Sovereign debt markets in major economies are entering a more sensitive phase, after inflation in government borrowing combined with rising interest rates and spending demands that are difficult to postpone, from defense and aging populations to climate change and energy. With US debt exceeding $40 trillion, and Japanese bond yields approaching levels not seen in three decades, the cost of debt service has become one of the most prominent challenges facing the G7 countries.
The problem is not limited to the United States and Japan; Germany, which has a much lower debt burden than most of its peers, has seen its bond yields rise to their highest levels since 2011, while France faces increasing financial pressures. Added to this picture is the war with Iran, high energy prices, and extreme weather events, which are factors that raise public spending and bring inflation risks back to the forefront. The most important shift in bond markets came after the “Covid-19” pandemic, and then accelerated with the Russian-Ukrainian war. Central banks have aggressively raised interest rates to combat inflation, ending a long era of cheap money that allowed governments to increase their debt at a relatively low cost. Today, investors are demanding higher returns for holding long-term debt. A new factor has also been added, which is the huge wave of borrowing from giant technology companies to finance artificial intelligence infrastructure. This increases competition for capital, and prompts investors to demand more attractive returns.
The repercussions extend beyond government budgets; Sovereign bonds represent the reference price for borrowing in the economy, and therefore their high yields are transmitted to corporate loans, real estate financing, and residential mortgages, and ultimately put pressure on investment, consumption, and growth.
• Adaptation efforts
Some governments are trying to adapt by increasing reliance on short-term bonds, after the cost of long-term borrowing has become relatively higher. But this strategy carries a different risk; Governments are forced to refinance their debts at a faster pace, which means that any new rate hikes are transmitted more quickly to the budget. The problem increases with the decline in purchases of some traditional investors in long-term bonds, such as insurance companies and pension funds, in conjunction with central banks reducing their bond portfolios. Debt levels reveal the scale of the challenge. Government debt is approximately equal to or exceeds economic output in most G7 countries with the exception of Germany, while Japan tops the list with debt more than twice the size of its economy.
The pressures do not seem likely to disappear quickly; An aging population raises the costs of retirement and health care, while climate transitions require massive investments in infrastructure and energy. At the same time, geopolitical tensions have led to increased defense spending, especially in Europe. The German Finance Ministry told Reuters that the Russian war had raised financing needs for massive defense investments, which contributed to increasing borrowing costs.
The burden is increasingly evident in interest payments; Although they are still below historical peaks in a number of economies, interest costs as a percentage of GDP have risen in most countries of the group, and noticeably in the United States. In OECD countries, interest payments have already exceeded defense spending in 2024.
• Additional challenges
The United States faces an additional challenge in the form of a rising “term premium,” that is, the additional return that investors demand for the risks of holding long-term bonds. This reflects concerns about fiscal policy, the Federal Reserve reducing its bond holdings, and uncertainty about inflation and monetary policy. And it's not just American; Term premiums in major OECD economies reached their highest levels in more than a decade.
As for Europe, it presents a more mixed picture. The yield differences between the bonds of some eurozone countries and German bonds have declined compared to the sovereign debt crisis more than a decade ago.
Italy stands out as a striking example. Political stability, falling budget deficits, and increasing European cohesion have helped push its debt risk premium recently to its lowest levels since 2008. France, on the other hand, has become a bigger source of concern. The political division that followed the 2024 elections hampered efforts to control the deficit, while an independent report commissioned by the government in July warned of a possible sharp deterioration in public finances during the rest of the decade, if decision makers did not move quickly to control spending.
• Japan crisis
But Japan may be the most sensitive link in this global equation. The ten-year government bond yield has become close to the 3 percent level for the first time since the mid-nineties, in a radical shift for a market accustomed to very low interest contracts. Three pressures combine in Japan: These are the huge government debt, the return of inflation, expectations of tightening monetary policy, along with concerns related to the spending plans adopted by Prime Minister Sanae Takaichi. The government has already had to reduce some long-term bond issuances to help achieve a better balance between supply and demand, but the pressures on yields have not disappeared.
The Japanese threat has a global dimension. For decades, Japanese institutions and investors have been an important source of demand for US and European bonds, due to weak domestic yields. If Japanese bonds become more attractive, parts of that money may move back in. And here the most dangerous episode appears; The rise in Japanese yields may withdraw liquidity from Western debt markets, which raises US and European yields, and in turn increases the cost of servicing government debt.
Therefore, the question before the G7 is no longer just how much debt governments can take on, but rather what price investors will demand to finance it. As defense, climate and social spending needs persist, governments must balance supporting their economies with maintaining bond market confidence. If high returns continue, the cost of debt may transform from a manageable financial item into a direct constraint on growth, living standards, and economic policies in the coming years.
The US dollar fell on Friday, heading towards recording a weekly loss, after investors concluded that the US Treasury's plan to expand bond buyback operations may provide temporary relief to the markets, but it does not address the fundamental problem of ballooning debt and fiscal deficit. This revived concerns about the attractiveness of US assets, and pushed some investors towards other currencies, gold and Bitcoin. US Treasury Secretary Scott Besent announced that the government may increase its purchases of Treasury bonds further, a day after the ministry announced a doubling of the volume of repurchases of long-term securities during the next quarter, in an attempt to contain the sharp rise in yields.
Pisant also said that he and the Director of the White House Office of Management and Budget, Russell Vogt, would begin new efforts to control public finances under the guidance of US President Donald Trump, but these statements were not enough to remove anxiety from the markets, especially with the US government debt exceeding the level of 40 trillion dollars.
