Hyperscale my debt!

0:00Rob Armstrong: Heaven knows there is a lot going on in markets at the moment. The AI companies are saying they might accidentally kill us all, whoopsie, but they want our money anyway. Meanwhile, the mighty global government bond market has been thrown into a mincing machine and there's no end in sight. But the cool kids know there's more to markets even than that. And the biggest thing that people are not talking about enough is all going down in the bit of finance where companies get their hands on money to play with. The corporate bond market is one for the hipsters, honestly, and it's not usually the sexy stuff.

0:38Rob Armstrong: But right now it's getting a huge revamp because US big tech is borrowing big bucks and rewiring the market in the process. So today on the show, hype, hyperscalers, and how this is all changing the game for companies everywhere. This is Unhedged from the Financial Times. I'm Katie Martin, a markets columnist in the FT Dungeon in a weirdly warm and sunny London. Joining me down the line from New York City is my usual partner in crime, the big man, Rob Armstrong, who has not yet had his morning bagel. Rob, say hello. Hello.

1:17Katie Martin: My stomach is rumbly, but otherwise I feel okay.

1:19Rob Armstrong: If you hear a rumbling noise, listeners, that's what it is. But also with me in the studio, making her Unhedged debut, she's overworked and over here, it's Emily Herbert from our markets reporting team. Emily, how are you? I'm well, thanks, Katie. Yeah, I'm delighted you've carved out time to come and speak to us because you do the hard work, you and Ian Smith. So my top tip to you, if you're new to the Unhedged podcast, Emily is just don't take any nonsense from Rob. Just remember that and you'll be fine. Perfect. Yeah. So listeners, if you listen to this humble podcast, you'll be at least vaguely familiar with the government bond market.

1:59Rob Armstrong: If you're not, then clearly Rob and I are doing something wrong. But it's kind of the same deal for companies. If they want money to buy another company or build a factory or whatever it is, then they can get a loan from a bank or they can go cap in hand and borrow the dosh from investors, generally big professional investment firms rather than normie retail investors. This is a really important part of the financial system and it's getting a big glow up at the hands of hyperscalers. So, Emily, you've been writing about this recently. First off, what is a hyperscaler? What are we talking about here?

2:34Yeah, so the hyperscalers are the kind of big companies that we talk about a lot when it comes to AI and they're the ones which are investing in the kind of physical infrastructure of this. They're kind of building the data centres to house all of this cloud computing capacity. So it's companies like Amazon, it's Alphabet, it's Meta, it's Oracle, it's those ones. What it is not at this point is the AI labs like OpenAI and Anthropic, which are building the models themselves.

3:04Rob Armstrong: So they're already like companies that we're very familiar with from other things. And they're public companies. They're listed on the stock market and they can borrow money in the corporate bond market. So the labs are like these huge money furnaces where money goes to die. They're just like burning it on like creating AI widgets, whereas these are companies that are generally like dripping with money already, aren't they? Yeah, they have so much money. And I guess the labs, we'll know more about the labs probably soon when they are public companies. And I mean, we should take a slight detour here.

3:36Rob Armstrong: Like, Rob, are we allowed to call this AI now or does your glorious leader, he's told us we have to call it SI, right?

3:45Katie Martin: Once again, Katie, I will not take responsibility for the US president. We are allowed to call it AI on this show, if not elsewhere in America. We're safe here in the studio.

3:57Rob Armstrong: Donald Trump says there's nothing artificial about it. It's actually super intelligence. Anyway, we're going to call it AI. So for ages, like these massive tech companies, when they wanted to do AI build-ups, these companies have got money coming out of their ears, right, just from their daily course of business. So they didn't need to borrow any money to do it. They could just find money down the back of the sofa and build a data centre for a few million dollars. So why are they borrowing money to do it now? What's that about? Basically, they need more money. I mean, you know, we've all promised to do things and then realised we don't actually have enough money.

4:31Right. And so they have gone to the bond market and they're expected to borrow a very, very, very large amount of money over the next few years to do this.

4:42Katie Martin: Do we have even a ballpark estimate of what that number is? Yeah, so far this year, Goldman Sachs said to us that investors have lent AI-related groups about$500 billion. The hyperscalers, they account for about$200 billion of that. But for the hyperscalers, over the next few years to about 2030, we think it's going to be about a trillion dollars of debt.

