A global scramble for money to fund artificial intelligence (AI) infrastructure and rising government borrowing are driving up the cost of capital worldwide, forcing companies to tap debt and equity markets more aggressively, according to a new report by Goldman Sachs.

The bank says a surge in AI-related capex has eaten into free cash flows, while governments are borrowing more for infrastructure, energy security and defence, together lifting funding costs across the private and public sectors.

Two big themes: AI boom and higher rates

Goldman Sachs notes that the two topics dominating investor conversations — rapid AI investment and rising interest rates — are now closely linked.

“In the private sector a surge in capex spending to fund AI infrastructure has eaten into free cash flow and forced companies to raise more in debt and equity markets,” the report said.

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At the same time, higher government borrowing and inflationary pressures from energy prices have added to the rise in funding costs.

The bank points out that as recently as 2022, 30-year government bond yields in Germany and Japan were close to zero. Since then, higher yields, along with greater uncertainty around geopolitics and AI, have pushed up the global cost of capital.

Companies borrowing more to fund AI build-out

The impact is already visible in corporate financing data. Capital expenditure by AA-rated issuers rose 65% year-on-year in the second quarter, marking the 10th consecutive quarter in which aggregate AA capex growth exceeded 35%, the report said.

To fund this investment, companies have increasingly turned to credit and equity markets. US convertible bond issuance has reached $135 billion so far this year, with AI-related borrowers accounting for 44% of the total, according to Goldman Sachs.

The bank’s credit team has raised its full-year US investment-grade gross issuance forecast by $200 billion to $2.3 trillion, with AI-related issuers accounting for about a quarter of US investment-grade gross supply this year.

What higher cost of capital means for stocks?

Goldman Sachs warns that higher funding costs could put pressure on equities if earnings growth slows. While technology valuations have moderated and are below their 20-year median globally, the key risk is whether the current strength in earnings proves sustainable.

“Nonetheless, any slowdown in profit growth, in an environment of a much higher cost of capital, could put downward pressure on equity prices,” the report added.

The bank expects earnings growth and nominal GDP growth to remain important drivers of equity performance, while noting that higher bond yields are likely to limit further valuation expansion. It added that opportunities are broadening across geographies, sectors and factors as earnings growth becomes more widely distributed.

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Who is paying for the AI race?

For both investors and companies, the AI infrastructure boom is also becoming a financing issue. As companies borrow more and governments compete for funds, borrowing costs and bond yields are rising. According to the report details, this can affect investors and businesses.

Higher interest costs can reduce profits, delay new projects and make it harder for weaker companies to repay or refinance debt. However, sectors and regions that continue to deliver steady growth may still attract investment, even as higher yields put pressure on valuations.

Near-record equity rally vs bonds

The report added that the equities have been delivering near-record outperformance versus bonds in recent years. On a 10-year rolling annualised basis, the excess return of stocks over bonds — the ex post equity risk premium — has climbed to levels close to historical highs for both US and global portfolios.

A long-run series from 1900 to the 2020s shows this premium oscillating between roughly -10% and +20%, with the latest readings near the top end, marking an unusually strong stretch for equities relative to fixed income.

Why rising yields now matter

As per the report, this surge in bond yields comes after that extended period of equity outperformance. As stocks have continued to beat bonds, equity risk premia have fallen back to levels last seen in the late 1990s, leaving equity markets more vulnerable to further increases in bond yields.

That said, in the US and Japan, the equity risk premium has bounced off recent lows, suggesting some initial stabilisation even as the broader risk of higher yields weighing on valuations remains.