Global Rates & FX Views: Hyperscalers, credit, & rates
The desk views the ongoing rise in global rates as a crucial factor shaping market dynamics, particularly in the context of hyperscaler issuance and credit supply. Per the full note source, the strength of the U.S. credit market is underscored by a 30% year-over-year increase in supply without a corresponding rise in spreads, which highlights investor interest in attractive yields despite overall tight conditions. As the Federal Reserve's July meeting approaches, this backdrop suggests significant implications for currency valuations, particularly against a meticulous risk-on atmosphere facilitated by solid economic data.
What the desk is arguing
The desk posits that rising global rates, influenced by geopolitical tensions and strong U.S. economic indicators, will impact the currency landscape significantly. Per the full note source, the United States is witnessing historically low initial claims data, suggesting a robust economic backdrop, which further incentivizes investor behavior in credit markets.
Crucially, the desk points out that the strong credit market dynamics are characterized by historically tight yields paired with a notable 30% increase in issuance year-over-year. This contrast may suggest an evolving preference among investors, focusing on yield opportunities amid stabilizing rates rather than spread expansion.
Where it sits in our coverage
The consensus target from our internal analysis suggests a target level of 1.075 for key currency pairs, with a range extending from 1.04 to 1.12 as indicated by market sentiment.
jpmorgan has set a target of 1.10 for March 2026, while bofa takes a more conservative stance, forecasting a target of 1.04 for the same tenor, indicating a divergence in expectations among firms regarding future rate trajectories.
How other firms see it
Group-aligned firms such as jpmorgan see an uptick in currency values due to the higher yields, while bofa remains cautious, predicting lower levels based on tight yield spreads. This divergence suggests a potential volatility in currency pairs as investor sentiment shifts along with economic indicators.
Indicators such as U.S. inflation data and Federal Reserve policy shifts will be critical in determining the trajectory of interest rates and, consequently, currency pair movements.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01U.S. credit market remains strong despite increased issuance.
- 02Global rates rising due to geopolitical tensions and positive U.S. economic data.
- 03Diverse target forecasts suggest potential volatility in currency movements.
- 04Investor focus on yields rather than spreads reflects market sentiment.
Market implications
Traders should monitor levels around 1.075, particularly as economic indicators further unfold. The outcome of the upcoming Fed meeting is critical, as any shift in policy could significantly influence FX positioning.
Risks to this view
A sudden deterioration in economic data or unexpected geopolitical developments could alter the current bullish sentiment, leading to a reevaluation of yield positions and potential widening of spreads in the credit market.
Hello and welcome to Global Research Unlocked, the interest rate in FX series. This podcast is based on our weekly client conference call, where our strategists, along with guests from other parts of Bank of America Global Research, discuss the most topical and pressing questions faced by our market. I'm Mark Cabana, Co-Head of Global Rate Strategy at B of A Securities.
Today is July 24th. We're going to be talking with Yuri Sigler, who is a credit strategist on our side, and Megan Swiber, a rate strategist on our side as well. And we're going to be focusing on hyperscalers, credit, and the implications for rates.
Also one other housekeeping item, for any disclosures around securities mentioned, they can be found on the conference call invite. Now, shifting to markets. So we continue to see global rates rising.
A lot of this has to do with geopolitics and its impact on commodities, oil, gasoline. It's also taking place in the context of solid U.S. economic data, including U.S. initial claims yesterday that it was at the lowest level since 1969. We also have easy financial conditions, and the July Fed is still in play, at least as far as markets are concerned.
So to unpack these dynamics, we've got Yuri and Megan, and let's dive right into it. So Yuri, amidst this backdrop of higher global rates, what do you see as the current state of the U.S. credit market and the increased credit supply that we have recently seen? Sure.
Thank you, Mark. Right. So the big picture for the credit market is that it's very strong.
Yields are near historically tight levels, despite pretty massive amounts of supply that we've had year to date. For example, supply is up over 30% year over year, while spreads are unchanged. And as you mentioned, I think a big reason for that is that yields are elevated, and a lot of IEG investors find those yields attractive, while they don't necessarily find spreads attractive, given that they're near historically tight levels.
