Credit investors should guard against potential downside risks tied to "AI exuberance" after optimism around the technology helped yield premiums drop to their lowest in decades, according to HSBC Bank strategists.
"In the US, a significant share of recent US GDP growth is tied to AI, whether directly through investment spending or indirectly through the wealth effect from AI-related stocks," said Song Jin Lee and Tom Russell in a report. "Any disappointment could reverberate through credit markets through several channels."
Corporate bond spreads are near their tightest levels since the run-up to the 2007 global financial crisis, as investors look past geopolitical gyrations and chase yields that remain elevated by historical standards. Even with a strong macroeconomic backdrop, the upside for bond investors appears limited, especially as technology giants sell tens of billions of dollars of debt, putting pressure on credit spreads to potentially widen.
Pricing has already "fully reflected" a benign outlook for the debt class, supported by mostly healthy fundamentals for corporate borrowers in developed markets, the strategists wrote. However, the moves in premiums have failed to reflect the "narrow base on which the current optimism is built."
The bank is urging investors to consider diversification strategies that keep some distance from US tech bonds, pointing to parts of the euro credit, which are less exposed to the AI cycle. Most of the gains from further upside for the US economy and AI will go to equity holders, not creditors, according to the strategists.
Even with upside surprises in AI, US private credit has significant exposure to high-yield software companies whose business models may be challenged. Asian investment-grade credit may provide protection against a downturn in risk sentiment and fiscal-induced volatility, the note added.
HSBC isn't the only one pointing to skewed risks for credit at current spreads. Christian Mueller-Glissmann, head of asset allocation research for Goldman Sachs Group Inc., said in a Bloomberg Television interview this week that "credit is the weakest link" and investors face potential "carry unwind risk" tied to the dollar and yen. He is underweight credit, but overweight equities based on the earnings outlook.
