AI-Driven Corporate Investment Surge

Despite large deficits, booming capital expenditures and a looser regulatory environment, the Fed appears poised to cut rates further to support the slowing labor market. This could set the stage for a level of corporate risk-taking not seen since the 1990s.

Read more insights from Morgan Stanley.

----- Transcript ----- 

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. 

Today, a look at the forces that could heat up corporate activity in 2026 – if the labor market can hold up.

It's Monday, September 29th at 2pm in London.

Bill Martin, a former chairman of the Federal Reserve in the 50’s and 60’s, famously joked that “it was the Fed's job to take away the punch bowl just when the party is getting good.” 

That quote seems relevant because a host of trends are pointing to a pretty lively scene over the next 12 months. First, the U.S. government is spending significantly more than it's taking in. This deficit running at about 6.5 percent of the size of the whole economy is providing stimulus. It's only been larger during the great financial crisis, COVID and World War II. It's punch. 

Next to the corporate sector. As you've heard us discuss on this podcast, we here at Morgan Stanley think that AI related spending could amount to one of the largest waves of investment ever recorded – dwarfing the shale boom of the 2010s and the telecommunication spending of the late 1990s. Importantly, we think this spending is ramping up right now. Morgan Stanley estimates that investments by large tech companies will increase by 70 percent this year, and between 2024 and 2027, we think this spending is going to go up by two and a half times. Note that this doesn't even account for the enormous amount of power and electricity infrastructure that's going to be need to be built to support all this. Hence more economic punch. 

Finally, there's a deregulatory push. My bank research colleagues believe that lower capital requirements for U.S. banks could boost their balance sheet capacity by an additional $1 trillion in risk weighted terms. And a more supportive regulatory environment for mergers should help activity there continue to grow. Again, more punch.

Heavy government spending, heavy corporate spending, more bank lending and risk taking capacity. And what's next from the Federal Reserve? Well, they're not exactly taking the punch away. We think that the Fed is set to cut rates five more times to a midpoint of two and 7/8ths. 

The Fed's supportive efforts are based on a real fear that labor markets are already starting to slow, despite the other supportive factors mentioned previously. And a broad weakening of the economy would absolutely warrant such support from the Fed. 

But if growth doesn't slow – large deficits, booming capital expenditure, a looser regulatory environment, and now Fed rate cuts – would all support even more corporate risk taking possibly in a way that we haven't seen since the 1990s. For credit, that boom would be preferable to a sharp slowing of the economy, but it comes with its own risks.

Expect talk of this scenario next year to grow if economic data does hold up.

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