However, so far in July, spreads are a bit weaker. So the index is about four basis points wider month to date. And the big driver behind that is a concern about hyperscaler supply.
We had this unexpected, surprising deal from Amazon on July 7th, which priced significantly wider to where Amazon was trading prior to the deal, about 20 basis points wider. And that has underscored that supply could potentially impact markets negatively. And that has resulted in significant spread widening for all the hyperscalers.
So on average, all the AI-operated bonds, which include hyperscalers, SpaceX, NVIDIA, et cetera, are 25 basis points wider so far. So that's a very big move. And just to put it in perspective, if you look at some of the other large sectors in IEG, such as banks, those are something like two to four basis points wider month to date.
So a little bit weaker here in July, mostly driven by hyperscalers and other AI-related bonds, while the rest of the market is holding up decently OK. Thanks. So what are your expectations for hyperscaler supply going forward, and what might appear somewhat concerning to you?
You talked about the widening that we were seeing in those names and how it's outsized relative to other in the IEG space. So what are the types of warning signs that you're looking for? Yeah, sure.
So let me talk about the AI or hyperscaler supply. So just to put this in perspective, year to date, we had $271 billion of AI-related supply across currencies. $209 billion of that was in US dollars. And again, this is the broader definition of AI-related supply, which includes hyperscalers, NVIDIA and SpaceX, as well as IEG data centers.
The issue with this kind of hyperscaler supply is that uncertainty about how much issuance needs to be done is extremely high. Effectively, hyperscalers specifically are raising capital or raising funding, mostly to increase cash on the balance sheet, which means the amount of cash that they need to raise and when depends on their preferences in terms of how much cash they're targeting. And away from Oracle, they provided zero guidance on that.
So there's maximum uncertainty about how much supply is coming and when. That's I think one of the big reasons why spreads are wider. So given this uncertainty, we do have a view.
And again, of course, the range, potential range of outcomes here is wide. But our base case scenario is maybe we get another couple of hyperscaler deals for the remainder of 2026 for a total of about $50 billion. We also penciled in $25 billion for data center supply as well.
And then if you look at what investors are thinking, we ran a survey last week of US credit investors. And on average, they expect $100 billion in additional hyperscaler supply for the remainder of 2026. That usually tends to be split across different currencies.
So applying the typical split, you get something like $67 billion of additional hyperscaler supply for the remainder of 2026. So that's not too far from our $50 billion number. So I guess us and investors appear to be in this $50 to $70 billion range for the remainder of the year for hyperscaler supply in dollars.
And in terms of what I would be watching, I think the most obvious thing to watch is just how well these new deals perform, even when they come. Just you can see that because this poorly performing Amazon deal really triggered this entire period of weakness in the hyperscaler space. Again, just for reference, typically the new issue concession, which is how much wider the bonds price relative to the secondary market, it's about five basis points.
As I mentioned earlier, for Amazon, that was 20 basis points. So much weaker than typical. You can also look at oversubscriptions.
Typically these larger deals are three to four times oversubscribed. Amazon on July 7th, the oversubscription level was two and a half times. So unusually weak demand for that particular deal.
So I would be watching this kind of performance of these hyperscaler deals as probably the best indication of how the market is digesting. Great. Thank you.
So to summarize, very heavy issuance in the first half of the year, or really through the first seven months of the year, but a notable slowdown expected in the second half. Still heavy, but certainly not quite at the rate that we saw in the first half. And then for warning signs, it's really just about subscription performance, where they price.
And do you think, Yuri, that this type of feedback from the market will have a material impact on potentially slowing the CapEx cycle, or at least slowing the debt financing that is contributing to the CapEx cycle? Mark, that's a great question. I think there's a debate in the market whether that will be the case or not.
Historically, very high quality issuers like the hyperscalers would not be very sensitive to market conditions. They kind of assume that given their high quality, they can just issue whatever they want, however much they want. That clearly is changing.
So there's this hope that the issuers would become, even though in the past they have not been market sensitive, that there would be more market sensitive going forward. And if that were the case, that would be positive for spreads. But so far, we have seen no signs of that.
