Morgan Stanley reiterated that AI financing demand remains robust, and the investment it drives will spur credit market expansion, with total issuance of investment-grade bonds expected to surge to USD 2.25 trillion. However, credit spreads are projected to widen only modestly. Meanwhile, Morgan Stanley maintains its view that the Federal Reserve will cut interest rates three more times in this cycle, while the European Central Bank is expected to implement two additional rate cuts by 2026.
Morgan Stanley's 2026 outlook report has sparked intense debate among clients, focusing on investments in artificial intelligence (AI), the Federal Reserve's policy path, and the outlook for the credit market.
Morgan Stanley predicts that driven by capital expenditures and merger activities, the annual total issuance of U.S. investment-grade bonds will surge to $2.25 trillion, but credit spreads will only moderately widen by about 15 basis points. Some clients are skeptical about this, while the bank maintains its view that major central banks will continue to adopt an accommodative stance, expecting the Federal Reserve and the European Central Bank to further cut interest rates in 2026, which differs from some market expectations and the official statements of the European Central Bank.
Shortly after releasing the outlook report, the bank's chief economist Seth Carpenter and chief fixed income strategist Vishwanath Tirupattur responded to concentrated client feedback in a recent report.
AI Investment Boom: Discrepancies in Growth Expectations and Financing Paths
Morgan Stanley's core pillar for its 2026 capital expenditure forecast is the firm belief that the demand for computing power in the coming years will far exceed supply, which will drive a surge in investments related to AI and data centers. The bank reiterated that the credit market will become the key channel for funding the next wave of AI investments, and that this portion of expenditure is "relatively insensitive" to macro conditions such as interest rates and economic growth.
However, customer feedback shows a duality. According to the bank's report, some customers question: why is there no prediction that AI capital expenditure will bring about "higher growth"?
In response to this, Morgan Stanley stated that it is a process that has been ongoing for many years, and its boosting effect on economic growth will gradually become apparent over time. This suggests that there is a cognitive difference between the bank and some more optimistic investors regarding the pace and scale of AI's impact.
Credit market debate: Will the $2.25 trillion bond issuance wave impact interest rate spreads?
A forecast by Morgan Stanley's US credit strategists has drawn significant market attention: total issuance of investment-grade (IG) bonds is projected to reach $2.25 trillion in 2026 (a year-on-year increase of 25%), with net issuance reaching $1 trillion (a year-on-year increase of 60%).
The bank believes that as capital expenditure growth outpaces revenue growth, putting pressure on free cash flow, credit will become a critical financing bridge. AI is not the sole driver; a rebound in mergers and acquisitions (M&A) activity will also play an important role.
Despite the expected surge in issuance, the bank anticipates only a moderate widening of credit spreads by approximately 15 basis points, remaining at the lower end of the historical range. This has become another point of contention for clients, with some arguing that spreads should widen much more significantly.
Morgan Stanley defended its view, stating that several factors will help stabilize spreads:
First, most AI-related issuance will come from high-quality (AA-AAA rated) issuers;
Second, ongoing policy easing (with three more interest rate cuts anticipated from the Federal Reserve);
Third, the economy is expected to experience a mild reacceleration;
Finally, continued demand from yield-seeking investors will also help anchor spreads.
Divergence in central bank policies: The Federal Reserve and the European Central Bank’s interest rate cut paths
The Federal Reserve's policy path remains a focal point of market debate. Morgan Stanley admitted that there had been fluctuations within the bank regarding whether the Fed would cut rates in December; currently, it expects a rate cut in December. The challenging situation at present is that while the US economy remains resilient, the labor market is slowing down. This slowdown trend has decisive implications for markets, particularly the credit market.
Outside the United States, the bank's forecasts for the European Central Bank (ECB) have also faced the strongest opposition. Morgan Stanley expects the ECB to cut interest rates twice more in 2026 and explicitly disagrees with President Lagarde’s statement that “the disinflation process has ended.” The bank believes there is still a negative output gap in the eurozone, which will eventually lead to inflation falling below the ECB’s 2% target.
The Debate on the Yield Curve: 'Bull' and 'Bear' Steepening
At the macro-strategy level, Morgan Stanley defines 2026 as a “transition year” for global interest rates — shifting from synchronized tightening to asynchronous normalization. Its view that government bond yields will remain range-bound has gained widespread acceptance.
However, the real point of debate lies in the shape of the yield curve. While clients and Morgan Stanley generally agree that the yield curve will steepen further, the nature of this steepening — whether it is a “bull steepening” driven by falling rates or a “bear steepening” caused by faster increases in long-term rates — remains a focal point of contention. This divergence stems from Morgan Stanley’s belief that the market will price in the Fed’s easing bias earlier than expected.
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