IMF Warns AI Borrowing and Hedge Funds Amplify Sovereign Bond Risks

The International Monetary Fund warned on Tuesday that government bond yields could rise sharply and disorderly due to inflation, mounting debt, and AI-related borrowing pressure. The IMF's latest Global Financial Stability Report cautioned that sovereign bond risk is deteriorating, citing a sharp rise in yields as a credible near-term threat with severe consequences given the foundational role of bond markets.

AI financing creates circular risks in bond markets

Rapidly expanding AI borrowing is competing with sovereign bonds for investor capital. The borrowing by AI firms is rapidly rising, with hyperscalers' share of global investment-grade bond issuance rising to 10% from less than 1% since 2024. The IMF sounded the alarm over a web of 'circular' financing deals among AI firms.

Since 2023, 14 publicly disclosed deals have channeled about $300 billion of equity and $650 billion of debt into financially weaker AI firms. In exchange, investors secured $1.4 trillion of future revenue commitments through services or chip orders. Jason Wu, assistant director of the IMF monetary and capital markets department, highlighted the unique risk. "What makes this a little bit unusual compared to previous deals is the future revenue commitments, hence the circularity," Wu said at a press briefing.

Wu warned of a 'triple whammy' if AI commercialisation falls short. Equity investments would deplete in value, debt may be difficult to service, and the massive future revenue commitments may not materialize. Concentration among a handful of firms amplifies the danger, posing broader market risk.

Hedge fund activity and liquidity concerns add to market fragility

Hedge funds' growing share of the US Treasuries market increases susceptibility to a disorderly unwind. Their share rose to about 9% in 2025 from about 4% in 2022, mostly through highly arbitraged strategies. Caio Ferreira, IMF deputy division chief for financial supervision and regulation, said the worry stems from rising leverage and increasingly overlapping positions, where multiple funds hold identical trades that could amplify any collective unwinding.

While liquidity has held up in US, European, and UK government bond markets, Japan’s market remains an exception. Liquidity there has continued to deteriorate following the end of yield curve control as yield volatility increased.

IMF urges action to mitigate rollover and collateral risks

Government bond yields in several advanced economies have climbed to multidecade highs. Higher energy costs linked to the Middle East conflict and expectations of tighter monetary policy have driven the increases. The high debt load and rollover risks make the market susceptible to more frequent fiscal and inflation shocks.

The IMF urged debt managers globally to lengthen maturities. Replacing long-term debt with short-term borrowing on a large scale could significantly exacerbate rollover risk across sovereign markets. A sharp rise in sovereign bond yields would mark down asset values through higher discount rates, including for AI-related assets, and erode the value of government bonds posted as collateral.

Global debt nears historic peak as financial stability frays

Global public debt is on track to soon exceed 100% of GDP. The IMF warned last week that this is a historic and troubling milestone, with debt nearing its highest level since World War II. This amplifies vulnerabilities in an already strained financial system.

Marc Seidner, CIO of non-traditional strategies at Pacific Investment Management, noted that AI-linked issuance has grown large enough to compete with government bonds for investor capital. The warning was issued as more than 18,000 delegates gathered at the IMF-World Bank annual meetings in Bangkok. The IMF urged debt managers globally to lengthen maturities, warning that replacing long-term debt with short-term borrowing on a large scale could significantly exacerbate rollover risk.