Europe’s debt stress is hitting corporate borrowing costs. Goldman flags who’s vulnerable

Europe's sovereign debt worries are starting to show up in corporate borrowing costs, potentially leaving some companies with less cash to invest or return to shareholders, according to Goldman Sachs.

Corporate borrowers in Europe are being squeezed from two directions — rising yields in government debt and surging U.S. hyperscalers' bond issuance, which is increasing competition for capital.

Hyperscaler debt issuance is set to increase from $250 billion in 2026 to $420 billion in 2027, Goldman Sachs said in an Oct. 23 note, while global artificial intelligence project finance could double to $300 billion as tech giants increasingly turn to bond markets to fund the AI investment build-out.

That comes against a backdrop of rising borrowing costs globally. Yields on France's 10-year government bonds, known as OATs, moved beyond 5% on Oct. 21 for the first time since 2002. The spread over Germany's 10-year Bunds peaked at more than 177 basis points a day later, amid concerns about spillover risks elsewhere in Europe.

Developed economies including the U.S., the U.K. and Japan have also faced similar borrowing pressures this year.

Debt costs rise

With credit conditions tightening, Goldman analysts said higher interest costs are now starting to eat into company margins.

They noted that investment-grade yields in Europe have risen about 30 basis points to 4.4% since the start of September, with spreads to the sovereign risk-free rate widening by some 24 basis points to 117 basis points.

At the same time, high-yield borrowing costs have climbed around 90 basis points to 7%, with spreads widening by 94 basis points to 354 basis points.

Interest expense has increased from 1.25% to 1.85% of sales among Stoxx 600 companies since 2022 as refinancing costs have steadily risen, Goldman said. That 60 basis point increase has cut earnings by more than 5% over that period, according to the bank's analysts.

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France-Germany 10-Year Bonds.

The strain could intensify for companies with debt coming due or borrowing costs that reset with interest rates.

"The average maturity of Stoxx 600 debt is around seven years; one quarter must be refinanced within the next two years and a further quarter is floating-rate debt," Goldman analysts said.

"Higher rates could therefore feed through to around half of the debt relatively quickly," they noted.

Who is vulnerable?

That leaves companies with weak cash generation, limited pricing power, near-term refinancing needs or significant floating-rate debt particularly exposed, Goldman analysts said. "Rising yields increase their financing costs, while wider spreads compound the pressure on those facing near-term refinancing requirements."

The pressure could force some management teams to prioritize their balance sheets over other uses of cash.

"Management teams are consequently becoming more focused on reducing leverage, potentially diverting capital away from investment or shareholder returns," the analysts said.

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Stoxx 600.

Goldman analysts said they do not expect a "systemic credit event," noting that a mix of easing commodity prices, moderating inflation and interest rates, and improved growth in 2027 should help temper balance-sheet stress.

Instead, they see the rising cost of debt as a "growing constraint" for some companies, particularly as slowing earnings momentum creates another headwind.

Goldman expects earnings to grow by less than 10% in Europe next year, down from about 20% this year, and by less than 15% in the U.S., down from more than 30%.

Fixed income opportunities

Mike Bell, head of market strategy at RBC BlueBay Asset Management, said rising borrowing costs are unlikely to pose a major problem for investment-grade corporate borrowers.

But he warned that the shift increases the need for investors to be more selective in high-yield credit.

"The main implication of higher bond yields in our view is that the yields now available on government bonds, investment grade corporate credit, securitized credit and select high yield credit look increasingly compelling on a risk versus reward basis relative to equities," Bell told CNBC in an email.

"We would encourage multi-asset investors to consider what they realistically expect U.S. equities to deliver over the coming years from the starting point of the currently elevated cyclically adjusted price to earnings ratio and compare those expected equity returns with the yields available across the fixed income universe," Bell said.

"When we do that, it makes us think that fixed income is starting to look increasingly attractive compared with many developed market stocks."