Update Bonds: How to navigate the challenge of AI?
Bond yields have fallen globally this year, especially over the last few weeks, despite improving economic indicators. (As bond yields decline, bond prices rise.) Inflation expectations are still higher than around year-end, however, suggesting that investors are starting to think (more than they had previously) that central banks can control future inflation with lower interest rates.
Bond yields have fallen globally this year, especially over the last few weeks, despite improving economic indicators. (As bond yields decline, bond prices rise.) Inflation expectations are still higher than around year-end, however, suggesting that investors are starting to think (more than they had previously) that central banks can control future inflation with lower interest rates.
This is actually the case that Kevin Warsh made to advocate lower interest rates, seducing US President Donald Trump to appoint him as the next Chair of the US Federal Reserve. Productivity gains from the implementation of artificial intelligence (AI) will reduce costs over the next few years, putting a lid on price increases as companies increase profits by reducing costs.
Equity investors have been struggling with the impact of AI for some time already. Macro analysists and bond investors are increasingly focussing on this issue too, if only because the big AI spenders are now starting to tap bond markets. Abundant cash reserves are no longer sufficient to finance huge investments in building the AI capacity for the future.
While the spending boom of investment in AI infrastructure further accelerates in 2026, supporting economic growth, the questions about the impact of using all that infrastructure are wide open. Picking the winners and avoiding the losers will be key to successful investing in such periods of revolutionary change, but it will be challenging. As long as you think that the global economy will be one of the winners, as productivity gets a significant boost, it could pay off to increase risk in a well diversified portfolio approach, as winners outweigh losers overall.
In this context, investment-grade corporate bonds could be increasingly interesting for European bond investors. Sovereign bonds in peripheral countries used to provide an alternative with similar risk premiums. However, these spreads are now significantly lower, while challenges for euro sovereigns over the next few years are perhaps even more existential than AI challenges for corporates.
Recession risks continue to fade as countries and companies chase each other to remain ahead in the AI race. And meanwhile, the default risk of investment-grade corporate bonds is very low. However, as we may be approaching a disruptive period, an active policy may be required to at least avoid indiscriminate selling on downgrades into high yield. Otherwise, you may need a bigger buffer than the current historically tight spread levels to beat sovereign bonds after all.
Chris Huys