Instead of calming down, Treasuries retreated after the initial relief from the buyback plan subsided. The 30-year US bond yield rose by about 1.4 basis points to 5.2508 percent, while the 10-year benchmark bond yield stabilized at 4.7041 percent, after rising 4.5 basis points in the previous session.
These movements indicate that markets have begun to view rising yields as a financial problem rather than a technical disturbance in bond market liquidity. The government's repurchase of bonds can ease supply pressures and improve liquidity, but it does not alone reduce the size of the deficit or future borrowing needs. Vitaly Mechoulam, a strategist at Goldman Sachs, said that the doubts are not related to the ability of policymakers to influence long-term returns; History shows that this can be achieved temporarily, but the current problem increasingly appears to be financial rather than technical.
He added that the experiences of developed markets show the possibility of reducing the term premium, but the experiences of emerging markets indicate that when investors begin to focus on the dynamics of sovereign debt financing, attempts to curb returns gradually become less effective. The dollar was harmed by these concerns. The US currency index, which measures its performance against a basket of six major currencies, fell to 98.76 points, near its lowest levels in three months, heading for a weekly loss of approximately 0.9 percent.
On the other hand, the euro settled near its highest level in three months at $1.1693, heading for weekly gains of about 1 percent. The British pound rose to $1.3643, approaching its highest levels in six months, bringing its weekly gains to about 0.8 percent.
The Australian dollar also rose to its highest level in two and a half months at $0.71445, and the New Zealand dollar reached $0.59735, its highest level since June 1.
Carol Kong, currency strategist at Commonwealth Bank of Australia, said that long-term bond buybacks represent another example of the US government using unconventional tools to manage borrowing costs, at a time when the country is suffering from high debt, deficits and policy uncertainty.
Kong believes that these measures may become an additional factor that pressures investor sentiment towards dollar-denominated assets, and may encourage increased hedging of the US currency and diversification of portfolios away from it. In Asia, the yen settled at 159.01 against the dollar. This came after data showed an acceleration in core inflation in Japan during July. This strengthened the justification for the Bank of Japan to raise interest rates, a factor that may provide additional support for the Japanese currency if expectations of monetary tightening continue. The most notable beneficiaries of concern about US assets were gold and Bitcoin. The cryptocurrency rose 3.65 percent to $75.306.50, after recording the highest level in more than two months, and is heading for a weekly gain of about 19 percent, which will be the largest in two and a half years.
Spot gold is also set to rise by more than 3 percent during the week. Market movements reveal that the issue is no longer limited to the US Treasury’s ability to calm the bond market in the short term, but rather to the extent of Washington’s ability to provide a convincing fiscal path that limits the growth of debt and deficit. Until tangible results of public fiscal consolidation efforts appear, the dollar and bond yields may remain vulnerable to volatility, as investors continue to search for hedging tools and diversify their assets away from US risks.
European stocks were largely stable on Friday, but headed towards recording a second weekly loss in a row, with global bond yields continuing to rise and oil prices rising due to faltering diplomatic efforts in the US-Iranian tension.
These developments present investors with a more complex equation that combines rising financing costs, renewed inflation risks, and the possibility of continued pressure on corporate profits.
The European Stoxx 600 index rose by a limited amount of 0.06 percent to 650.79 points by 07:05 GMT, but it remained on its way to ending the week on a decline for the second time in a row.
The main pressures come from fixed income markets, after US Treasury bond yields returned to their rise, weakening the relief caused by the US Treasury's actions earlier in the week.
The Treasury had announced doubling the volume of long-term bond repurchase operations in an attempt to support liquidity and calm the rise in borrowing costs. Treasury Secretary Scott Besent also said that the government may increase repurchase operations in the future, while raising the possibility of launching new efforts to adjust public finances.
But markets treated these measures more as a short-term remedy than a solution to the fundamental problem of high American debt and deficits. This is of direct importance for Europe, because higher US yields tend to push global borrowing costs higher, and increase pressure on stock valuations, especially high-growth companies and sectors sensitive to interest rates.
At the same time, oil is once again a major source of concern for European investors. Besant expanded the scope of the economic threats made by US President Donald Trump against Iran, saying that Washington would impose “the harshest sanctions in history” on Tehran. These statements reduced hopes of reaching a breakthrough that would allow the full reopening of the Strait of Hormuz.
Brent crude rose to $94.71 per barrel, its highest level in a month, before falling partially due to profit-taking operations. The continuation of oil near these levels represents an important challenge for the European economy, which is highly dependent on energy imports. Higher crude not only raises the energy bill, but could gradually trickle down to transportation, manufacturing, and consumer goods costs, threatening to keep inflation higher for longer.
This scenario, in turn, may limit the ability of central banks to ease monetary policy and keep bond yields high. Hence, European stocks face a double pressure between the high cost of production inputs on the one hand, and the high discount rate used in evaluating companies on the other hand. The repercussions are not evenly distributed across sectors. The basic resources sector led the gains, rising 1.3 percent, benefiting from the weakness of the dollar and the rise in gold prices.
Mining and resource companies usually benefit from rising commodity prices, which provides European indices with some protection against the decline of sectors most exposed to rising energy and interest costs.
In contrast, sectors such as industry, transportation, chemicals and energy-intensive companies become more vulnerable to margin pressures if oil continues at high levels. Also, heavily indebted companies may face an increase in refinancing costs if the wave of rising global bond yields continues.
The importance of the energy crisis extends beyond corporate profits to European growth expectations. If oil prices remain high while financial conditions tighten, consumer spending and investments may come under additional pressure, putting investors at risk of returning an uncomfortable combination of slow growth and high inflation.
