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(Bloomberg) — European corporate bonds are vulnerable to the aftershocks of the war in Iran, with spreads for both investment grade and junk bonds expected to widen by year end, according to strategists at Deutsche Bank AG.

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Credit strategists led by Steve Caprio are now underweight euro-denominated credit compared to US dollar credit in their global allocations. While the AI disruption theme is a risk for US credit, “the aftershocks of the Iran war are playing out faster,” they wrote in a note to clients on Monday.

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“Sticky inflation, rising shipping costs, memory chip shortages that could impact key cyclical sectors and continued tariff uncertainty are all headwinds, particularly in Europe,” they wrote. “At a minimum, the outlook until year-end calls for more dispersion and some spread widening.”

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For euro high-grade bonds, spreads will likely widen by almost 20 basis points, to 95 basis points, by the end of the year, according to the strategists. The region’s junk bonds are expected to see 77 basis points of widening, to 345 basis points, they wrote.

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European manufacturers managed to ride out the spike in energy prices in 2022 thanks to a rebound in labor markets after the pandemic and an accommodative European Central Bank, but “neither of these are in place today,” the strategists wrote.

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For US dollar investment grade bonds, they expect a more modest widening of 10 basis points by year end, to 82 basis points. Junk bonds are seen adding 39 basis points.

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“In the US, our concern is less acute, but more structural. The US is a mix of AI tailwinds and AI headwinds, and right now the AI tailwinds are stronger than we expected,” they wrote.

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In the European sub-investment grade space, single-B rated firms face bond and loan maturities that are “well above historical averages” in the next two to three years, with 44% of them flipping to negative free cash flow if total funding costs rise by half a percentage point, the strategists wrote.

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The US and Iran said they reached an interim agreement to reopen the Strait of Hormuz, with officials set to meet in Switzerland on Friday to formally sign the agreement.

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