The Big Idea
Credit markets fear AI and private credit more than war
This material is a Marketing Communication and does not constitute Independent Investment Research.
US credit markets see AI and private credit these days as much bigger risks than war. Investment grade and high yield have widened with each round of speculation about AI and the state of private credit while spreads have moved little since war broke out with Iran. Of course, it’s early. Both AI and private credit are opaque, AI also coming with little precedent. War, on the other hand, has translated for the market into a matter of oil prices. And there is plenty of transparency and a long track record on both war and oil. It shows again that markets hate uncertainty more than anything else.
Worries about AI and private credit have pulled spreads wider since at least the beginning of the year led by technology companies and by financials with some assumed private debt exposure. The option-adjusted spread on investment grade financial debt is wider by 17 bp or 19% in spread since the beginning of the year with the spread on high yield financials wider by 75 bp or 28% in spread (Exhibit 1). The OAS on investment grade tech companies is wider by 17 bp or 15% in spread over that period with high yield tech wider by 127 bp or 30% in spread. For context, the average investment grade name is wider this year by 13% in spread with the average high yield name out by 9%. Financials and tech have underperformed their average peer on spread across the rating spectrum.
Exhibit 1: Financials and tech have led credit spreads wider
Note: Change in spreads from 12/31/26 to 3/6/26. Tech = Technology, Fin = senior financials, Comm = communications, HC = healthcare, Mat = materials, Enrg = energy, Cons D = consumer discretionary, Con St = consumer staples, Ind = industrials, Util = utilities.
Source: Bloomberg, Santander US Capital Markets
War, by contrast, has barely touched investment grade credit spreads and has had only marginally more effect on high yield. Every investment grade sector except consumer discretionary initially tightened after March 27, the day before war broke out, with every high yield sector also tightening. Spreads have since ended up net wider, but by single basis points except for high yield tech and energy, which are each 12 bp tighter (Exhibit 2). The results in high yield are striking. Those leveraged balance sheets have much more at stake if war impeded economic growth or damaged corporate balance sheets, but high-yield spreads show no obvious sign of alarm.
Exhibit 2: Since the outbreak of war with Iran, credit spreads are tighter
Note: Changes from 2/27/26 to 3/6/26. Tech = Technology, Fin = senior financials, Comm = communications, HC = healthcare, Mat = materials, Enrg = energy, Cons D = consumer discretionary, Con St = consumer staples, Ind = industrials, Util = utilities.
Source: Bloomberg, Santander US Capital Markets
The difference in reaction is the difference in uncertainty. Private credit has some transparency in the loan portfolio disclosures of publicly traded business development companies, the disclosures of CLOs backed by middle market loans, the statistics on leveraged loans reported by LSTA and indirectly from the analysis by regulators of bank loans to BDCs and private credit funds. Still, most of the territory covered by private debt funds is dark. As for AI, the technology and its impact on revenues, expenses, profits and balance sheet look set to evolve for years. The range of possibilities for war, for now, is getting framed in terms of how long oil supply might get constrained by the conflict. That seems like a risk much easier to price, with instruments that can help hedge it. Markets can deal with that.
AI and private credit look likely to keep debt markets nervous longer than the war in Iran. That should bias spreads in financials and technology wider than investment grade or high yield peers. It should also be a great opportunity for fundamental experts with patient capital to pick up value in the debt of issuers punished by uncertainty. As for the rest of us, the best position may be in the bleachers.
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The view in rates
Concern about oil prices and inflation should make it hard for longer US rates to move lower until there is more clarity on the length of the conflict in Iran and limits to the flow of oil through the Persian Gulf. Instead, signs that businesses are trying to pass through the costs of tariffs both old and new could push longer rates higher. The front end of the curve, in the meantime, is probably stuck around current levels. The Fed is almost certain to stay on hold through the end of Powell’s term as chair in May, and probably beyond that if oil is still recovering and if tariffs do keep inflation above target.
The 2s10s Treasury slope traded Friday at 58 bp, steeper by 1 bp in the last week, with 5s30s at 103 bp.
Key market levels:
- Setting on 3-month term SOFR traded Friday at 366 bp, unchanged in the last four weeks
- Further out the curve, the 2-year note traded Friday at 3.56%, up 16 bp in the last week. The 10-year note traded at 4.14%, up 17 bp in the last week
- The Treasury yield curve traded Friday with 2s10s at 58 bp, steeper by 1 bp in the last week. The 5s30s traded Friday at 103 bp, flatter by 7 bp
- Breakeven 10-year inflation traded Friday at 235 bp, up 8 bp in the last week. The 10-year real rate finished the week at 179 bp, up 9 bp in the last week
The view in spreads
Higher volatility is pushing nominal spreads in MBS wider, and option-adjusted spreads are leaking wider to compete with corporate debt that has widened on concerns with private credit and AI. Technicals are nevertheless constructive for both MBS and corporate debt. Fixed income mutual funds and ETFs are getting some of the heaviest inflows in five years, creating a steady bid for both spread assets. Fannie Mae and Freddie Mac continue to add to their mortgage portfolios, and insurers continue to issue annuities and buy corporate and structured credit. Supply in MBS is relatively low, although gross and net issuance in corporate debt is likely to contribute to softer spreads in that asset.
Investment grade credit still faces a challenge this year from a sizable 9% to 11% jump in net supply in part to fund AI infrastructure. That could outstrip 5% to 7% growth in outstanding Treasury debt, widening the corporate-Treasury spread, and 2% growth in outstanding agency MBS, widening the corporate-MBS spread. Supply in MBS is even less after excluding Ginnie Mae custom pools, which are not included in the Bloomberg MBS index.
The Bloomberg US investment grade corporate bond index OAS traded on Friday at 81 bp, tighter by 1 bp in the last week. Nominal par 30-year MBS spreads to the blend of 5- and 10-year Treasury yields traded Friday at 113 bp, wider by 6 bp in the last week. Par 30-year MBS TOAS closed Friday at 16 bp, 1 bp wider in the last week.
The view in credit
Bank lending to non-bank financial institutions, including private debt funds and business development companies, has expanded at an extraordinary pace in the last few years, raising the possibility that lending has outstripped experience and infrastructure for underwriting and monitoring. Bank regulators continue to focus on that category of lending, which could eventually tighten the private credit markets. But for now, credit metrics for NBFI lending are strong relative to traditional bank lending such as C&I. The balance sheets of smaller companies show signs of rising leverage and lower operating margins. Leveraged loans also are showing signs of stress, with the combination of payment defaults and liability management exercises, or LMEs, often pursued instead of bankruptcy, back to 2020 post-Covid peaks.
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