5:08Rob Armstrong: Ooh. So, you know, we've all been there. A trillion here, a trillion there. Before you know it, you're talking about some serious money, right? It's serious money, yeah. But there's a number of fun things going on here. Like they are issuing gigantic bonds. So the US corporate bond market is pretty well accustomed to like taking down some pretty big deals. But these companies are like, oh, we can't do it all in dollars. Let's do some in euros. Let's do some in sterling. Let's do some in Swiss francs, Canadian dollars or whatever. And those markets are tiny and suddenly the Americans are coming, right?

5:42Yeah, it's a really interesting part of all this is the fact that the companies, I think that there's a sense that they don't want to exhaust any one market or really push their costs up in any one place. So they're kind of really spreading their tentacles across the world. That may sound like I have a view, but no.

6:02Katie Martin: They're very friendly tentacles. They're spreading their neutral tentacles across the world. They're going everywhere they can. They're going to wherever there are investors. But for some of these markets, I mean, it's just like immediately, by far, the biggest bond that they've ever seen.

6:19Rob Armstrong: Yeah, that's the funny thing here.

6:21Katie Martin: How much are they having to pay? So you use the word spread in a different sense. But let me ask about spreads. How much more than the government does a meta or an alphabet have to pay to get money? Yeah, increasingly quite a bit more than the government. Oh, right. So when these bonds are first being issued earlier this year, you know, they are very high quality companies. Their balance sheets are exceptional by and large, not uniformly. Ahem, Oracle. I didn't want to say it. Not you, Oracle.

6:57But yeah, they could borrow money with a little bit of extra premium over what the government would have to pay. But later into this year, that has really blown out. And they're having to now pay when they go to the market, especially in the US, quite a bit more than the government would pay, quite a bit more than other companies that are a similar quality to them.

7:18Katie Martin: What do you make of that? This is a very interesting fact, Emily. What's that telling us? Yeah, I mean, what investors are saying about this is that it's not to do with the quality of the company. I mean, most people we spoke to weren't worried about these companies, their quality. They weren't even really worried about the kind of AI uncertainty of it all, which is a whole other thing. The death robots. Yeah, you know, that one. But what they're worried about is the amount of money that these companies are expecting to spend on their data center build out, all of this capex. and the big problem is that investors just don't know how much more debt is going to come because every quarter these companies come to the market and they revise up the number for how much they expect to spend on their capex and this means more debt and I think until investors have a sense of how much more of this debt is going to come to them they just keep asking for more and more premium.

8:11Rob Armstrong: There's a pretty direct parallel there to the government bond market but let's come on to that. In a minute. Like, so when I talk to people in markets about this debt binge from the hyperscalers, they say there's so much interesting stuff going on here. Like one is, as you mentioned, when they come to the market in euros, for example, Amazon comes along and says, boom, we're going to issue like 14 billion euros like in one go. And like Europe's not used to accommodating bonds of this size. And then, you know, Amazon comes along, Meta comes along, Alphabet comes along and they're just like dumping these massive, massive bonds on the market.

8:46Rob Armstrong: And like the good thing about that is that it says to European companies that want to get hold of money, it's like you can actually borrow a lot of money in Europe. And maybe corporate Europe has been a little bit timid up to this point in not sort of testing the market for size. And the other thing is they're coming along in currencies that are like in terms of corporate borrowing, like quite random. Like they've pretty much invented a global Australian dollar corporate bond market out of nowhere, which is pretty impressive. and again says to other companies, why don't you issue in Australian dollars?

9:20Rob Armstrong: Why don't you issue in Canadian dollars? Yeah, I think there's definitely some positives for those smaller markets. And I think the sterling market is a good example of that. Like we had the 100-year bond from Alphabet and I think it actually was quite exciting because for people who work in the sterling credit market, it hadn't been the most lively time. And then you've suddenly got these really cool, new, exciting bonds. and everyone's talking about sterling credit and it shows other companies that they can do it too. I think you could say the same about the Swiss market probably but I also think that for other companies who like to issue their debt in that currency it does also create some problems.

