Auctions of government bonds are usually so routine that they generate little attention. But Japan’s sale of 20-year debt last month was an exception.
As financial newswires flashed the dismal results around the world, the prices of the longest dated Japanese sovereign bonds dropped sharply, pushing up yields and increasing borrowing costs. An auction of US 20-year bonds the following day also attracted a lukewarm response.
Close attention to the finer details of government bond auctions and higher yields on longer-dated debt are symptoms of the same thing: wobbling investor appetite for such instruments just at the moment when many finance ministries are planning record levels of issuance, and as the world economy enters a new and uncertain era.
For the first time in almost a generation, governments are starting to face resistance from the market when they try to sell long-term debt.
“It’s a classic supply-and-demand mismatch problem, but on a global scale,” says Amanda Stitt, a fixed-income specialist at $1.6tn asset manager T Rowe Price. “The era of cheap, long-term funding is over, and now governments are jostling in a crowded room of sellers.”
The reticence among some investors has taken 30-year government borrowing costs in countries such as the UK, Japan and the US to or near their highest in decades and moved the question of debt sustainability up the political agenda. In many countries, the mounting cost of servicing debt interest threatens to squeeze government spending in other areas.
Rising supply, whether from increased government borrowing, or central banks selling the bonds they purchased in the aftermath of the financial crisis and the Covid-19 pandemic, is coming up against a pullback in demand from some traditional buyers such as pension funds and life insurers.
Indebted exchequers risk becoming more vulnerable to pushback from bond investors. Skirmishes over US trade policy this year and the infamous 2022 gilts crisis that followed the UK’s “mini” Budget are a marker of what is to come if public finances are not tightened, investment veterans warn. The ramifications, both for how economies are managed and the outlook for the corporate sector, could be significant and widespread.
“The bond market has never been more powerful, because we’ve never had so much debt,” says Ed Yardeni, the economist who coined the term “bond vigilantes” in the 1980s to describe investors whose activities drove governments to strengthen public finances.
“We have to look at the [debt problem] globally now,” he adds, citing rising borrowing costs in the UK, Japan and elsewhere. “The risk is: bond vigilantes of the world unite.”
At the heart of the global economy, long-term yields in the $29tn US Treasuries market have topped 5 per cent in recent weeks, close to the levels reached in 2023 — when investors feared interest rates would have to stay higher for longer to contain inflation — and before that their highest since the financial crisis.
This is taking place just as a tax and spending bill that could add more than $2tn to America’s debt makes its way through Congress, and amid the continuing fallout from President Donald Trump’s imposition of tariffs on America’s trading partners.
Some of the leading figures on Wall Street have been sounding the alarm about the country’s fiscal position.
Jamie Dimon, chief executive of JPMorgan Chase, warned last week that mounting debts could “crack” the Treasuries market, prompting reassurances from Treasury secretary Scott Bessent that the US is “never going to default” on its obligations.
On Thursday, BlackRock chief executive Larry Fink said that if the economy continued to grow at around 2 per cent, “the deficits are going to overwhelm this country”, while Citadel founder Ken Griffin said it was “just fiscally irresponsible” to run deficits of 6 or 7 per cent of GDP while there was full employment.
Elon Musk, the tech billionaire who was until recently a regular fixture in the Trump White House, has described the bill as a “disgusting abomination” and said Congress was “making America bankrupt”.
France’s debt burden was described as a “sword of Damocles” last year by then prime minister Michel Barnier. Europe’s third-largest economy is expected to spend €62bn on debt interest this year, roughly equivalent to combined spending on defence and education, excluding pensions.
In the UK, 30-year government borrowing costs reached their highest levels since 1998 this year amid investor concerns over the growing debt pile and ministers’ lack of headroom against their self-imposed fiscal rules. Even Germany, a historically reticent borrower with much lower debt levels, is planning to increase Bund issuance.
In Japan, where the central bank’s ultra-loose monetary policy kept long-dated yields below 1 per cent for years, a brutal sell-off has taken them to record highs. The 30-year yield on Japanese government bonds is hovering around 3 per cent.
