Executive Summary
Morgan Stanley's credit chief Andrew Sheets delivers a counterintuitive thesis: the credit cycle will 'burn hotter before it burns out' in 2026, despite spreads sitting at 25-year tights. The firm forecasts US investment grade net issuance to surge 60% to $1 trillion, driven by AI infrastructure spending and increased M&A activity. This massive supply wave should force US spreads wider even in a healthy economy, creating a regional arbitrage opportunity. European and Asian credit markets, facing less issuance pressure, are positioned to outperform with 4-6% total returns. The setup mirrors 2005 or 1997-98, when similar CapEx cycles and rate environments preceded credit's final rally phase. Sheets identifies the 5-10 year maturity sweet spot as optimal positioning, benefiting from steep curves and carry dynamics. While recession remains the primary risk, the confluence of central bank easing, fiscal stimulus, and the largest investment cycle in a generation around AI creates an unusually stimulative backdrop that should extend credit's run.
Key Insights
what Andrew Sheets said“We forecast net issuance to rise significantly in US investment grade, up over 60% 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.”
what Andrew Sheets said“Credit curves are steep and our US interest rate strategists are expecting the US Treasury curve to steep in significantly further. That should mean that so-called carry and roll down and where you position on the maturity curve are a pretty big driver of your ultimate result. In our view, corporate bonds between 5 and 10 year maturity in both the US and Europe will offer the best risk or reward.”
what Andrew Sheets said“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.”
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