Thoughts on the Market: Is the Credit Cycle Overheating?

Host: Andrew Sheets, Head of Corporate Credit Research, Morgan Stanley
Date: December 12, 2025

Episode Overview

In this episode, Andrew Sheets analyzes the state of the global credit markets as we look ahead to 2026. Despite concerns about the credit cycle overheating—signaled by tight credit spreads, aggressive issuance, and soaring corporate activity—Sheets explains why Morgan Stanley believes the cycle may "burn hotter before it burns out." He compares the current backdrop to historical analogs and offers actionable insights for credit investors navigating this dynamic environment.

Key Discussion Points and Insights

1. Current State of Global Credit Markets

• Credit Spreads at Multi-decade Tights (00:37)
  • US and Asian credit spreads are at "25 year plus tights."
  • There’s increasing aggressiveness in issuance and corporate activity.
  • Signs of pressure are evident especially in lower-rated parts of the market.
• Investor Anxiety (00:54)
  • Credit investors feel the cycle may be cracking under its own weight.

2. Why Morgan Stanley Expects Credit to Burn Hotter in 2026

• Unusually Stimulative Backdrop (01:08)
  • Central banks are cutting rates.
  • Governments are increasing spending.
  • Regulatory policy is easing.
• The “AI Investment Cycle” (01:19)
  • The investment boom around artificial intelligence mirrors historical transformational tech cycles.

Quote:

"We think that 2026 brings a credit cycle that burns hotter before it burns out."
— Andrew Sheets (01:05)

3. Historical Parallels: What’s 2026 Likely to Resemble?

• Echoes of 2005, 1997, and 1998 (01:32)
  • Sheets points to parallels in capital expenditure, mergers, rates, and employment to these years.
• Dueling Narratives (02:03)
  • 2025: Low-end consumer struggles, but another force (now AI spending) keeps the market strong.
  • 1997/98: Investors gain confidence in a transformative technology (then the Internet, now AI).

4. The Central Role of Corporate Bond Issuance

• Significant US Investment Grade Issuance Forecast (02:26)
  • Net issuance to rise over 60% from 2020, to ~$1 trillion.
  • Driven by increased tech spend (AI), capex, and M&A activity.
• Implications for Spreads (02:44)
  • Aggressive issuance could widen US credit spreads, even amid healthy demand.

Quote:

"All of those bonds being sold to the market should mean that US spreads need to move wider to adjust."
— Andrew Sheets (02:45)

5. Regional and Sectoral Dispersion

• Europe/Asia Investment Grade & Global High Yield (02:53)
  • Less issuance relative to the US, forecast to outperform US investment grade credit in total returns.
• Expected Returns (03:10)
  • 4–6% returns for these markets—below US equities but above cash.
• Importance of Positioning (03:24)
  • Single name and sector selection (“dispersion”) will be critical.
  • Maturity positioning matters, with steepening yield curves making 5–10 year maturities attractive.

6. Key Risks and Scenarios

• Primary Risk: Recession (03:47)
  • Would lead to wider spreads, lower yields, and underperformance of high yield vs. investment grade.
• “Milder Bear Case”: Aggressive Supply (04:05)
  • If corporate supply is even stronger, could resemble late 1998/99—wider spreads despite a strong economy and rising equities.

Quote:

"Back then, US investment grade spreads were roughly 30 basis points wider than current levels even though the economy was strong and even though the equity market kept going up."
— Andrew Sheets (04:17)

Notable Quotes & Memorable Moments

• On Market Concerns:

  "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? Not quite yet, according to our views here at Morgan Stanley."
  — Andrew Sheets (00:52)

• On the Role of AI in Extending the Cycle:

  "All of that, alongside maybe the largest investment cycle in a generation around artificial intelligence, should spur more risk taking from a corporate sector that has the capacity to do so."
  — Andrew Sheets (01:16)

• Investment Guidance:

  "In our view, corporate bonds between 5 and 10 year maturity in both the US and Europe will offer the best risk reward."
  — Andrew Sheets (03:32)

Timestamps for Important Segments

• State of the Credit Market: 00:37–01:05
• Policy Environment & AI Cycle: 01:06–01:22
• Historical Parallels & Playbook: 01:32–02:18
• Issuance and Spread Outlook: 02:26–02:51
• Regional Outperformance: 02:53–03:12
• Investment Strategy: 03:24–03:46
• Risks & Scenarios: 03:47–04:26

Summary Flow & Takeaways

Andrew Sheets offers a measured, historical perspective: The conditions that usually precede credit market excess are present, but stimulative policy and transformative tech investment (AI) suggest more risk-taking before a downturn. Investors should prepare for wider spreads in the US, favor global diversification, and be selective with both sector exposure and maturity positioning. While recession risk looms, the cycle—bolstered by policy support and AI-driven capital spending—has room to run hotter first.