I'm LongbridgeAI, I can summarize articles.Muddy Waters Capital founder Carson Block believes AI will trigger mass unemployment, leading to high jobless rates and economic weakening, eroding corporate revenues and debt-servicing capabilities, ultimately widening credit spreads and sparking a wave of defaults. He also pointed out that the market currently has excessive passive investment, and the liquidity of corporate bond ETFs is much higher than that of their underlying bonds, which will amplify volatility when shocks occur
Short-selling firm Muddy Waters Capital has set its sights on the corporate credit market. Founder and CEO Carson Block believes that the accelerated popularization of artificial intelligence will trigger a wave of mass unemployment, ultimately leading to the deterioration of corporate financial conditions and widening credit spreads.
In an interview with Bloomberg Television on Tuesday, Block elaborated on this logic and stated that he has begun shorting exchange-traded funds (ETFs) that track 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 market reactions will precede the actual employment shock, meaning the shorting window may open before any substantial deterioration in economic data.
This bet comes against a backdrop of heightened market vigilance towards potential risks in the private credit sector. Should a crisis erupt in this area, spillover effects would further impact the publicly traded credit market, creating a compounding resonance with Block's bet.
The AI Replacement Wave 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 companies in the United States will replace employees with some form of AI technology, and that one AI technology could replace up to seven jobs.
He uses the legal industry as an example: work that previously required engaging law firms and paying their bills, he can now complete himself using Anthropic's Claude software. In his opinion, this shift is accelerating and replicating across various industries.
Block's logical chain is: Mass AI-driven job replacement will lead to higher unemployment rates and economic weakening, which in turn will erode corporate revenues and debt-servicing capabilities, ultimately widening credit spreads and triggering a wave of defaults.
Controlling Exposure with Bear Put Spreads
Given the unpredictable path of employment market evolution, Block has not opted for direct shorting of ETFs to avoid the cost of uncertainty associated with holding long-term short positions.
He favors using options strategies, specifically recommending bear put spreads—which involve simultaneously buying and selling put options with the same expiration date but different strike prices.
Block categorizes these trades as "convex trades," characterized by a non-linear upward-sloping payoff curve. They have the potential to amplify gains when the underlying asset falls significantly, while limiting downside risk.
This structure allows for controllable holding costs while retaining substantial profit potential during sharp market downturns.
Passive Investment and Liquidity Mismatch Between ETFs and Underlying Bonds Amplify Shocks
Another layer of Block's logic for shorting the credit market stems from his assessment of the market structure itself. He believes that passive investment is currently excessive in the market; once a trend forms, passive funds will automatically amplify price volatility.
The more critical issue is the liquidity mismatch: The liquidity of corporate bond ETFs themselves is far greater than that of the underlying bonds they hold.
This means that when fundamentals deteriorate and investors rush to redeem their holdings, ETFs will struggle to liquidate the underlying assets at reasonable prices in a short period, leading to more significant price discounts and market shocks.
This structural vulnerability, combined with the potential risks in the private credit sector, leads Block to believe that the downside risks in the current corporate credit market are severely underestimated.