Rising Debt Levels Put Major Economies in Bond Market Spotlight
London – Surging government debt levels are increasingly becoming a point of concern for the world’s largest economies, with bond investors closely scrutinizing nations that aren’t doing enough to manage their finances. Recent events, such as Moody’s stripping the United States of its triple-A credit rating and weak demand at Japanese bond auctions, have sharpened market focus on two of the biggest global economies. While a full-blown debt crisis isn’t the primary expectation, warning signs are definitely flashing.
Let’s look at which countries are currently in the market’s spotlight and why:
1. United States
The U.S. has quickly risen to the top of investors’ worry lists following a sharp bond sell-off in April. Compounding these concerns is President Donald Trump’s new tax and spending bill, which a nonpartisan think tank, the Committee for a Responsible Federal Budget, estimates could add around $3.3 trillion to the national debt by 2034. Moody’s recent downgrade of the U.S. credit rating is another blow, and JPMorgan CEO Jamie Dimon has warned of a “crack in the bond market” partly due to excessive spending.
However, the U.S. enjoys some protection due to the dollar’s status as the world’s primary reserve currency. Treasury Secretary Scott Bessent has also asserted that the country will never default on its debt. Investors generally believe authorities will prevent 10-year Treasury yields, which serve as a benchmark for borrowing costs across the economy, from rising significantly above 4.5%. The banking industry is also hopeful that U.S. regulators might soon revise the supplementary leverage ratio, which could reduce required cash reserves for banks and encourage their greater participation in the Treasury market.
2. Japan
For many years, Japan was seen as an exception, with markets seemingly unconcerned by its enormous debt pile. This perception is now shifting. Japan’s public debt, at more than twice its economic output, is the largest among developed nations.
In May, its longer-dated bond yields hit record highs after a 20-year bond sale produced the worst auction result since 2012, raising doubts about investor demand. Thirty-year borrowing costs have jumped 60 basis points over the last three months, outpacing even the U.S. This shift is primarily due to waning demand from traditional buyers like life insurers and pension funds. Compounding this, the Bank of Japan’s bond holdings, which constitute roughly half the market, fell for the first time in 16 years. Prime Minister Shigeru Ishiba is also facing pressure for increased spending and tax cuts. While policymakers are considering temporarily reducing super-long bond sales to ease market concerns, a recent weak auction suggests the issues might be more deeply rooted. Nordea chief market strategist Jan von Gerich noted, “The weak Japanese auctions are a symptom that something is happening underneath.”
3. United Kingdom
In Europe, the UK, with its debt nearing 100% of GDP, remains susceptible to global bond market sell-offs, even as it emphasizes fiscal discipline. Finance Minister Rachel Reeves’ multi-year spending review next week could be the next major test for the UK, which is the only G7 economy with 30-year borrowing costs exceeding 5%. Rabobank strategist Jane Foley suggests the government is preparing for increased spending on defense and health, despite pledges to avoid tax increases and maintain tight spending. The IMF has urged Reeves to stick to plans for lower public borrowing. Sam Lynton-Brown, global head of macro strategy at BNP Paribas, believes an earlier cessation of active Bank of England bond sales could potentially support the gilt market.
4. France
Pressure in France’s bond market, which was a concern last year due to political instability hindering austerity efforts, has eased. The risk premium investors demand for holding French debt over German debt has narrowed to around 66 basis points from 90 basis points in November. Investors are also positioning for a decline in overall euro area risk premiums, fueled by expectations of greater European cohesion, particularly in areas like defense.
However, caution is still warranted. Prime Minister Francois Bayrou is set to announce a four-year deficit-cutting roadmap in July, which could trigger significant budgetary debates in parliament. Carmignac fixed income fund manager Eliezer Ben Zimra noted that “France has not had any improvement on the debt side since the COVID crisis.”
5. Italy
Italy has moved down the list of market worries, benefiting from improved political and economic stability and enhanced creditworthiness. Its budget deficit notably dropped to 3.4% of output in 2024 from 7.2% in 2023, and it’s projected to fall further to 2.9% in 2026, matching forecasts for Germany. Kenneth Broux, head of corporate research FX and rates at Societe Generale, remarked that such a performance was “unheard of many years ago.” Broux added that while Italy still faces long-term debt challenges, its relatively better performance compared to countries like France and a diversification towards European assets have bolstered its bonds. The yield gap between Italian and German 10-year bonds is currently near its narrowest since 2021, at just under 100 basis points.
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