2026 Credit Cycle: Stimulus, AI Fueling Issuance Before Burnout

Key Quotes

"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 highs in the US and Asia. Issuance and 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?

Andrew Sheets highlights that despite current market conditions, including tight credit spreads and aggressive corporate activity, many investors are questioning the sustainability of the situation. Sheets notes that credit investors are conditioned to anticipate problems, and the current environment presents numerous indicators that typically signal an impending credit cycle downturn.

"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 the corporate sector that has the capacity to do so."

Andrew Sheets explains Morgan Stanley's contrarian view that the credit cycle is not yet cracking. Sheets attributes this to a confluence of stimulative factors, including central bank rate cuts, government spending, and easing regulations. Sheets also points to the significant investment cycle driven by artificial intelligence as a catalyst for increased corporate risk-taking.

"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."

Andrew Sheets draws parallels between the projected 2026 credit market environment and historical periods like 2005 and 1997-1998. Sheets notes that these past periods shared similar economic indicators, such as capital expenditure, merger activity, interest rates, and unemployment rates, to those anticipated for the upcoming year. This comparison suggests a potential for similar market dynamics and investor strategies.

"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 US, European, and Asia credit. We forecast net issuance to rise significantly in US 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."

Andrew Sheets emphasizes the critical role of corporate bond issuance in shaping the credit market's trajectory. Sheets forecasts a substantial increase in US investment-grade issuance, projecting it to exceed 60% compared to 2025 and reach approximately $1 trillion. Sheets attributes this surge to increased technology spending for AI, alongside broader capital expenditures and merger activities.

"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 out-perform US investment grade on our forecast. In total returns, we think that all of these markets produce a return of around 4 to 6%."

Andrew Sheets suggests that certain credit markets may offer more favorable prospects due to lower relative issuance levels. Sheets specifically highlights European and Asian investment grade, as well as global high yield, predicting they will outperform US investment grade. Sheets forecasts total returns for these markets to be in the range of 4% to 6%.

"The most significant risk for global credit remains recession, which we think would argue for wider spreads on both economic grounds, but also through weaker demand, as yields would fall. It wouldn't mean that our spread forecasts are too optimistic and that our expectation that high yield out-performs investment grade would be wrong."

Andrew Sheets identifies recession as the primary risk to the global credit market. Sheets explains that a recession would likely lead to wider credit spreads due to economic weakness and reduced demand, causing yields to decline. Sheets further notes that such a scenario would invalidate the current forecasts for spreads and the expectation of high yield outperforming investment grade.