Iran war adds pressure to European corporate bonds

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European corporate bonds under pressure

Highlights

Deutsche Bank now favors U.S. dollar credit over euro corporate bonds.
Euro investment-grade spreads are expected to widen to 95 basis points by year-end.
European high-yield spreads could widen to 345 basis points.

Credit strategists led by Steve Caprio moved euro credit to underweight versus U.S. dollar credit in global allocations, according to Bloomberg. The shift reflects a view that the Iran conflict is no longer only an energy story but a broader pressure point for corporate balance sheets, especially in Europe. A separate Deutsche Bank note earlier warned that markets were pricing the conflict inconsistently across equities, rates and credit, with credit spreads still tight despite weaker growth expectations and a fresh energy shock.

Europe faces the sharper squeeze

Deutsche Bank expects spreads on euro investment-grade corporate bonds to widen by almost 20 basis points to 95 basis points by year-end. In European high-yield debt, the bank sees spreads widening by 77 basis points to 345 basis points.

The pressure points are familiar but harder to absorb than in 2022. Energy costs remain elevated, shipping remains vulnerable to Middle East disruption, and memory-chip shortages could hit cyclical sectors. Tariff uncertainty adds another layer of strain. European manufacturers managed the 2022 energy shock with help from a strong post-pandemic labor market and an accommodative European Central Bank, but Deutsche Bank argues those supports are no longer in place.

The bank is especially concerned about weaker-rated borrowers. In Europe’s sub-investment-grade market, single-B companies face bond and loan maturities above historical averages over the next two to three years. If total funding costs rise by just half a percentage point, 44% of those firms could flip into negative free cash flow, according to the strategists.

U.S. credit looks more resilient

The U.S. market is not risk-free, but Deutsche Bank sees the pressure as less immediate. For U.S. investment-grade bonds, the bank expects spreads to widen by 10 basis points to 82 basis points by year-end. U.S. high-yield spreads are expected to rise by 39 basis points.

Part of the difference is the AI trade. Deutsche Bank sees both risks and support from artificial intelligence in U.S. credit but says the positive forces are stronger than expected. That contrasts with Europe, where companies are more exposed to energy costs, manufacturing weakness, and trade friction.

Credit markets price a fragile calm

The U.S. and Iran have reached a framework to extend the ceasefire for 60 days and reopen the Strait of Hormuz, with a formal signing expected in Switzerland on Friday. The strait handled about 20% of global oil and LNG before the war, but a full return to normal shipping may take time because mine-clearing, infrastructure repair, and security guarantees remain unresolved.

For credit investors, that means relief over the deal may not be enough. If shipping delays, energy costs, or inflation persist, Europe’s tighter spreads could quickly become harder to defend.

In addition, we wrote that global bond sales climb as defense spending and refinancing needs grow.

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