Five ways to tell if market trouble lies ahead

Two decades ago, I discovered the signalling power of credit default swaps. When the price of derivatives rises, this shows that investors are worrying that borrowers will go bust.

Back then, one hint of the trouble to come was that CDS prices for mortgage bonds and banks rose — despite the cheer in equity markets. That was a proverbial canary in the coal mine.

Is the same thing happening again today? Quite possibly. Last week US equity markets hit record highs amid fresh evidence of US economic strength. But even as AI hype drives an equity rally, CDS prices for AI-linked borrowers such as Meta, Google and Microsoft have quietly risen, with a particularly marked jump for Oracle. Last week SpaceX CDS prices surged too, after reports of a $40bn funding call.

Some observers think this signal is distorted because the CDS market is thinly traded. Meanwhile bulls insist that soaring equity prices are justified because US corporate earnings are expected to have risen by 27 per cent in the third quarter.

But, if nothing else, those CDS prices show it is not just French bonds that are signalling unease. Far from it. Investors should be asking at least five questions now to assess whether trouble lies ahead.

First, can we believe tech company forecasts? Analysts currently expect “the sector’s operating cash flow to double to roughly $2.4tn by 2028” thanks to surging AI product demand, says Torsten Sløk of Apollo.

But analysts also project muted future cash flows for non-tech companies. That, says Sløk, “raises the question of who exactly will be writing all those cheques to buy AI services”. Maybe tech customers are too gloomy. But if it is tech projections that are over-optimistic, then we are in a bubble — which will eventually pop.

Second, who will fund the AI build-out? Initially, tech companies used internal resources. But now those have run out and they are on a wild debt binge to fund projected capital expenditure. “The quantum of debt that is hitting the marketplace is historic,” Greg Peters, a top official at PGIM, recently told the FT.

This is already sucking funding from other sectors. One top American financier recently suggested America needs “a Fannie Mae style entity to fund the AI build-out” — in other words, a way to repackage tech debt like mortgages. That seems unlikely to happen. But it shows what is at stake.

Third, how high will rates go? In my view, Scott Bessent, US Treasury secretary, deserved applause last year for keeping 10-year Treasury rates at about 4 per cent. He did this by using tactics such as shorter issuance maturities. But such methods are no longer working: 10-year rates have jumped above 5 per cent. Bessent himself insists, though, that AI-powered growth will soon cut the deficit, reducing the pressure.

Meanwhile the view among Wall Street financiers I have spoken to is that, if growth stays above 3 per cent, a US debt crisis can be avoided. Nonetheless, Bessent’s job is getting harder. Because banks are funding the AI boom, they are buying fewer Treasuries, and other countries are no longer recycling as many excess dollars into US bonds. “East Asia now runs a massive surplus, but almost none of it appears to flow into the US bond market,” says Brad Setser of the Council on Foreign Relations.

That means hedge funds now wield far more influence in setting prices — and they could flee if a storm hits, pushing rates higher still. That could lead to market accidents, particularly given how government and tech company leverage has surged. “Refinancing risk is real for the legacy data centers,” says famed short seller Jim Chanos. Hence the move in CDS prices.

Fourth, will oil push rates even higher? Thus far the global economy has weathered the rise in energy prices due to the war in Iran. But oil stockpiles are now so “scarily thin” that more price rises could loom, a top Saudi official says.

And recent social media posts from Mohammad Bagher Ghalibaf, speaker of Iran’s parliament, explicitly say Tehran wants to create financial stress by using blockades to raise oil prices and US rates. Investors should take note. “[Iran] can’t beat the US military, so it’s targeting the $40tn America owes,” warns Jay Martin, a financial pundit.

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Finally, if the AI boom falters, what happens to growth? Right now, this looks strong in the US. And new analysis from NYU Stern and DHL shows that “global goods trade grew faster in the first half of 2026 than in any half-year in the past 15 years” except post-Covid.

But 76 per cent of that rise was driven by AI-linked trade, and tech investment also accounts for much of America’s recent growth. If the AI frenzy slows — whether because of higher rates, safety concerns or moratoriums on data centre construction — that will hurt. Hence US President Donald Trump’s scorn for those who criticise AI.

Don’t get me wrong: I am not arguing that these questions portend an immediate equity slump. Exuberance can last a long time — as we learnt two decades ago. But the air in the markets is getting worse. Don’t ignore the canaries.

gillian.tett@ft.com