Credit markets have a “debt” problem, not a “risk” problem

Another thing that AI’s disrupting: how investors judge risk in the $7.5 trillion US corporate bond market.

In a note titled “Redefining Quality in Credit,” Amanda Lynam, chief credit strategist at Goldman Sachs, recently observed that ratings are serving as an “imperfect proxy” for how investors want to be positioned.

Corporate bonds are of course credit instruments, but they are also very much bonds (it’s right there in the name). As such, their values are impacted by both the ebbs and flows of how risky investors think it is to lend to individual companies as well as changes in risk-free rates. The pick-up in issuance year to date has come primarily from bonds with higher credit ratings, which are underperforming lower-rated counterparts.

Even after taking into account that higher-quality debt is more negatively impacted by higher interest rates, those bonds are still underperforming riskier debt in 2026! So the nascent trend is that riskier bonds are actually "higher quality" because they're less bond and more risk.

Per Lynam:

“The catalyst has been the growing tension between solid fundamentals and challenging supply technicals within certain ‘high quality’ rating cohorts. In IG and HY, the highest rating categories (i.e., AAs in IG, and BBs in HY) are generating historically elevated shares of total debt issuance, driven in large part by AI-related financing. The returns within these rating categories also tend to be the most sensitive to higher interest rates, given their longer duration profiles and thinner spread 'cushions' to buffer total returns.

This backdrop is driving outperformance from the lower-rated cohorts. For example, across the USD and EUR markets, BBBs have outperformed AAs and As on both a total and excess return basis.”

“Bonds” are out of favor while “risk” is in vogue because the kind of debt growth we’re getting now is risk-reducing and profit-enhancing, at least on shorter time horizons.

Hyperscalers — the companies with among the biggest revenue-generating capabilities in the world and robust balance sheets — are driving a ton of borrowing, as is the US government. Fiscal deficits and megacap tech capex are other companies’ profits.

The way debt problems become risk problems is if these fail to create sufficient returns, or if all of the spending associated with the increase in indebtedness fuels inflation, and that inflation causes the central bank to jack up interest rates until overall activity succumbs to tighter policy.

In any event, for now these dynamics are on track for a performance gap between higher and lower quality investment grade debt that hasn’t been since the financial crisis.

“While down-in-quality outperformance within IG is not unusual from an excess-return perspective, the current divergence is somewhat pronounced. For example, if returns continue on the current trajectory, 2026 will mark the first year in the post-GFC period that AAs have posted negative excess returns while both As and BBBs have generated positive excess returns."