HSBC Strategists Warn Credit Investors to Beware Potential Risks from "AI Frenzy"

HSBC strategists have cautioned credit investors to be vigilant about potential downside risks associated with the "artificial intelligence (AI) frenzy." This warning comes as optimistic sentiment surrounding AI technology has driven credit spreads down to multi-decade lows. “In the United States, a significant portion of recent GDP growth has been linked to AI, whether directly through investment expenditure or indirectly via the wealth effect from AI-related stocks,” noted Song Jin Lee and Tom Russell in a report. “Any disappointing developments could trigger ripple effects across the credit market through multiple channels.” Corporate bond spreads are approaching the lows seen just before the 2007 global financial crisis, as investors look past geopolitical volatility and chase yields that remain high by historical standards. Even with a robust macroeconomic backdrop, the upside for bond investors appears limited, especially as tech giants issue tens of billions of dollars in new bonds, potentially exerting widening pressure on credit spreads. These strategists wrote that pricing has already "fully reflected" the favorable outlook for such bonds, primarily benefiting from the generally solid fundamentals of corporate borrowers in developed markets. However, the volatility of premiums fails to reflect the reality that "the current optimism is built on a fragile foundation." The bank urged investors to consider diversification strategies, suggesting a measured avoidance of US tech bonds, and pointed out that certain credit assets in the eurozone have less exposure to the AI cycle. The strategists argue that the benefits from further US economic and AI growth will primarily flow to equity holders rather than creditors. Even in the event of an unexpected positive development in the AI sector, US private credit maintains significant exposure to high-yield software companies, whose business models could face challenges. The report added that Asian investment-grade credit might be better positioned to withstand risks from deteriorating market sentiment and volatility induced by fiscal policy.