Finance ministers do have some levers they can pull. Some have switched to more issuance of short-dated debt, where yields are more a function of interest rates and less about supply and inflation dynamics. Central banks could also pause the unwinding of bond holdings built up in the aftermath of crises.
But barring a big step-up in growth, reducing runaway spending is the only durable solution, fund managers say. Craig Inches, head of rates and cash at Royal London Asset Management, says excessive borrowing is the main cause of indigestion in long-term debt markets, forcing tough decisions over cost cuts.
“The question is, do governments have the stomach for it?”
Borrowing costs have been marching higher since the Covid pandemic as inflation rose and central banks reduced their buying. But the recent selling has been especially felt in long-term debt, where prices have fallen faster and yields risen more than in shorter-term bonds.
The yield gap between two-year and 30-year US Treasuries has reached about a percentage point, its highest in three years, with similar steepening elsewhere. Many big fund managers are placing bets that so-called yield curves — which show the cost of borrowing at various bond maturities — will continue to steepen.
This is a problem for governments, which issue debt at a range of maturities not only to meet the demands of different investors, but also to spread out their own refinancings and reduce their exposure to swings in market interest rates.
Even with such management strategies, government debt interest costs for the OECD group of rich nations have already reached their highest since at least 2007. In many instances, spending on debt interest exceeds the budgets of big government departments such as defence or education.
Central banks in most big economies are still on a path of cutting interest rates, which has kept short-term rates relatively well tethered. But they have less influence over longer-term borrowing costs. There, investors’ expectations for inflation — which can eviscerate the fixed returns offered by bonds — and concerns over excess supply are also critical.
Measures of the so-called term premium, a theoretical measure of the part of the long-term interest rate that compensates investors for this uncertainty, are rising. Most analysts believe that long-term interest rates will continue to climb, helped by investors’ “steepener” bets.
Government bond prices also act as a benchmark for corporate borrowing costs, so a deeper problem at the long end of the curve will spill into companies’ borrowing costs too.
“The higher that those rates go, and the less control that central banks have on the long end, the more pressure that puts on the private sector,” says Mike Scott, head of global high yield at Man Group.
Questions over demand for long-term sovereign debt have been exacerbated by an exodus of some of the more reliable buyers of this government paper. In the UK, traditional “defined benefit” workplace pension funds have mostly closed to new members and their existing members are ageing — meaning they have less need for long-term debt. Their place is increasingly being taken in the gilts market by hedge funds who want shorter-term bonds.
A similar effect is playing out in Japan, where the country’s postwar baby boom generation is ageing and no longer needs the same level of long-term debt holdings, analysts say.
That has combined with a revival of inflation to fuel a sell-off that has taken Japanese government bond yields to record highs in recent weeks. One of the most reliable bets in the long-term global bond market is fading.
“Governments across the developed world are issuing more debt into the market, just as their anchor, JGBs, becomes untethered,” says James Novotny, an investment manager at Jupiter Asset Management.
Finance ministers and debt managers have sought to soften the blow from rising market borrowing costs.
The UK’s Debt Management Office moved this year to scale back its long-term debt sales, with its chief executive citing the “declining strength” of demand for longer-dated debt and the need to maintain value for money for the taxpayer.
In Japan, the government triggered speculation that it would make a similar move when it canvassed the market last month on its issuance plans. There are precedents for stronger actions: in 2001, the US paused 30-year debt sales entirely.
And in the US, despite Bessent’s repeated criticism of his predecessor Janet Yellen for relying more on shorter-term debt issuance, he has said any move to “term out” debt maturities would be “path dependent” and has suggested instead it could up its buybacks of older debt.
The amount of wriggle room countries have depends on the profile of their existing maturities. The UK is in a relatively healthy position, given that the average maturity in its debt stock is 14 years.
But some investors warn that shortening debt maturities makes countries more susceptible to refinancing risks, a feature more familiar in emerging markets. “[It] won’t solve the underlying demand problem, merely pushing it down the curve,” says T Rowe’s Stitt.
There are other tools. Central banks could also stop or scale back their selling of sovereign debt amassed during previous emergency programmes, so-called quantitative tightening to unwind quantitative easing.
