AI-tech expansion in a resilient market

The strength in equity markets has been grabbing most financial headlines. However, the relative robustness of credit markets is also worthy of investors’ attention. Admittedly, credit investors are likely managing their expectations on returns going forward.

With yields currently at elevated levels, and with credit spreads already historically tight, the capacity to generate incremental total returns is limited compared to previous periods. While yields could be considered attractive from an income perspective, the gene­ral view is that curve positioning and the evolution of the curve will have a more prominent impact on overall returns.

Meanwhile, the hefty supply of corporate credit is expected to continue to be well absorbed. Concerns on economic growth, particularly in Europe, could be impacting sector considerations. In this respect, a key theme relates to the growing share of the market accounted for by technology, with such a trend evidently driven by the artificial intelligence (AI) investment boom.

Global investment bank Morgan Stanley estimates that 2026 AI-related corporate debt issuance could reach $500 billion, already standing at $236 billion as of end May.

Indeed, while AI has been a protagonist within equity markets for extended periods, it is now becoming more prominent in the corporate debt space, particularly in the US Investment Grade (IG) segment. Credit investors are financing the substantial capital expenditure plans of corporations, most notably hyperscalers, which are investing massive amounts in the construction of data centres, power supply and infrastructures required to operate AI models, and the acquisition of components such as servers.

AI is also viewed to be driving certain structural shifts within corporate debt markets. Such bond issues have typically been larger than average.

This week, Amazon.com Inc is planning to raise $25 billion in a multi-tranche deal, after already raising more than $50 billion earlier this year. Given the use of proceeds, certain AI-related corporate debt is exhibiting features that in some ways are similar to project and infrastructure finance, including typically long-term obligations to better align with expected future cash flows.

It is expected that private credit, which is a segment of the market that has been growing even beyond developments related to AI, could also play a greater role in funding the AI boom.

Market analysts also note that since most of the major issuers of these bonds tend to have relatively high credit ratings, the increased activity is benefiting the wider market in terms of the average credit rating.

However, credit investors should not ignore potential vulnerabilities. In the future, the credit profiles of issuers will depend on whether the sizeable investments actually do generate the productivity gains being currently anticipated.

Should returns fall short of expectations, credit profiles could deteriorate, in turn leading to wider spreads, tightening financing conditions and unfavourable pricing for refinancing transactions.

AI-related corporate debt issuance could reach $500 billion- Karl Falzon

Given the growing proportions of this space of the market, one could expect a negative spillover effect on the wider corporate bond market.

AI-related debt issuance is so far more of a US phenomenon. Therefore, investors specifically focused on euro credit are likely to believe that developments in terms of benchmark yields are more of an immediate consideration.

Euro benchmark yields have reached multi-year highs in recent months, mainly on the back of expectations for increased fiscal spending, the expansion in supply of sovereign debt, and inflationary pressures.

Yields retraced lower during past weeks, with the German 10-year bond yield dropping from previous highs of around 3.20%. Meanwhile, in its mid-June meeting, the ECB hiked interest rates by 25 basis points, with the interest rate on the deposit facility now standing at 2.25%. This was the first increase since 2023.

The ECB noted inflationary pressures from the Middle Eastern crisis and revised upwards its inflation forecasts for 2026 (3.00%) and 2027 (2.3%). It also highlighted that it will pursue a “data-dependent approach”. ECB President Christine Lagarde also highlighted the improved resilience of the eurozone’s economy to shocks.

Many investors, including credit investors, would agree, comforted by the relative health of corporate fundamentals notwithstanding a slowing economy and high rates. 

On the other hand, even though investors would seem to have become accustomed to the structurally higher yields, with credit spreads already tight it would be imprudent for investors to ignore the risks from further increases in yields or heightened volatility in sovereign debt markets.

Karl Falzon is head of capital markets at Curmi & Partners Ltd.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi & Partners Ltd, with registered address Finance House, Princess Elizabeth Street, Ta Xbiex, Malta XBX 1102, is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.