The "addiction to debt" that can't be kicked
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Major overseas economies are becoming addicted to debt and unable to extricate themselves. Expansionary fiscal policies are dragging them into a protracted “debt test”.
Since the end of August, a global long-term bond selloff has swept in from continental Europe. In France, the government faced a confidence vote, leading the market to doubt the feasibility of its fiscal tightening plans. Subsequently, concerns over the UK’s budget plan and expectations of fiscal expansion in Japan due to political instability have together fueled this storm.
The chain reaction quickly became apparent. The yield on the UK’s 30-year government bond hit its highest level since 1998. Long-term rates in Japan, France, and Germany also reached decades-highs, accompanied by depreciation of the pound, euro, and yen. The spillover effect of this selloff also spread across the Atlantic, pushing the yield on US 30-year Treasuries to approach 5% again and exerting pressure on global stock markets.
(30-year UK, US, Japan, and Germany government bonds are touching multi-decade highs)
Although market volatility indicators have subsided in this wave, and spillover effects are more limited compared with the UK bond crisis in 2022, it shows that fiscal expansion combined with higher inflation benchmarks has become the core factor driving sovereign debt risk.
Political Uncertainty Ignites Debt Concerns
The recent sharp upturn in global long-term bond yields has been ignited by a series of specific political and fiscal events in various countries.
The storm began in France. On August 25, French Prime Minister Bayrou held a press conference announcing a government confidence vote to be held on September 8, and betting markets showed a probability of more than 80% that he would fail and resign before the end of September.
The risk of a government collapse greatly increased the difficulty of implementing France’s fiscal tightening plan and amplified market concerns over French debt.
On a single day, the 30-year French bond yield rose by 8 basis points, and the yield spread between French and German bonds widened from 70 to 77 basis points. As of the latest, the 30-year French bond yield has further climbed to 4.5%, approaching Italy’s 4.65% level.
In the UK, following Prime Minister Starmer’s Cabinet reshuffle on Monday, the market is focused on the upcoming autumn budget.
It is expected that Finance Minister Reeves, hindered in efforts to cut spending, may be forced to seek greater tax increases in the budget.
The market worries that tax increases could damage economic growth and actually lead to a larger fiscal deficit. On Tuesday, the yield on the 30-year UK bond jumped 8 basis points to 5.72%, hitting its highest level since 1998, while the pound fell 1.5% against the US dollar.
In Japan, political turmoil within the ruling party has also triggered tension in the government bond market.
As previously reported by Wallstreetcn, core ally Moriyama Hiroshi of Japanese Prime Minister Shigeru Ishiba expressed his intention to resign. The market believes that the weakening of government power may lead to lax fiscal discipline, or even a permanent cut in consumption tax to stimulate the economy, which would render Japan’s already heavy debt burden unsustainable. This week, Japan’s 30-year government bond yield hit a record high as a result.
Persistently High Deficits Have Become the Norm
Persistently high fiscal deficits in peacetime have evolved from rare occurrences to international practice.
Deutsche Bank analysts, citing historical data, point out that large-scale deficits were once the unique product of wartime. But today, whether in the UK, France, or the United States, persistent fiscal deficits have become the norm:
France has not run a budget surplus since 1974.
(France government budget deficit as a percentage of GDP over the past 200 years)Italy’s last budget surplus was nearly a century ago in 1925.
(Italy government budget deficit as a percentage of GDP)In the US, according to Moody’s, even without extending tax cuts from the Trump era, the fiscal deficit as a percentage of GDP will rise to 9% within a decade.
(US deficit as a percentage of GDP)
Debt Addiction: The Structural Dilemma Behind the Storm
According to China Securities, the repeated new highs in overseas long-term bond yields have not only cyclical factors, but also profound structural reasons.
From a cyclical perspective, inflation is the key determinant of short-term interest rate trends.
Take the UK as an example, service sector inflation continues to exceed expectations (rising from 4.73% to 4.98%), forcing the Bank of England to maintain tight monetary policy. High interest rates directly increase the government’s interest payments, which in turn exacerbates concerns over fiscal sustainability, creating a vicious circle.
In the short term, if the economy cools and inflation subsides, the central bank may begin rate cuts, which could temporarily ease cyclical pressure.
This also explains why, despite new US fiscal spending bills in the second half of the year, as inflation cools, the market’s focus on fiscal issues has actually lessened.
However, more damaging than cyclical factors is governments’ structural “debt addiction.”
After the pandemic, to deal with economic shock, major developed economies completely abandoned the old fiscal tightening mentality, and debt levels have risen rapidly, bringing two major structural challenges:
First, social welfare spending driven by aging populations becomes hard to reduce. France is a typical example: its government debt to GDP ratio is as high as 114%, with up to 4% of its deficit being an “unshrinkable” baseline deficit, and political turmoil makes its tightening plan even more remote.Second, high debt itself brings heavy interest payment costs. According to estimates, even if interest rates fall, the interest cost of US Treasuries as a percentage of GDP will continue to rise in the next decade.
Finally, the positive correlation between sovereign bonds and stocks is now increasing.
This means the value of bonds as a portfolio hedging tool is declining. Investors worry that their risks can't be hedged, so they demand higher long-term yields as compensation—that is, more “term premium.”
Overall, even if short-term rates fall in the future due to the economic cycle, it will be difficult for long-term rates to return to persistently low levels of the past. With both government debt at high levels and rising term premiums, the systemic risk of elevated long-term yields cannot be ignored.
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