Spiraling Bond Yields And Ai Borrowing Are Growing Threats To The Financial System, Imf Says

• The IMF says sovereign and corporate debt markets are becoming a systemic risk.
• A report published on Tuesday says AI-linked borrowing could compete with government bonds.
• Meanwhile, the market is at risk of disruption from "disorderly" moves in bond yields.

The normally sleepy bond market is a growing risk to global financial system, the International Monetary Fund said Tuesday.

Bonds aren't normally associated with the bouts of withering volatility that investors have weathered recently, but the latest spasms have put the market on the IMF's radar.

The threat the IMF sees is twofold: markets could be hit by a "disorderly" rise in yields, and an explosion of AI-linked bond issuance could compete with government debt for investors' attention.

In its most recent Global Financial Stability Report, the IMF highlighted the threat it sees the sovereign-bond market facing from the AI buildout, as Big Tech hyperscalers turn increasingly to the debt market to finance their projects. This puts them in competition with governments that are trying to sell ever more debt themselves in order to fund themselves.

"Recently, surging AI-related debt issuances that may compete with sovereign bonds for investor demand has been cited as an additional source of pressure on bond markets. Current term premiums are at the upper end of historical ranges, especially for advanced economy bonds," the report said.

The IMF said that doesn't view AI borrowing as the primary catalyst for current bond market instability. In its view, the combination of surging energy prices, higher short-term interest rate expectations, and high term premiums have pushed the market into precarious territory.

Yet, it views AI debt issuance as a cause for concern, particularly as the implications could extend far beyond the bond market, compromising other asset classes. Bond yields have already spiked to two-decade highs, which some finance pros see as a red flag for the stock market.

"Given government bonds' foundational importance to financial markets, a sharp rise in bond yields would depreciate asset valuations through higher discount rates—including on AI-related assets— and erode the value of government bonds used as collateral in derivatives and other financial transactions."

The report's authors note that despite these concerns, some parts of the bond market have stabilized. They note that hedge funds have reduced some highly leveraged bond trades without causing a major disruption to the broader market.

That said, the report also highlighted that many governments remain vulnerable, as considerable portions of their debt require refinancing, keeping rollover risks elevated.

"Historically high government debt levels—the root cause of a more fragile bond market— remain unresolved, and persistently high fiscal deficits in major economies continue to add pressure," IMF added.

The group also noted that since its last Global Financial Stability Report in April, bond market risks have increased. But as AI-related debt issuance shows no sign of slowing, the organization sees high risk for both the bond market and the broader AI trade.

"A reassessment of AI related prospects could sharply reduce investment, trigger equity market corrections, and tighten financial conditions, with global spillovers," IMF added.