US fixed income faces repricing as AI threatens software firms, but high yield's limited tech exposure may attract flows from stressed private credit.
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Hello and welcome back to The Weekly Fix.
Well, it has been a volatile first quarter for US fixed income markets as investors try to navigate pressure on multiple fronts — including geopolitical conflict, technological disruption and continued concerns in private credit and direct lending.
The result has been a meaningful repricing across risk assets with spreads on both investment grade and high yield bonds now trading at the widest levels seen since liberation day last year.
Much of this move has been driven by AI displacement risk and specifically that parts of the software sector could face structural obsolescence as a result. At the same time, questions around underwriting standards in private credit — a market with much heavier exposure to software — is raising alarm bells that a broader and deeper repricing of assets is yet to come.
The one notable exception to this move has been in energy, where spreads have actually tightened year to date as higher oil prices due to the ongoing conflict in Iran should bolster margins in a sector that has already spent years deleveraging and repairing balance sheets.
The question now for many investors is: what has been overdone, and what risks still lay ahead?
As it relates to the recent software selloff — or what some have called the “SaaSpocalypse” — we do believe the risk is real for certain parts of the industry, particularly the more narrowly focused or single-vertical software businesses, and that this could lead to higher default rates and lower recoveries in the space.
However, replacing core enterprise systems remains extremely expensive and operationally risky.
So, in our view, the bigger risk is not immediate displacement, but longer-term reinvestment pressure. Software companies are asset-light and relatively low capex, which allows them to protect cash flow when conditions tighten. But staying competitive in an AI-driven world will likely require significant investment in new workflows, AI integration, and research and development.
But it is not just the risk itself that matters — it’s where the concentration of that risk lies that will have the most meaningful impact on investor portfolios. And not every market is created equal in this respect.
For example, within US high yield, technology represents less than 5% of the market, and under 4% of that is tied to software. In contrast, leveraged loans have roughly 17% in software related exposure, while private credit and direct lending portfolios have north of 30% exposure to the sector.
On top of that, the US high yield market today is larger, more liquid, and higher quality than it has been historically.
So not only does high yield have less direct exposure to software disruption, but many issuers are also better positioned to adapt to technological change.
As investors begin to pause allocations to private credit and other middle market direct lending, regular way high yield bonds may increasingly emerge as the natural replacement for investors’ seemingly insatiable demand for yield. This could create a powerful potential tailwind for an already structurally resilient high yield bond market and is an area we are keeping an eye on as we look for opportunities to find value in a turbulent and uncertain market backdrop.
Thanks for listening to The Weekly Fix, and we’ll see you next week.
Key points
Widespread repricing across credit markets driven by AI displacement fears, particularly in software, with spreads at widest levels since last year—though energy is tightening on higher oil prices
Software risk is concentrated in private markets, with direct lending holding 30%+ exposure versus under 4% in US high yield
High yield may capture private credit outflows as investors pause middle market allocations