Soaring debts in developed economies are exerting pressure on markets that are already worried
In a shift from trade wars and geopolitical tension, the burden of rising government debt in developed nations has gained prominence, but not as much as it should. Even after Donald Trump's departure from the White House, this issue persists, with escalating debts crushing the economic systems of these nations and exerting pressure on global markets.
Recently, the United States lost its last top credit rating, AAA, from Moody's, and Japanese government bond auctions have received little investor interest. These events have forced a closer look at the economies and astronomical debts of the U.S. and Japan.
For the U.S., investor worry began in April, following mass Treasury bond sell-offs. To the gloom, the tax cut bill and growing government spending added further concerns. According to analysts from the Committee for a Responsible Federal Budget (CRFB), this bill will add nearly $3.3 trillion to the U.S. debt by 2034.
The possession of the largest reserve world currency offers some protection to the U.S., making it the top dog in the "debt league." However, the White House considers the concerns misplaced and the panic overblown. For instance, Treasury Secretary, Scott Muzynski, recently assured that the U.S. will never default on its debt.
Investors keep a nervous eye on the debt market but hope that authorities will take radical steps and prevent, for example, the yield on 10-year Treasury bonds from exceeding 4.5%. Banks remain generally optimistic, feeling that regulators will soon cut mandatory cash reserves held by banks, allowing them to play a more active role in the debt market.
For years, Japan has been the poster child of how markets can close their eyes to massive government debt, with it exceeding twice the size of its economy. However, the situation has undergone a significant change.
In May, the yields on long-term Japanese government bonds hit record highs. At the same time, the auction for 20-year government bonds recorded the weakest performance since 2012. The yields on 30-year bonds have risen by 60 basis points in the last three months, even surpassing the growth rate of 10-year Treasury bonds. Analysts blame weak investor appetite from traditional Japanese government bond buyers, such as insurance companies and pension funds. Strangely enough, the timing could not be worse – a time when the reserves of the central bank, accounting for almost half the size of Japan's bond market, have shrunk for the first time in 16 years. Meanwhile, the Prime Minister, Shinzo Abe, faces increasing pressure to reduce government spending.
The explanation might be overly simple. It's possible that the situation is more complicated than it seems at first glance.
"The weak bond auctions in Japan are signs of something strange going on beneath the surface," Nordea's chief market strategist, Ien von Graevenitz, told Reuters.
There are "weak links in the debt chain" in Europe too, such as the UK, whose national debt is approaching 100% of its GDP. A remarkable fact is that the UK is the only G7 member with 30-year government bond yields over 5%.
The British government recently announced plans to significantly increase defense and healthcare spending. At the same time, it has pledged not to raise taxes and called for financial discipline and reduction in expenditure.
"There are no signs of improvement with the debt situation in the UK after the end of the COVID-19 pandemic," said Elizer Zimra from Carmignac.
In France, pressure on the bond market has intensified significantly last year, primarily due to political instability, which may hinder efforts to reduce spending. French Prime Minister, François Barbin, plans to announce a 4-year program to reduce the deficit in July, which will undoubtedly lead to major difficulties in approving the next budget.
In the case of Italy—another troubled member of the G7 due to its debt—the situation has slightly improved in recent times due to political and economic stability, as well as an improvement in the credit rating. The budget deficit last year fell more than twice: from 7.2% in 2023 to 3.4% of GDP. According to projections, it will decline to 2.9%, which coincides with Germany's projections, noted Kenneth Bru from Societe Generale.
"This hasn't happened for many years," admitted Kenneth Bru, struck by the successes of Giorgia Meloni.
The long-term debt dynamics in Italy, once a negative example for debt management, continue to arouse concerns, explained Bru, but the situation in Italy with debt has significantly improved and is now more favourable than in neighboring countries, including France.
The fact that the yield difference between 10-year Italian and German bonds is now the smallest since 2020 gives hope to Italians.
- The weak auction performances and rising yields in Japanese government bonds indicate a potential strain in the finance industry, causing investors to question the sustainability of Japan's enormous debt in the business realm.
- As the UK's national debt approaches 100% of its GDP, there are growing concerns about 'weak links' in the debt chain within the European industry, with the UK's 30-year government bond yields being higher than any other G7 member, raising finance industry eyebrows.
