Global economies are contending with surging government debt levels, exacerbated by persistent spending demands for issues like aging populations, climate change, and defense. The recent escalation in the Middle East has reignited inflation risks, placing additional strain on governments already managing multiple shocks.
Borrowing costs across G7 nations have sharply increased following the pandemic and international conflicts, as central banks raised interest rates to combat inflation. Investors now demand higher returns to offset the risk of holding government debt. Britain currently faces the highest borrowing costs among G7 peers.
Governments are increasingly selling shorter-term bonds to mitigate the impact of rising borrowing costs. However, this strategy carries its own risks, as debt must be repaid or refinanced sooner, leading to faster increases in interest expenses.
Across the G7, excluding Germany, debt levels are now equivalent to or exceed economic output. Historical crises have consistently raised debt levels, impacting growth and spending. Japan, with debt more than double its economic output, leads the G7. Even Germany is increasing borrowing for defense and investment.
Higher borrowing costs are significantly impacting government interest payments as they refinance older, lower-cost debt. In the U.S., interest payments as a share of output have risen steadily, surpassing defense spending across OECD countries in 2024.
An increase in the "term premium" on U.S. Treasuries indicates investors are demanding more compensation for holding longer-term bonds, reflecting concerns over fiscal policy, central bank actions, and inflation uncertainty. This trend is global, with major OECD countries experiencing the highest term premiums in over a decade.
While some improvements are seen in the European bond market, with reduced risk premiums for countries like Italy due to increased cohesion and stability, France now faces greater investor risk amid political uncertainty impacting deficit reduction efforts.
Japan, the world's most indebted nation, is under scrutiny. Past bond sales revealed significant investor concerns, prompting adjustments in sales strategies. Despite efforts to stabilize demand, borrowing costs remain under upward pressure.