An unprecedented wave of debt raising to finance artificial intelligence (AI) infrastructure is triggering a capital tug-of-war between governments and technology giants.

Bank of America strategists say this is driving up borrowing costs for developing nations, even as geopolitical tensions, elevated oil prices and rising policy rates were already exerting upward pressure on bond yields.

In the second half of this year, the average yield on emerging market dollar bonds has surged by nearly 1 percentage point, reaching its highest level since April last year.

Merveille Paja, who heads sovereign credit strategy for Eastern Europe, the Middle East and Africa at Bank of America, said this could pose challenges for governments seeking to refinance maturing debt.

Data shows that just two tech giants, Amazon and Alphabet, have already issued approximately $70 billion equivalent in debt so far in the second half of this year.

By contrast, since July 1, international bond issuance by emerging market sovereign borrowers has halved year-on-year to $45 billion, down from $91 billion in the same period last year.

Issuance by investment-grade emerging market countries fell 56% to $29 billion. So far in October, there has been no issuance at all.

"Hyperscaler tech companies can indeed crowd out emerging markets, and that is genuinely a risk for our asset class," Paja said in an interview.

She said that as global financial conditions tighten, rising yields could hurt issuers waiting for a better moment to refinance.Recommended reading: Under the AI financing flood, Washington and Silicon Valley compete for capital; "reverse crowding out effect" pushes up US Treasury yields.

Bond investors are being forced to choose between two options: AI-related corporate bonds with strong profitability and higher yields, or emerging market sovereign debt battered by the ongoing US-Iran war and rising US Treasury yields.

According to one index, the yield premium on emerging market sovereign bonds relative to US Treasuries briefly narrowed to 1.5 percentage points in June, roughly half its five-year average premium.

However, the impact is not the same for countries with the tightest spreads and those with higher risk premiums.

Investment-grade emerging markets face the greatest risk of rising financing costs, because they must compete for capital with hyperscaler tech companies of similar credit ratings.

"Among investment-grade sovereign issuers with the tightest spreads, some pressure has already emerged. Investors can more easily substitute between high-rated emerging market sovereign bonds and investment-grade tech company bonds," said Micah James, global head of emerging market research at Vanguard.

As the era of low interest rates ends, competition for capital, widening fiscal deficits in the US and Europe, and growing financing needs in developing countries are all forcing investors to become more selective.

Eoghan McDonagh, chief portfolio manager for emerging market bonds at Allianz, believes this could even benefit high-quality emerging market issuers.

"For us, it is not a choice between emerging market bonds and hyperscaler tech company bonds. We monitor the spread between the two to help judge when valuations are attractive. Demand from US institutional investors has been solid, using investment-grade emerging market sovereign bonds as a tool to diversify some exposure to hyperscaler tech companies," McDonagh said.