Barclays’ Moyeen Islam argued in a recent note that there was “significant merit in a pause in active selling” by the Bank of England, saying it could help lift gilts and have “significant positive consequences for the fiscal outlook”. The bank is set to announce in September how much it will sell into the market over the coming year as part of its own QT, although in a letter to the Treasury last month, BoE governor Andrew Bailey said there had been “no evidence of gilt sales having a negative impact on market functioning across a range of financial markets measures”.
Central bankers are conscious of the effect of the long-term debt sell-off on monetary policy, too. Catherine Mann, a member of the BoE’s rate-setting committee, said in a recent speech that it was “important for a monetary policymaker to consider the interactions of QT and policy rate decisions, especially at a time where these two tools are acting in different directions”.
The effects of QT in tightening financial conditions “cannot be perfectly offset” by interest rate cuts, she warned, and “the combination of tools and their macroeconomic effects must be carefully considered”.
The path of the public finances in the US, the world’s largest borrower, will be crucial to whether the world can work through its glut of long-term debt.
The Congressional Budget Office said on Wednesday that Trump’s self-styled “big beautiful bill” would extend the budget deficit and add $2.4tn to the public debt by 2034.
The US has long been afforded more flexibility than other countries in its public finances, given the dollar’s central role in global trade and finance, and the status of Treasuries as the world’s reserve asset.
But analysts have increasingly warned that a ramping-up in the country’s long-term debt sales, just as global investors are showing signs of diversifying away from dollar assets, could create the conditions for an accident.
The US lost its last AAA credit rating in May as Moody’s warned of its deteriorating debt dynamics. Anxiety is already high in the market after the trade war sell-off in April and Trump’s broadsides against Jay Powell, chair of the Federal Reserve, unsettling big investors’ confidence in Fed independence and the implications for long-term inflation control.
The bill is “throwing a little bit more petrol on the fire” of the US debt problems, says April LaRusse, head of investment specialists at Insight Investment, a big fixed-income investor. It “looks pretty bad” in terms of its deficit impact, she adds, “even if you make some kind assumptions” on the revenues that tariffs may bring in.
One concern is that deteriorating debt dynamics in some countries make them less resilient to future surprises or bad political choices. “In a handful of countries, debt is sustainable but vulnerable to new shocks,” says Peder Beck-Friis, an economist at bond giant Pimco. He cites the UK and Italy as examples.
In others, such as the US and France — which last had a balanced budget in 1974 — debt looks to be “very unsustainable under the current path” without some degree of consolidation, he argues.
Others believe the US and other nations are in the foothills of a debt sustainability crisis. Veteran investor Ray Dalio has warned of a “death spiral” where borrowing costs are forced higher in a self-fulfilling cycle.
But most investors think the US can escape this trap, partly through pressure from the bond market. “Hemingway described the path to insolvency as ‘gradually, then suddenly’,” wrote Standard Chartered’s Steve Englander in a recent note. “The US, in our view, is likely to stay on the ‘gradually’ part for an extended period, quite possibly forever.”
Another option is that countries erode the real-terms value of their debt by tolerating a higher level of inflation than they would have had otherwise. “Effective default through inflation risk could become a material risk,” warns Englander.
The danger is that government spending and the need to maintain orderly debt markets become a dominant force for monetary policy, rather than other factors such as economic growth or inflation.
“What I’m really concerned about is that you end up in the fiscal dominance story,” says Bill Campbell, a fund manager at DoubleLine Capital, where increased government borrowing and spending “crowds out” private investment. That, he warns, could lead to a “permanently lower growth trajectory . . . [a] long-term malaise of lower growth, and a massive debt overhang”.
For many investors, the economic ill-effects of the long build-up in sovereign debt are a bigger concern than the more remote possibility of a government bond meltdown in a large economy.
“It’s not our base case that we have a debt blow-up,” says Jamie Patton, a bond fund manager at US investment house TCW. “[But] as a taxpayer and a US citizen, I am deeply concerned,” she adds, depicting a Congress that has progressively “less capacity” to make tax and spending decisions. “We have a big problem on our hands.”
Data visualisation by Ray Douglas