10:00You wouldn't really want to be going to the market on the same day that Meta was also coming to that market.

10:07Rob Armstrong: But so when I talk to bankers about this I was having a conversation with a couple of bankers about it the other day and they were saying, we are absolutely stunned at how much of these bonds investors have been able to take down. Like previously, we wouldn't have said that you could take billions and billions of pounds in one go. And they're like, oh, actually, it turns out you can do that perfectly easily. There's plenty of money sitting in investment firms that wants to go into corporate bonds. We are surprised about this. And the big question that everyone has been asking is, when do they run out of capacity?

10:39Rob Armstrong: Because if you're an investment firm, you're like, okay, hey, I've got this chunk of money over here that I intend to put in stocks. I've got this chunk over here I intend to put in government bonds, which is getting chewed up and spat out. And I've got this much money over here that I want to put into corporate debt. And at some point, you have to move those proportions around to make room for one or the other, because you're taking down much more corporate debt than you previously expected. But from what you're saying, like, so the borrowing cost is ticking higher for these hyperscalers. Is that a sign that we are slightly running out of capacity here in the market to keep taking this down?

11:13It's a bit different in different places, right? So the US dollar corporate market is so big and so liquid, it's going to take a real lot for investors in dollars to run out of money. I think maybe in some of the smaller markets, you know, you are starting to see signs that, you know, investors are maybe reaching a limit. You wouldn't want to borrow much more there. I guess the question it raises is like, does it have knock on effects for other asset classes? as you say, because like these bonds are now at a pretty good price for what you're buying. Maybe you say, actually, you know what, I'll take a bit of my money out of that I keep for stocks.

11:46I'll put it into the corporate bonds. Does that then weigh on the stock market? I mean, this debt can't be taken down from the existing pool of money forever and ever and ever.

11:55Rob Armstrong: No, that leads us to the question that Rob and I have long very publicly disagreed on, which is the extent to which this is eating into the government bond markets. So, like, Rob, where is the U.S. 10-year yield today? Like, the market is getting absolutely obliterated, isn't it?

12:14Katie Martin: 5.3 something. I mean, it is. A couple of months ago, I was like, if the 10-year Treasury goes above 5 and stays there, Scott Besant is going to get fired. But now... Scott, the house.

12:27Rob Armstrong: Besant.

12:28Katie Martin: Scott, the house, Besant. You can't fire the house. Look. So, but here we are. It's really remarkable. And so, you know, it's natural to think, although we're going to go ahead and disagree about this, it's natural to think these much more solvent and very large, almost country-sized entities issuing debt at a higher yield than you can get for the government, people might be like, you know what? You know who I trust slightly more than the U.S. government? Alphabet.

13:02Rob Armstrong: If you trust Mark Zuckerberg more than you trust Scott Besson, what does that say about you as a person? I don't know. That's a topic for a whole other podcast. So when I talk to bankers about this, they're like, look, this is definitely a thing. It's not like anyone is selling US government bonds so that they can buy hyperscaler debt. But what they are doing is saying, OK, I've got a certain amount of money to deploy over the course of this month. Maybe previously I was expecting to put 100 lots of it into US government bonds. But now there's all this juicy other debt over here from Alphabet and Meta and all these other guys.

13:37Rob Armstrong: So maybe I'll just put 80 of it in government bonds and 20 of it into this other pot instead. And I've never thought this is like the reason why US government bond markets are like crapping out. But it doesn't help, does it? No, I don't think it helps. Rob might disagree. As you say, it's definitely not the main thing. There are so many other things that are bad for government bonds right now. And it is a bit of a hot debate on Wall Street at the moment, I would say. Some people have a very strong view that this isn't really weighing on treasuries. Some people have a very strong view. And actually, Scott the House Besson and Kevin Walsh, the chair of the Fed, both have said that the hyperscalar debt splurge is weighing on treasuries.

14:21Katie Martin: Well, they would, wouldn't they? Well, they would. Right. Because they would.

14:26Rob Armstrong: They're blaming the other guy. Rob, why are you so convinced that this is a silly argument?

