AI Has Already Disrupted the Stock Market. Now It's Coming for the Bond Market.
For decades, bonds have played a fairly straightforward role in any investment portfolio. While stocks are expected to provide growth—in exchange for some occasional volatility—bonds are expected to provide stability and predictability, allowing a diversified investor to sleep peacefully.
But this year, the bond market has been anything but boring. Both short- and long-term treasury yields have moved up in tandem as inflation expectations, Federal Reserve policy, and the federal government's substantial borrowing needs have all come into sharper focus simultaneously. Then, add to the mix that some of the largest technology companies in the world have begun borrowing money at a pace rarely seen outside of a major financial crisis, driven by the staggering capital requirements of the AI buildout.
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The same AI revolution that has already distorted the valuations of both tech and non-tech companies alike has increased volatility and redirected vast amounts of capital within the stock market. It is now beginning to make waves across the bond market as well. For the first time in several years, Treasury securities are competing for investor capital against a massive supply of bonds being issued by some of the world’s strongest corporate balance sheets. And considering those companies need to offer investors a premium above treasuries to court investor attention, that competition could have significant consequences for anyone who owns bonds.
One of the defining characteristics of America's largest technology companies over the last few decades has been their ability to generate large amounts of free cash flow. Unlike manufacturers that must continuously borrow money to build factories and purchase equipment, companies like Amazon, Alphabet, Meta, and Microsoft have built businesses that could use generated free cash flow to finance much of their growth internally.
Now, the race to build infrastructure to support each company’s AI ambitions has changed that equation. Training and operating increasingly sophisticated AI models requires enormous data centers filled with expensive semiconductors, networking equipment, cooling systems, and electrical infrastructure. The companies developing these systems also need land and access to an extraordinary amount of power.
The result has been a dramatic change in how some of America's largest technology companies finance themselves. Rather than relying almost exclusively on the cash their businesses generate, hyperscalers are increasingly turning to the bond market. One estimate from Goldman Sachs expects that investment-grade bond issuance among the five largest hyperscalers—which includes Oracle—will reach as much as $250 billion by the end of 2026 alone, creating a serious problem for anyone else who needs to borrow money through the fixed income markets.
Historically, one of the U.S. Treasury Department’s greatest advantages has been that there is no real substitute for the perceived safety of its bills, notes, and bonds. Without question, pension funds, insurance companies, mutual funds, banks, foreign governments, and wealthy individual investors buy those securities issued by the government since the interest they pay is generally considered to be the “risk free” rate of return.
When allocating capital, however, investors do not make these decisions in a vacuum. They are, instead, made relative to the other opportunities available at the same time. And right now, the federal government is asking investors to absorb significant Treasury debt at precisely the same time that some of the most highly rated corporations are asking those same investors to finance the AI revolution.
The difference is that corporate borrowers generally have to offer investors additional yield to compensate them for taking additional risk. And right now, they seem more than willing to.
Amazon provides a clear example of just how quickly this transformation has occurred. The company raised $37 billion in the U.S. bond market in March of this year, which was one of the largest corporate bond offerings ever completed. Just four months later, Amazon returned, looking for another $25 billion. The interest spread that those bonds offer seems to be enough to avert investor attention away from bonds with similar maturities issued by the U.S. government over the same period.
Stated simply, bond investors do not need to believe that Amazon is a safer bet than the U.S. government. They just need to believe that the additional yield Amazon offers is adequate compensation for the additional risk. And when you multiply that decision across several thousand institutional investors daily, it is easy to see how the increased competition for a finite pool of money is upending the capital markets entirely.
This does not mean hyperscaler borrowing is solely responsible for the recent increase in Treasury yields. When substantially more bonds are available for purchase, issuers have to make those securities increasingly more attractive to convince would-be investors to buy them. And when that happens, what was once considered to be the boring part of the portfolio is suddenly not so boring anymore.
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Malcolm Ethridge is the Managing Partner at Capital Area Planning Group, based in Washington, D.C. His areas of expertise include retirement planning, investment portfolio development, tax planning, insurance, equity compensation and other executive benefits.
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