Pimco says ‘credit loss cycle’ has begun, favours quality bonds

Pacific Investment Management Co. is warning that the “credit loss cycle is upon us” as heavy spending on artificial intelligence could widen economic outcomes and hit lower-quality borrowers. Pimco’s Richard Clarida, Andrew Balls and Daniel Ivascyn said in the firm’s latest annual secular outlook report that “the default cycle is reasserting itself, and we expect significantly higher losses in lower-quality credit such as leveraged and private direct lending.”

Pimco, which manages $2.3 trillion in assets, said the AI buildout could widen the range of economic outcomes over the next five years while leaving weaker and more heavily leveraged borrowers more exposed. High-grade credit spreads — the extra yield investors demand over US Treasuries to hold highly rated corporate debt — remain near their lowest levels in three decades. Demand for riskier debt has also held up despite a recent global bond selloff, as higher yields draw buyers. Pimco said that backdrop clashes with “elevated secular uncertainty,” and “we interpret this as complacency rather than strength.”

The firm also pointed to “increased instances of maturity extensions and payment-in-kind structures that allow borrowers to repay debt with more debt.”