Carson Block, founder of Muddy Waters Capital, believes that artificial intelligence (AI) will trigger widespread unemployment, leading to high unemployment rates and economic weakness. This, in turn, will erode corporate revenues and debt repayment capabilities, ultimately widening credit spreads and sparking a wave of defaults. He also pointed out that the current scale of passive investment in the market is excessively large, and the liquidity of corporate bond ETFs far exceeds that of the underlying bonds. This situation will amplify volatility when shocks occur.
Short-selling firm Muddy Waters Capital has set its sights on the corporate credit bond market. Founder and CEO Carson Block believes that the accelerated adoption of artificial intelligence will trigger a wave of mass unemployment, ultimately leading to deteriorating corporate financial conditions and widening credit spreads.
Block outlined the above logic in a Bloomberg Television interview on Tuesday this week, stating that he has begun shorting exchange-traded funds (ETFs) tracking corporate bonds, including Blackrock’s iShares iBoxx USD High Yield Corporate Bond ETF and iShares iBoxx USD Investment Grade Corporate Bond ETF.
He anticipates that the market reaction will precede actual employment shocks, meaning the window for short selling may occur before substantial deterioration in economic data.
This bet is against the backdrop of heightened vigilance in the market regarding potential risks in the private credit sector; once a crisis emerges in this area, spillover effects will further impact publicly traded credit markets, creating a compounded resonance with Block's wager.
The AI-driven wave of displacement will reshape the employment landscape.
Block holds an extremely aggressive view on the speed at which AI will replace human jobs. He predicts that within the next three to five years, a large number of U.S. companies will replace employees with some form of AI technology, with one AI technology potentially replacing up to seven job positions.
He cited the legal industry as an example: tasks that previously required outsourcing to law firms and paying bills are now being completed independently using Claude software from Anthropic. In his view, this transformation is accelerating across industries.
Block’s chain of reasoning is as follows: large-scale AI-driven job replacement will lead to higher unemployment rates and economic weakness, thereby eroding corporate revenue and debt repayment capacity, ultimately driving up credit spreads and triggering a wave of defaults.
Using bearish spread options to control exposure.
Given the unpredictable trajectory of the labor market, Block has avoided directly shorting ETFs to circumvent the uncertainty costs associated with holding short positions over the long term.
He prefers to use options strategies, specifically recommending the bear put spread—a strategy involving simultaneously buying and selling put options with the same expiration date but different strike prices.
Block categorizes such trades as 'convex trades,' characterized by a nonlinear upward-sloping payoff curve that has the potential to amplify returns when the underlying asset experiences significant declines, while maintaining limited downside risk.
This structure keeps the cost of holding positions manageable while retaining substantial profit potential in the event of a sudden shift in market sentiment.
The liquidity mismatch between passive investments, ETFs, and underlying bonds amplifies shocks.
Another rationale for Block's shorting of the credit bond market stems from his assessment of the market structure itself. He believes that the current market is overly dominated by passive investments, which will automatically exacerbate price fluctuations once trends emerge.
A more critical issue lies in the liquidity mismatch: the liquidity of corporate bond ETFs far exceeds that of the underlying bonds they hold.
This implies that when fundamentals deteriorate and investors redeem en masse, ETFs will struggle to liquidate their underlying assets at reasonable prices in a short period, resulting in deeper price discounts and greater market impact.
The aforementioned structural vulnerabilities, compounded by potential risks in the private credit sector, lead Block to believe that the downside risks in the current corporate credit market are being significantly underestimated by the market.
Editor/Lee