In October, France’s newly appointed prime minister Michel Barnier warned of a “sword of Damocles” hanging over the country — its “colossal” debt.His attempt to address the country’s creaking finances with a €60bn package of tax rises and spending cuts led to the end of his premiership just two months later. A downgrade of France’s credit rating by Moody’s followed, with the agency forecasting a rise in the debt-to-GDP level from 113 per cent in 2024 to 120 per cent by 2027. The risk for France, Moody’s warned, was the effects of a “negative feedback loop between higher deficits, a higher debt load and higher financing costs”.It is a scenario increasingly fretted over by policymakers across the developed world, as they watch debt levels reach or exceed 100 per cent of GDP. Veteran macro investor Ray Dalio has urged national governments to avoid a “debt death spiral”, where their fast-rising debts get out of control as they attempt to raise more money to cover surging interest payments, in turn driving those borrowing costs higher still.The OECD recently estimated that its 38 members were expected to borrow a record $17tn in 2025, up from $16tn last year. “Global debt markets face a difficult outlook,” the organisation warned in its annual debt report in March.Nevertheless, analysts do not believe a sovereign debt sustainability crisis among developed nations is likely in the near term, barring a big policy error. Worries over levels of government borrowing have been around for years, and bond markets have continued to absorb record issuance. Investors point to the power of central banks to arrest any rapid rise in bond yields through emergency asset-purchasing programmes. But a steady ratchet higher in bond yields since the start of the decade — in part due to central banks selling down those crisis holdings — has turned up the temperature. There is also unease about governments’ continuing reliance on fiscal stimulus to try to fuel economic growth.“Governments around the world have got used to running these huge deficits. Everyone has been asking themselves, how high can these deficits go and what is the endgame?” says a senior trader in government bonds.Yields on 30-year US Treasuries topped 5 per cent last month to reach their highest since late 2023, as investors dumped the debt in a sell-off driven by President Donald Trump’s trade war and exacerbated, fund managers say, by fiscal concerns. UK borrowing costs of the same maturity reached their highest since 1998.The rising cost of debt is already affecting governments’ priorities. Barnier’s successor François Bayrou warned last month France would be “heading to a crisis” without spending cuts and highlighted the risk from rising borrowing costs. Interest payments gobbled up 3.3 per cent of GDP across the OECD group of countries last year, the biggest share since at least 2007.“Public debts continue to increase with no limits in sight,” says Koen De Leus, chief economist at BNP Paribas’s Belgian arm. He argues that a “snowball effect is slowly forming” in countries such as the UK and Italy, where average interest rates on debt are beginning to outstrip growth rates. If countries do not at that point balance their budgets, “or better even realise a primary budget surplus, your [debt-to-GDP ratio] gets out of control,” De Leus adds. The US is also “entering the danger zone” on a similar analysis, he says.If the line where huge debts tip into a debt crisis is impossible to draw, turbulence in bond markets in recent months has supported the argument that it is getting closer, with investors regularly highlighting the UK, France and even the US as under pressure.During France’s political crisis at the end of last year, the additional interest rate on its debt relative to Germany’s benchmark Bunds reached its highest level since 2012, as investors feared for the near-term economic outlook. In the UK, the government warned of future tax rises even after it had unveiled a £14bn plan to improve the public finances, as rising yields erased the new chancellor’s wriggle room against her self-imposed fiscal rules. But the biggest worry is the near-$30tn Treasuries market, which not only funds US government spending but also provides the bedrock safe asset of the global financial system.Beyond the recent sharp sell off triggered by Trump launching his trade war, the size of the budget deficit, at more than 6 per cent of GDP, is a key concern highlighted by fund managers, along with the potential for it to deteriorate further through the president’s tax-cutting agenda. The Bank of England dropped a sale of long-dated bonds in the recent turmoil, underlining the threat to broader markets. Some commentators argue that these episodes are connected, reflecting that the bond market has moved into a new period of antagonism, where investors are putting pressure on governments to improve their finances. This is a policing role it has played in times past. “The bond vigilantes have come back following years of hibernation,” says BNP’s De Leus.Even Germany, a historically reluctant borrower, is turning on the fiscal taps, leading a European charge to increase defence spending. Many argue that a move higher in yields can be explained by normal inflationary pressures and doomsaying over debt is overdone. “Everyone is always worrying about government bond supply,” says Nick Hayes, a fund manager at Axa’s investment management arm. He argues supply is relatively easy to forecast, with countries telegraphing their borrowing plans, while demand is “near impossible” to predict. “So therefore people ‘overweight’ the worry about supply and ‘underweight’ an assumption on demand,” he adds.Big economies could avert problems if they can manage to stoke higher growth, or be forced to live with a higher level of inflation than they would have endured otherwise to “inflate away” some of their debt. All-important US Treasury yields, despite the recent sell-off, remain below levels seen two years ago. Many investors view the current level of yields as a hugely attractive entry point.Pete Drewienkiewicz, chief investment officer at consultancy Redington, argues long-dated gilts offer an attractive yield against peers and could outperform, given the UK’s “determined focus on fiscal responsibility”.One area where there is broad agreement is that yield curves will remain steep in an environment of greater debt supply. The extra interest rate paid on 30-year US debt versus 2-year debt has reached its highest in three years, and longer for the UK. Some bondholders expect governments to issue a greater proportion of short-term debt, to insulate themselves from higher long-term yields. The UK has said it would do so this year.Robert Dishner, senior portfolio manager at Neuberger Berman, argues that governments rolling their debt over more frequently would face “prices being determined on how well they are doing fiscal consolidation”, be that less spending, higher taxes or better growth.He adds: “More than a sovereign debt meltdown, markets are likely to keep governments on shorter leashes.” More