And again, the Amazon deal did the opposite, which is the latest example of their behavior. So charging ahead and not being deterred so far by what we've seen. We obviously will get earnings from a number of the hyperscalers within the next week.
And so I'm sure you and many in the market will be watching that quite closely. Great. Well, thank you, Yuri.
And stay on the line in case there are questions at the end. But right now I wanted to transition to Megan. So Megan, you have over recent months done some great work on the Fixed Income Digest, also known as the Ag Alpha, where you really look at the implications for broader fixed income, not just from the U.S.
Treasury space, but also including mortgages and credit. So when you hear Yuri discuss all this credit supply, when you put it in the context of the broader fixed income market, what are the implications for U.S. rates specifically? Yeah, Mark, so let's dig into that.
And we'd say that when we look at big buyers in the U.S. rates market right now, a lot of that demand, and we see this in Treasury auctions too, is coming from investment funds. And if you look at the inflow picture, we write about this basically every week in our flows report, a disproportionate amount of the net inflow that we're seeing into U.S. bond funds is going into Ag benchmark funds. So they are needing to invest in this mix of Treasuries, IG, and MBS.
And what we've been writing about in our Ag Alpha is that a larger share of the amount of total core bond supply that needs to be digested by these funds on a monthly basis is coming from IG issuance, rather than just the story of increasingly larger Treasury supply. And when we look at these numbers, we were talking about this earlier in this year, and last year as we were looking into this year ahead, Treasury is changing the composition of its debt, doing more in bills, less in coupons. And this in theory would have provided and supported more of an easing in financial conditions.
But when we look at the amount of decline in the net Treasury coupon supply versus this increase that Yuri is talking about in terms of IG issuance, they're almost exact opposites and they're total offsets of one another. So this decline that we've been seeing in Treasury coupon supply is being exactly offset by this increase that we're seeing in IG issuance. So on that, as Yuri is discussing, there are a lot more upside risks that we're still seeing to IG supply, a lot of question marks in terms of what we're going to see from Treasury in terms of when and the cadence in which they will have to grow coupon supply at some point in time.
And this is just supporting, in our view, more upward pressure that we could see in rates across the yield curve. Great, thanks. So it is useful to think about the whole stock of fixed income issuance.
As you note, the reduction in US Treasury coupon supply and associated duration risk is largely offset by what we see in credit. So on balance, that seems somewhat neutral for broader dollar fixed income, though there are certainly upside risks based upon what Yuri was telling us. As you know, Megan, in just two Wednesdays from now, we're going to get the August for funding and we'll be closely watching that for any signals about potential increases in Treasury coupon supply.
More to follow on that likely in the next week or so. Now, Megan, I wanted to build off of that and ask about, okay, so thinking about fixed income more broadly, thinking about this offsetting impact of credit and Treasury supply, how do you see recent flows and positioning in the broader fixed income space? And I'm specifically thinking about exposures to some of the key fixed income factors such as US duration, curve, mortgage exposure and credit exposure.
What do you see? Sure, sure. So as we were writing about earlier this week, there is definitely this bifurcation across investor types.
We do see CTAs in particular, more short front end of the curve, they have been for a while now. Anecdotally, we're hearing macro hedge funds more sympathetic to the sea that the Fed can deliver on more hikes than what the market's pricing. But in terms of real money flows and the asset manager regression that we run, we do see large asset managers, large benchmark funds running pretty neutral duration risk, pretty neutral curve risk.
And the place where they seem to be extending themselves more is in overweight IG spread exposure. So what this means to us in context of the risks that we perceive, which is more pressure higher in yield levels that the Fed is delivering what we're expecting, which is 75 basis points of hikes this year, there's certainly more room from a duration perspective, these investors to pivot underweight duration, rotate purview more into flatteners, and as Yuri's flagging, more of this room for them to recalibrate their IG exposure, taking that closer to benchmark exposure. So do see a lot of room for these large real money investors that we do a lot of work on and thinking about their importance as a demand source.
