability of the employment market’s evolution, Block has not opted to directly short ETFs, as a way to avoid the uncertainty costs associated with holding bearish positions long-term.

He prefers using options strategies, specifically recommending bear put spreads—i.e., simultaneously buying and selling put options with the same expiration but different strike prices.

Block categorizes such trades as "convex trades," characterized by a non-linear upward-sloping return curve, which offers the potential for amplified gains when the underlying asset drops sharply, while downside risk remains limited.

This structure keeps holding costs controllable while preserving substantial profit potential if market sentiment abruptly shifts.

Impact Amplified by Passive Investing and Liquidity Mismatch Between ETFs and Underlying Bonds

Block’s other logic for shorting the credit bond market stems from his assessment of market structure itself. He believes that the scale of passive investing is excessive; once a trend forms, passive capital will automatically amplify price swings.

The more crucial issue is liquidity mismatch: the liquidity of corporate bond ETFs far exceeds that of the underlying bonds they hold.

This means that when fundamentals deteriorate and investors rush to redeem, ETFs will struggle to liquidate underlying assets at reasonable prices in a short time frame, resulting in deeper price discounts and greater market shock.

This structural vulnerability, combined with potential risks in private credit, leads Block to believe that the current downside risk in the corporate credit market is being severely underestimated by the market.

Risk Warning and DisclaimerThe market carries risks, and investments require caution. This article does not constitute personal investment advice, nor does it take into account the individual investor's specific objectives, financial situation, or needs. Users should consider whether any opinion, view, or conclusion in this article suits their unique circumstances. Any investment made based on this content is at your own risk.