Our Head of Corporate Credit Research Andrew Sheets explains why
2026 might bring a credit cycle that burns hotter before it burns
out.
Read more insights from Morgan Stanley.
----- Transcript -----
Andrew Sheets: Welcome to Thoughts in the
Market. I'm Andrew Sheets, Head of Corporate Credit Research at
Morgan Stanley.
Today I'm going to talk about our outlook for global credit
markets in 2026 and why we think the credit cycle burns hotter
before it burns out.
It's Friday, December 12th at 2pm in London.
Surely it can't go on like this. That phrase is probably coming
up a lot as global credit investors sit down and plan for 2026.
Credit spreads are sitting at 25 year plus tights in the U.S. and
Asia. Issuance in corporate activity are increasingly aggressive.
Corporate CapEx is surging. Signs of pressure are clear in the
lowest rated parts of the market. And credit investors are
trained to worry. Aren't all of these and more signs that a
credit cycle is starting to crack under its own weight?
Not quite yet, according to our views here at Morgan Stanley.
Instead, we think that 2026 brings a credit cycle that burns
hotter before it burns out. The reason is partly due to an
unusually stimulative backdrop. Central banks are cutting
interest rates. Governments are spending more money, and
regulatory policy is easing. All of that, alongside maybe the
largest investment cycle in a generation around artificial
intelligence, should spur more risk taking from a corporate
sector that has the capacity to do so.
In turn, we think the playbook for credit is going to look a lot
like 2005 or 1997-1998. Both periods saw levels of capital
expenditure, merger activity, interest rates, and an unemployment
rate that are pretty similar to what Morgan Stanley expects next
year. And so, looking ahead to 2026, these two periods offer two
competing ways to view the year ahead.
2025 might be more similar to a period where the low-end consumer
really is starting to struggle, but that another force – back
then it was China, now it might be AI spending – keeps the
broader market humming. 1997 or 1998, on the other hand, would be
more similar to a narrative that investors are growing more
confident that a new technology is really transformative. Back
then, it was the internet and now it's AI.
Corporate bond issuance we think will be central to how this
resolves itself. This is a strong regional theme and a key driver
of our views across U.S., European and Asia Credit. We forecast
net issuance to rise significantly in U.S. investment grade up
over 60 percent versus 2025 to a total of around $1 trillion.
That rise is powered by a continued increase in technology
spending to fund AI as well as a broader increase in capital
expenditure and merger activity. All of those bonds being sold to
the market should mean that U.S. spreads need to move wider to
adjust. And that's true, even if underlying demand for credit
remains pretty healthy, thanks to high yields, and the economy
ultimately holds up.
We think this story is a bit better in other areas and regions
that have less relative issuance, including European and Asian
investment grade and global high yield. They all outperform U.S.
investment grade on our forecast. In total returns, we think that
all of these markets produce a return of around 4 to 6 percent,
and if that's true, it would underperform, say U.S. equities, but
outperform cash.
More granularly similar to 2025 or 2005, we think that single
name and sector dispersion remain major themes. And where you
position in maturity should also matter. Credit curves are steep
and our U.S. interest rate strategist are expecting the U.S.
Treasury curve to steepen significantly Further. That should mean
that so-called carry and roll down and where you position on the
maturity curve are a pretty big driver of your ultimate result.
In our view, corporate bonds between five- and 10-year maturity
in both the U.S. and Europe will offer the best risk reward.
The most significant risk for global credit remains recession,
which we think would argue for wider spreads on both economic
rounds, but also through weaker demand as yields would fall. It
would mean that our spread forecasts are too optimistic and that
our expectation that high yield outperforms investment grade
would be wrong. And then there's a milder version of this bear
case – that aggression and corporate supply are even stronger
than we think, and that creates conditions closer to late 1998 or
1999.
Back then, U.S. investment grade spreads were roughly 30 basis
points wider than current levels, even though the economy was
strong and even though the equity market kept going up.
Thank you as always for your time. If you find Thoughts of the
Market useful, let us know by leaving a review wherever you
listen. And also, please tell a friend or colleague about us
today.
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