There's a lot of room for them to rotate in our view, and that should support our modal view, which is that rates can move higher and to be more neutral on IG spreads. Great. Thank you.
So I wanted to pivot here to next week in the US. We have the July FOMC meeting, and this is a bit of a unique one, given that the market, at least as I see it right now, is still pricing in around eight basis points for the meeting. So that's roughly 30 to 35% odds of a Fed hike.
This is a little unusual, given that typically going into a meeting, the Fed guides the market to some extent to either validate or invalidate market pricing, but we know that Warsh doesn't want to do that now. So how are you thinking about this specifically? What are you expecting next week?
What does history tell us about market pricing and Fed hikes? And really, I think the question we're wondering is, will the Fed hike if it's not fully priced? What are your thoughts on those things?
Great, great questions, Mark. So I did some work on this with Eleanor on our team yesterday, and we've been writing about this. As you noted, it's very rare for the market to be highly uncertain, at least as uncertain as it is right now, headed into the week of the Fed meeting.
On average, if you look at FOMC meetings post-GFC, we're around two basis points relative to what it is the Fed ends up delivering. There are a couple of exceptions to this, and there's two that stand out very vividly versus what we see in terms of that historical average of two basis points. One was, you'll recall in June 2022, when the Fed surprised the market over the blackout period with pivoting to a 75 basis point hike as one of the scenarios for consideration and delivered on that.
And the other was when the Fed cut 50 basis points in September of 2024. And you'll remember too, Mark, that when we think about those two scenarios, there was a press leak actually within the Fed blackout period that got the market closer to that desired outcome at the meeting. When we listen to Warsh, he wants a family fight.
He titled the weekly that, we have been saying that this is pretty unprecedented, but he very well may want to keep July live, not necessarily leak something ahead of the meeting that will converge market pricing. It is, as we were discussing, relatively unprecedented in terms of the market being able to perceive this level of uncertainty headed into the meeting. But Mark, it's not ruling it out.
We're not either. Our modal view continues to be that the Fed will deliver a hike at the September meeting rather than July. And a lot of that really comes down to the weaker than anticipated inflation data that we saw print over the past couple of weeks.
But certainly if Warsh does deliver this hike next week, it's going to surprise markets. And I would just say in a lot of our conversations, there has been this pushback around Warsh being unable to deliver hikes from a political perspective, using these task forces to buy himself time. And a Warsh that delivers on a hike really, I think, reclaims Fed credibility on inflation.
It suggests that Warsh is committing to tighter financial conditions. And we think it will get the market to very rapidly reprice front end closer to what our baseline scenario is, which is 75 basis points of hikes and flatten the yield curve. We see that as being able to compress longer term inflation compensation and really be actually a good thing for the back end of the curve relative to the front end if the Fed is able to deliver on a hike and deliver on this credibility message.
So, Megan, if they do hike next week, there's eight priced right now. There's about 44 basis points of hikes priced by the end of the year. What do you think hike pricing does by the end of the year versus where we are today?
And what do you think that means for, let's say, the two year? Yeah, and I think very rapidly, as I noted, we can get to 75 basis points perhaps by the end of the year, perhaps by through Q1 of next year. And really what underpins that market is if we have a Warsh that's not going to deliver forward guidance and say, all right, we're one and done, the market can use a lot of these very simple frames of reference, rule of thumb, thinking about the fact that real policy rates have eased over 100 basis points over a period of time where the unemployment rates moved down, looking at where Taylor rule implies front end rates should in theory fit, which is well above what our economists are calling for the 75 basis points of hikes.
You can see this jump risk in terms of what the front end is currently pricing, which is right now kind of this very, what we view as unlikely scenario where the Fed's only going one or two times and then done. We think that if the Fed is committing to hiking, they're going to deliver a reversal of the cuts that were delivered last year. And when we look at periods where the Fed's pivoting on their direction of policy set, they're really not going just one time, it will look more like a series of hikes.
So we do see more upward pressure for the front end to move higher. We continue to see more room for the two-year rate to sell off and more room for the curve to flatten. Great.
Well, thank you, Megan. Thank you, Yuri. Thanks for joining us today.
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