The Big Idea
The high cost of funding the AI buildout
This material is a Marketing Communication and does not constitute Independent Investment Research.
The race to fund AI continues to shape debt markets. US dollar issuance through July is equivalent to 1.6% of US gross domestic product and is running at nearly 13 times last year’s pace. The borrowing spans almost every segment of the debt market, though 67% is investment grade corporate debt. Issuers are also tapping several currencies. Just five technology companies account for an outsized share. The heavy borrowing will likely keep technology credit spreads wide and long-term interest rates high.
New debt deals to fund AI have surged this year. US dollar issuance by hyperscalers, data centers and AI infrastructure projects reached $308 billion through July, nearly 13 times the $22 billion issued in the same period last year (Exhibit 1). The surge began in the second half of last year.
Exhibit 1: US dollar AI debt issuance is running 13 times the pace of last year
Note: Bond deals priced in US dollars by hyperscalers, data centers and other AI infrastructure projects and reported by Bloomberg.
Source: Bloomberg, Santander US Capital Markets
Funding demand is spreading across most major market segments: loans, investment grade and high yield corporate debt, asset-backed securities, commercial mortgage-backed securities, municipal debt and private debt. Investment grade corporate debt leads by a wide margin, followed by private and high-yield debt (Exhibit 2). Leading technology issuers carry investment grade ratings, and corporate debt markets can absorb the construction risk of data centers. ABS and CMBS require properties that generate cash flow from leases or mortgage loans. Issuance in those markets may rise after projects under construction begin producing cash flow.
Exhibit 2: More than 67% of dollar funding comes as investment grade debt
Note: Bond deals priced in US dollars by hyperscalers, data centers and other AI infrastructure projects and reported by Bloomberg.
Source: Bloomberg, Santander US Capital Markets
Five technology companies—Alphabet, Amazon, Meta, Microsoft and Oracle—have issued 42% of all US dollar debt intended to fund AI this year (Exhibit 3). That concentration leaves the technology sector vulnerable to weakness in a small group of issuers, although those issuers all have strong balance sheets for now.
Exhibit 3: Five hyperscalers account for 42% of total US dollar issuance
Note: Bond deals priced in US dollars by hyperscalers and reported by Bloomberg.
Source: Bloomberg, Santander US Capital Markets
Demand for AI funding has also pushed issuers beyond the US dollar market. US dollar borrowing reached $308 billion through July, while another $67 billion was issued in euros, Canadian dollars, British pounds, Swiss francs and Japanese yen (Exhibit 4).
Exhibit 4: The brunt of funding originates as US dollar-denominated debt
Note: Bond deals priced in any currency by hyperscalers, data centers and other AI infrastructure projects and reported by Bloomberg.
Source: Bloomberg, Santander US Capital Markets
The surge in technology debt has coincided with weaker investment grade technology spreads. To separate that move from broader market trends, compare the spread on technology debt with the investment grade index and express the gap in standard deviations from its average. Over the past year, technology spreads have widened to nearly three standard deviations above the index (Exhibit 5).
Exhibit 5: The surge in tech debt since last year has coincided with wider spreads
Source: Bloomberg, Santander US Capital Markets
The surge in technology debt may also be lifting US interest rates. Real rates at intermediate and longer maturities have risen sharply this year, helping push overall yields higher. If the real rate is the price that balances the supply of and demand for cash, heavy borrowing for AI infrastructure is consistent with higher real rates at the maturities those builders use.
If the AI buildout continues through 2026 and into 2027, technology spreads are unlikely to tighten to levels in other credit sectors. Long-term real yields are also unlikely to outperform shorter-term real yields.
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The view in rates
The market is pricing about 30 bp of Fed tightening by the end of 2026 and little change in 2027. That should keep the front end of the curve at 4.00% or higher through 2026, depending on expected short-term inflation. Renewed US-Iran conflict could push the expected Fed path and short-term rates higher. The 10-year Treasury note will likely spend more time above 4.40% than below it for the rest of the year. A durable US-Iran agreement could pull the yield below 4.40%, but technology companies’ demand for cash is likely to keep longer-term rates high.
Key market levels:
- Three-month term SOFR was set Friday at 375 bp, down 6 bp in two weeks.
- The 2-year Treasury note traded Friday at 4.19%, down 14 bp in two weeks. The 10-year note traded at 4.64%, down 4 bp.
- The Treasury yield curve traded Friday with the 2-year/10-year spread at 45 bp, 11 bp steeper in two weeks, and the 5-year/30-year spread at 85 bp, 12 bp steeper.
- The 10-year inflation breakeven traded Friday at 225 bp, up 1 bp in two weeks. The 5-year, 5-year forward breakeven was 234 bp, up 6 bp. The 10-year real rate ended the week at 240 bp, down 3 bp.
The view in spreads
The supply-demand balance looks neutral to negative for MBS, neutral for corporate debt overall and especially weak for technology debt. MBS net supply remains low, but the expected steady demand from Fannie Mae and Freddie Mac has not appeared. Insurers continue to issue annuities and buy corporate and structured credit, but credit markets face heavy financing needs for capital investment. In risk assets, carry will likely drive returns. Stay overweight MBS and favor higher coupons to add carry and reduce spread duration. Stay overweight corporate credit overall but underweight technology.
The Bloomberg US investment-grade corporate bond index option-adjusted spread traded Friday at 77 bp, 1 bp tighter in two weeks. Nominal par 30-year MBS spreads to a blend of 5- and 10-year Treasury yields were 113 bp, 3 bp tighter. Par 30-year MBS treasury option-adjusted spreads closed at 23 bp, 4 bp tighter.
The view in credit
Large companies have healthier balance sheets than smaller ones. Middle- and higher-income consumers also carry relatively little debt and have strong liquidity and wealth. Bank lending to nonbank financial institutions, including private debt funds and business development companies, continues to grow. Regulators remain focused on this lending, which could eventually tighten private credit markets. For now, however, credit measures for nonbank financial lending remain stronger than those for traditional bank lending, such as commercial and industrial loans.
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