14:31Katie Martin: I just think that the important buyers of treasuries in the world are not discretionary investors who are toggling back and forth between corporate and sovereign bonds. Those people definitely exist. There's a lot of bond managers with flexible mandates. But there's a lot more reserve managers, insurance companies, hedge funds or whatever who have a treasury-shaped hole to fill in their portfolio and they just keep on filling it.

15:10Rob Armstrong: Yeah, listeners, are you Team Rob or Team Emily and Katie on this? Let us know, unhedged at ft.com. We're genuinely interested in what you think here because this is like a long-running argument and it's quite fun and interesting. But just to kind of round off on, it strikes me that the stock market is like AI, AI, AI. Private markets are AI, AI, and a bit of software, which is basically AI. Corporate bond markets are AI, AI, AI. I'm not thrilled at like all the kind of big asset classes all being about one thing. Is that how it feels to you, Emily? Yeah, I think it's definitely a risk. I mean, there are still issuers in the corporate bond market which are much bigger than the AI companies, but they are growing quickly.

15:58And that's the thing that people hate in corporate bond markets, right, is when one bit starts getting really big really quickly. but yeah it's getting much harder I think for investors to find somewhere that is not AI where they can put money that will be kind of safe-ish if this all goes wrong which is not impossible and we've had I mean we've had stories about it this week we have something from the Bank of England and our colleague Michelle in New York who writes a lot about this stuff wrote about KKR warning about the concentration risk and the fact that yeah everything is AI.

16:32Rob Armstrong: So KKR the private Equity Company and the Bank of England both saying there's an awful lot of this hyperscaler debt out there. I don't know, Rob, do you feel happier or more worried knowing that everything is hinging on this one thing?

16:46Katie Martin: Well, it does feel like a music playing you dance moment, right? Where if you get out of the AI stuff, you're basically guaranteeing you're going to underperform your peers in the short run because this is the only game in town. So you have to weigh career risk against risk that it all blows up. You know, I think the economy looks a little broader than the market. And that reassures me, like we're seeing jobs added in sectors other than AI. But it does make me jumpy when the market is this thin and this concentrated.

17:21Rob Armstrong: Yeah, yeah, it's all a little bit scary. Speaking of scary, we're going to come back in just one second with Longshot.

17:34Rob Armstrong: Okie doke, it is time for long, short, that part of the show where we go long, a thing we love, or short, a thing we hate. Emily Herbert, as you've been kind enough to come along, tell us, what have you chosen? I am going long soup. Nice. Because it is October today. Yes. And I love a long, hot summer as much as the next person. That one was too long and too hot. It still is. It's still really hot. You're not going to make it more autumnal just by eating soup. Well, I've had some soup this week.

18:06Katie Martin: I put on a sweater yesterday. It's the same vibe.

18:10Rob Armstrong: There you go. That's basically it. I was hot. I just was trying to make it happen. It's so blooming hot. Rob, what are you saying?

18:21Katie Martin: We've talked about this before, but I have to come in again and go long. the great supermarket manager from Surrey, who we talked about in the last episode, who, because this was the guy who, or woman, I don't know if it's George or Georgette. It's a guy, yeah, yeah. It's a guy, I'll call him George. George had done very well in the contest by picking all these stocks that were beat up by AI hype. And one of the stocks, as I recall, that he picked was Accenture, which reported earnings this morning, and it's up another 20%. That stock is now up 80 % since early July. George from Surrey, you are the man.

19:04Rob Armstrong: He is such a bro, like absolutely knocking it out of the park. Yeah, enough respect. You should get him on the pod. We can take the show up to Surrey.

19:13Katie Martin: We can record in the supermarket.

19:15Rob Armstrong: That would be really good. So I am short sniffing. So Kid B in the Martin household has gone off to university and I have been tidying his room. And you know when you're tidying a room and you see something and you think, what is that? And your instinct is to pick it up and sniff it? I'm here to tell you, never sniff. Don't do that. Do not sniff the items. Nothing good happens. It's been a traumatic few days in the Martin household. So that's not you being sniffing because you're so emotional? No, no, no.

19:55Katie Martin: It's lovely and clean. It's just the horrible smell of adolescence.

19:59Rob Armstrong: Just, I don't even want to know. Emily, you've been a good sport. Thank you so much for coming on. Rob, we will chat again on Tuesday. So listeners, listen up then.