UBS Equities-Global Strategy _2026 Outlook AI Debt Boom Meets Credit Ris...-118964579

ab20 November 2025Global ResearchGlobal Strategy2026 Outlook: AI Debt Boom Meets Credit RiskGlobal: A US-led Correction, but the Credit Cycle Continues
Credit spreads are anticipated to rise modestly by year-end. US IG and HY spreads, after January's rally, are expected to widen to 100bp and 350bp in Q1 2026 due to slower growth and higher defaults, before narrowing to 85bp and 300bp by year-end amid recovery. EU credit markets may outperform during widening but underperform during tightening, with EU IG and HY spreads projected at 80bp and 275bp, respectively, by the end of 2026.
In our baseline US leveraged loans lead in excess and total returns at 6.7% and 9.6%, driven by higher carry and less sensitivity to UST yields. On a probability-weighted basis across scenarios EU HY offers the highest excess returns while US IG delivers the highest total returns, driven by the AI bust scenario.
We expect defaults to rise before stabilizing in late 2026, led by private credit which is in a more advanced stage of the credit cycle. Our forecast is for private credit default rates to rise by 200-300bp, with US leveraged loans and high yield increasing by 50-100bp through mid-2026 before stabilizing.
Top Trades: we like EU vs. US IG (rates hedged), Long US Equities vs. Credit, and Long Put Spreads on Divs Futures vs. selling HYG volatility.US: A Private Credit and AI Debt Financing Story
US markets face late-cycle stress, with rising credit risks, a 36% recession probability by late 2026, weakening corporate profits, higher interest costs, and more non-performing loans. In addition, we expect labor market softness into 2026, with declining consumer sentiment, durable goods sales and rising defaults.
IG and HY balance sheets may weaken before stabilizing in H2'26. Private credit stress, led by PIK loans, signals late-cycle dynamics. Private markets are set to be the leading theme in 2026, with rising sector concentration in services, technology, and healthcare, increasing default risks from sector-specific shocks.
We anticipate weaker US credit technicals in H1'26 due to increased issuance from hyperscaler CapEx ($300-400bn), higher M&A activity (+25% YoY), and reduced overseas demand amid declining rates. But demand may improve later in the year, driven by a steeper yield curve attracting retail investors.
Top Trades: we favor US AAA CLOs vs. IG, P&C Insurers vs. NBFI-exposed IBs via CDS, Banks and Tech, HY BBs and HY Industrials vs. HY Retail.EU: A J-curve Recovery and Dispersion Story
In Europe, we expect baseline growth of 1.1% in 2026, underpinned by domestic demand and assuming that defense and infrastructure spending will add 30bp to growth over the year. Risks to this forecast include possible delays in fiscal initiatives, trade-related headwinds, and additional monetary easing by the ECB.
We forecast the 10yr Bund yield to fall to ~2.5% by early 2026 before rising to ~3% by year-end, as growth follows a J-curve. We see limited value in duration