Bond giant Pimco is sounding the alarm on credit markets, warning that a sustained default cycle has officially taken hold after years of unusually low losses.
The firm, which manages $2.27 trillion in assets, declared in its 2026 outlook that “the credit loss cycle is upon us,” signaling a significant shift in the credit landscape.
“After years of effortless returns, the default cycle is reasserting itself, and we expect significantly higher losses in lower-quality credit such as leveraged and private direct lending,” the firm said.
The warning was authored by global economic advisor Richard Clarida, chief investment officer of global fixed income Andrew Balls, and chief investment officer Dan Ivascyn.
Ivascyn noted that “there’s a lot going on beneath the surface” despite credit spreads remaining close to their tightest levels on record, suggesting markets are masking deeper stress.
Pimco points to a massive wave of AI-related capital spending as a key driver, with the firm pegging AI-related debt issuance at roughly $100 billion per quarter across hyperscale operators.
The AI investment boom, combined with rising defense spending and energy security investments, could add as much as $14 trillion to global capital spending over the next five years.
That surge in leverage is pressuring the balance sheets of lower-quality borrowers and eroding free cash flow, particularly among companies financing data center buildouts with debt rather than cash.
Stress is most visible in private corporate credit and middle market direct lending, where Pimco is witnessing increased instances of maturity extensions and payment-in-kind structures that allow borrowers to repay debt with more debt.
Lincoln International calculates a “shadow default rate” of 6% as of August 2025, up sharply from just 2% in 2021, using payment-in-kind activity and loan amendment data as early warning signals.
High-grade credit spreads remain near their lowest levels in almost three decades, a dynamic Pimco views as a warning sign rather than a vote of confidence in markets.
“We interpret this as complacency rather than strength,” the firm said, warning that elevated secular uncertainty clashes with current tight spread levels across riskier debt categories.
Pimco’s strategic response centers on a decisive tilt toward quality, with the firm stating: “We view this as the beginning of a secular trend where quality and credit selection will matter more than ever.”
The firm sees more attractive risk-adjusted opportunities in asset-based finance, including equipment finance, consumer lending, residential mortgages, real estate credit, and select infrastructure finance.
Pimco also favors global government bonds as monetary policy paths diverge across countries, seeing opportunities for active country selection including emerging markets with credible policies and strong fundamentals.
The firm recommends owning intermediate-dated bonds, which it says offer competitive yields versus equities, while warning against heavy exposure at shorter or longer maturities.
Inflation-linked bonds and select real assets also feature prominently in Pimco’s recommended portfolio construction, with the firm noting that “real yields that are positive by historical standards can help provide a meaningful buffer to volatility.”
On gold, Pimco said it “has continued to serve as a neutral store of value in a world of partial confidence in fiat currencies,” reinforcing the case for hard assets amid geopolitical risk.
Pimco’s flagship $228 billion Income Fund has returned 0.3% year-to-date, beating 66% of peers, and is up 7.8% over the past 12 months while outperforming 90% of rivals over three and five years.
