Morgan Stanley has indicated that artificial intelligence is evolving from a mere capital markets trend into a tangible factor creating structural stress in credit markets. According to Vishwanath Tirupattur, the bank's head of North American fixed income research, market perceptions of AI are becoming sharply divided. On one side, tech giants continue their massive spending on infrastructure, while on the other, the software sector is experiencing significant sell-offs. This divergence reflects growing investor caution, recognizing that AI represents not only a growth opportunity but also a potential existential threat to existing business models.
Based on analysis from its trading desk, the bank has substantially 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 recovery in merger and acquisition activity, Morgan Stanley anticipates U.S. investment-grade bond issuance will hit a record $2.25 trillion in 2026.
Two key characteristics are noteworthy in this context. First, the investment landscape remains vast. AI-related investments are projected to grow by a cumulative 20% by 2028, yet current actual investment accounts for less than 20% of that projected total. This suggests the majority of investment opportunities still lie ahead.
Second, the structure of financing is changing. Unlike the spending phases of 2025 and earlier, the next stage of development will rely more heavily on a diversified credit market. This includes secured and unsecured financing, securitization and structured products, as well as joint venture models. The sheer scale of upcoming capital expenditures is too large to be supported by equity financing alone, positioning credit to play a central role in systemic funding.
Weakness in the stock market is now spreading to credit markets. Year-to-date, the S&P Software Index has fallen by 23%. This pressure is particularly evident in credit sectors with significant exposure to the software industry, such as leveraged loans and Business Development Companies (BDCs).
Morgan Stanley warns that sentiment in related sectors may remain subdued. Credit investors might need to wait longer or see more substantial price corrections before re-entering the market. Although default rates are currently low, as AI adoption accelerates and uncertainties persist, price declines in credit markets could widen and deepen.
AI investment commitments are reshaping the financing landscape. Recent earnings reports from major hyperscale cloud providers confirm that spending pledges for AI infrastructure are accelerating. Brian Nowak, a Morgan Stanley internet equity analyst, notes that leading platforms with the richest data resources and strongest investment capabilities are widening their competitive advantages at an unprecedented pace, exceeding expectations from just weeks ago.
Based on updated guidance, Morgan Stanley's equity team has significantly raised its forecasts, now expecting capital expenditure from hyperscale cloud providers to reach $740 billion in 2026, a sharp increase from the $570 billion forecast at the start of the year. The core rationale remains sound: demand for computing power continues to significantly outstrip supply.
This financing demand is profoundly impacting the bond market. Morgan Stanley projects that, driven by AI-related capital spending and a rebound in M&A activity, U.S. investment-grade bond issuance will climb to a record $2.25 trillion in 2026. This surge in supply could lead to a slight widening of investment-grade credit spreads by year-end. However, the bank suggests the current market dynamic is more akin to periods like 1997-98 or 2005, where credit spreads widened even as equities rallied, rather than signaling a cycle's end.
Concerns about AI's disruptive risks are intensifying. This anxiety stems not from doubts about the technology's potential, but from a growing market realization that AI's transformative power is real, and massive capital spending is rapidly turning that potential into reality. Recent reports suggesting advanced AI models are nearing the capability to perform most software engineering tasks have served as a wake-up call for investors, prompting a reassessment of two key questions: the speed of disruption within the software industry, and the breadth of its spillover effects.
In equity markets, the software sector has been hit hard. The S&P Software Index is down 23% year-to-date, while the S&P 500 has remained largely flat. This stark divergence clearly illustrates how the market is pricing in AI disruption risks.
Stock market weakness is transmitting to credit markets, with pressure concentrated in areas most exposed to software. Data shows U.S. software-related leveraged loans have fallen approximately 3.4% year-to-date, dragging the overall leveraged loan index into negative territory with a 0.4% decline. In contrast, high-yield bonds with lower software exposure have still generated positive returns, indicating the risk has not yet spread broadly.
Morgan Stanley maintains a cautious outlook. The bank believes sentiment in software and related sectors may stay weak, and it remains unclear what catalyst could reverse the trend. Credit investors may require a longer waiting period or more significant price corrections before returning.
Although default rates are currently low, as AI application accelerates and uncertainty persists, price declines in credit markets could worsen and deepen, partly because it is difficult to identify which companies face genuine existential threats. Morgan Stanley warns that when default rates eventually rise, recovery rates could be significantly below historical averages due to the asset-light nature of many affected companies.
From a broader perspective, the bank notes that while a surge in supply may push investment-grade credit spreads wider, the current market environment resembles historical periods where credit and equities diverged without signaling a cycle's end. As credit strategists, Morgan Stanley is closely monitoring the mounting pressures within credit markets, concluding that the engine of future productivity is currently catalyzing significant market turbulence.