Bond investors see themselves as ‘vigilantes’ who check government excess. Yet Japanese government gross debt stretches to a world-high 204% of GDP, a level that threatens global economic stability. US federal debt has doubled in the past decade to US$40 trillion. As this equals 126% of output, many warn of a debt crisis that will jeopardise the country’s superpower status. The ratio for France is 118%, a height that could trigger another eurozone debt crisis. The UK’s ratio of 104% is stirring talk of an IMF bailout à la 1976. The percentage for the advanced world is 108%.
The question arises as to why bond investors allowed these ratios to soar from the 1970s. Before then, government spending was small relative to economies, thus deficits didn’t create debt piles, and the public viewed debt as a moral failing, thus leaders sought to balance budgets outside of wartime.
One explanation is that society became more tolerant about debt when consumer credit cards became widespread from the late 1970s. Politicians exploited this shift by running ever-larger deficits funded by borrowing, while investors (and economists) contorted themselves to justify why ballooning government debt didn’t matter.
The nonchalance about debt was reinforced in recent times when interest rates fell to historic lows. Governments could easily meet their repayments.
Not anymore. Bond yields worldwide are hurtling to heights last seen before the global financial crisis of 2008. Note that bond prices fall when yields rise. Yields on US 30-year Treasuries reached a 19-year high of 5.33% on 18 August, up 4.3 percentage points from 2020 lows. To support bonds, Washington unexpectedly pledged to “at least double” its buybacks of longer-dated bonds. But the attempt faltered within 24 hours, as might similar endeavours.
London’s debt too is yielding the most since 2007. Paris’s borrowing costs are their highest since 2008. Japanese yields, at three-decade highs, are nearing record highs. Even countries with relatively low public debt such as Australia (Canberra’s gross debt is 51% of GDP) and Germany (Berlin’s ratio is 65%) have seen government yields hit 15-year highs.
Yields are rising because bond investors have turned vigilantes for six reasons centred around the US bond market, the benchmark for global credit.
Inflation
The core reason is that inflation has accelerated beyond central-bank targets. Prices are rising because wars and bad weather have boosted commodity prices, AI demand is bolstering the price of computer components and electricity, and tariffs are raising import costs.
Faster inflation is poison for bonds in two ways. One is that when central banks raise rates to quell inflation, yields on short-term bonds likewise jump to maintain investor interest. The other is that faster inflation reduces the present value of future bond repayments. Longer-dated bonds are savaged more because they represent more fixed payments.
Risk-reward
A second reason yields are rising is that investors want greater compensation for government credit risk because swelling interest repayments are stretching budgets already in deficit and facing other strains as populations age, military needs rise and industry policy gains geopolitical significance.
The debt-servicing costs for Washington, which is running a deficit at 7% of GDP, doubled in the past five years to US$1.2 trillion in fiscal 2025. These repayments now account for 15% of Washington’s outlays, surpassing military spending for the first time. In Tokyo’s budget, about 25% goes on interest repayments.
The risk is a vicious cycle whereby ballooning interest repayments widen deficits and force governments to sell more bonds, which boosts the interest bill, and so on.
Political influence
A third reason for higher yields is that investors have little faith that new Federal Reserve Chair Kevin Warsh will prioritise fighting inflation when President Donald Trump wants his appointee to cut rates.
AI capital demands
A fourth explanation is that hyperscalers are selling so much debt to fund AI infrastructure they are reducing the capital available for government debt. Bloomberg reports investment-grade companies have sold US$1.5 trillion of bonds this year, a jump of 36% from a year earlier.
Re-shoring
A fifth reason is that investors are fretful that rising Japanese yields will encourage Japanese to reshore some of the US$3.8 trillion they hold in foreign debt securities.
Easing demand from official buyers
A sixth is that a loss of faith in US political institutions' ability to repair Washington’s finances is troubling traditional official buyers of US debt such as central banks, sovereign wealth funds and treasuries in China and Persian Gulf countries. Combined with geopolitical motives, these institutions are reducing US assets as a percentage of reserves, with the result that in June, gold overtook US Treasuries to become the topmost reserve asset for central banks.
Consequences
What are the consequences of the bond rout?
- The coming political fight when governments seek to cut spending and raise taxes to repair their budgets.
- Commercial and personal interest rates will rise and slow, even shrink, economies. While Australia might have relatively low federal debt, even if it’s A$1trillion, Canberra’s budget is in deficit, higher interest repayments are squeezing indebted state governments, climbing mortgage rates will menace housing, and the country faces steeper repayments on foreign debt of A$3.2 trillion as of 31 March, which, at 160% of GDP, is high by international standards. In the 12 months to March 31, Australian repayments on foreign-owned debt instruments reached A$80 billion.
- Rising yields might sabotage the global stock rally because higher interest rates slow economies and thus hurt profits, and they reduce the value today of future earnings.
- Governments will have little ability to stimulate economies come any slowdown, just when faster inflation is forcing central banks to tighten monetary policy. Governments could even magnify any slump if they tighten fiscal policy to placate bond investors.
- Falling bond prices might trouble some financial institutions as happened to Silicon Valley Bank in 2023. A systemic scare is possible.
In short, everyone suffers when government bonds are no longer as safe as they should be.
To be sure, no one expects a Western country to default as Cyprus and Greece did during the eurozone debt crisis. It’s true too that interest rates are only rising to historical norms after being abnormally low. But government (and business and household) debts are bigger now compared with the size of economies. Thus, even lowish rates pose dangers.
If a crisis eventuates, blame spendthrift politicians but also the public’s tolerance of debt that defanged bond vigilantes.
Michael Collins is a freelance writer and editor, economist, and investment specialist. Republished with permission from the author’s Substack newsletter @denouementwatch.