When Donald Trump was asked recently about the threat of rising interest rates on US government debt, he told baffled reporters: “The ultimate intervention is our military. And if we have to use that, we will.”
Perhaps not surprisingly, his bellicose words did not soothe fractious bond markets, and his resumption of the bombing campaign against Iran only made matters worse.
The past fortnight has seen a wave of instability sweeping through government bond markets in major economies – with knock-on effects for millions of borrowers. The interest rate, or yield, on 10-year US government borrowing hit 4.8% on Friday, up from 4.64% 10 days ago. At one point midweek, the 30-year yield touched its highest level since 2008.
Neil Shearing, the chief economist at the consultancy Capital Economics, said one impetus for the current wobble had been markets taking a fresh look at the state of US public finances. “There’s been a recalibration,” he said.
Total US government debt has surged past $40tn (£29.5tn), and annual deficits are forecast to be an eye-watering 6% of GDP for the foreseeable future.
Such figures were long deemed barely to matter given the status of US government bonds, or treasuries, as the ultimate safe-haven investment. But as the events that led up to the 2008 financial crisis revealed, things don’t matter in the markets until they do.
“I think we are starting to see a more realistic reassessment of the fiscal pressure in the US,” Shearing said. “What marks the US out is that there’s not really an acknowledgment of the fact that there might be a problem. There’s no plan.”
Russell Jones, a veteran bond market analyst at Llewellyn Consulting, said: “The thing about economics is that often markets delay the judgment and, you know, you can’t really time when they suddenly decide that that’s enough.”
The US treasury secretary Scott Bessent’s recent fumbled attempts to intervene in financial markets – to help Tokyo prop up the yen and then to calm bond yields – have only added to the sense that policymakers are panicking.
Layered on top of these concerns is a more immediate worry about inflation taking off again as a result of renewed hostilities in the Middle East. Oil prices have risen back above $90 a barrel since the US and Iran resumed tit-for-tat attacks.
That has increased expectations that central banks will have to raise interest rates – another factor that puts upward pressure on yields.
Every pronouncement by policymakers is being closely scrutinised for clues, including a key speech by the new Federal Reserve chair, Kevin Warsh, last Friday that was read by markets as signalling a willingness to act.
The European Central Bank is expected to lead the charge with a rate rise next week, but markets are telegraphing higher borrowing costs across major economies.
That includes the UK, where investors are now pencilling in three quarter-point rate rises over the next 12 months, and Japan, where the decades-long period of deflation and rock-bottom rates is finally coming to an end.
A dramatic expansion of borrowing by AI “hyperscalers” in the US, to help fund the massive planned expansion of datacentres, has offered investors an alternative home for their cash – and raised questions about the market’s ability to absorb so much debt simultaneously.
Recent calculations by the investment group Vanguard put the value of debt issued by five major tech companies at $135bn (£100bn) this year, up from an average of $35bn between 2020 and 2024.
There is potentially an even more fundamental explanation for an upward shift in borrowing costs, too – based on the growing prevalence of inflationary shocks not just as a result of geopolitical chaos but because of the climate emergency.
Some economists, including the Bank of England policymaker Swati Dhingra, have argued these increasingly regular shocks, as a result of extreme weather events and resulting economic upheaval, could lead to structurally higher interest rates.
Whatever the causes of rising bond yields, the impact is already rippling out worldwide. Public borrowing has increased dramatically in recent years as policymakers have stepped in to cushion consumers against Covid shutdowns, wrestled with sharply higher energy prices since Russia’s invasion of Ukraine, and stepped up defence spending. That means small changes in global interest rates can have an outsized impact on government budgets.
In the UK, where £1 in every £12 of public spending already goes on debt interest, Andy Burnham, the prime minister, was pressed this week by the opposition leader, Kemi Badenoch, about the rising cost of government borrowing.
Higher yields on gilts, as UK government bonds are known, will feed through into predictions of higher interest rate costs for the Treasury ahead of the new chancellor John Healey’s autumn budget.
David Aikman, the director of the National Institute of Economic and Social Research, urged the government to take the opportunity to implement spending cuts and/or tax increases to help insulate the UK from higher borrowing costs.
“There will be a lot of talk about the fiscal rules. I think that’s slightly missing the point,” he said. “The big point here is we’ve just got a lot of debt, whether you’re missing the rules or not. And it means we’re really vulnerable.”
On the other side of the world, Australian policymakers have been wrestling with similar challenges. Bond yields have breached 15-year highs just days after the country passed A$1tn in government debt.
The timing of the two milestones comes at a difficult time for a Labor government that is under pressure to rein in historically high levels of spending.
Falling house prices in a property-obsessed nation are adding to a mood of discontent. Bets have firmed that the Reserve Bank of Australia could deliver another interest rate hike later this month to tame stubbornly high inflation.
Jim Chalmers, the treasurer, has been at pains to highlight Australia’s relatively strong budget position internationally. Australia’s debt is equivalent to about half the size of the economy, which pales against other advanced nations. Similarly, the commonwealth is running deficits, but of less than 1% of GDP.
Chris Richardson, an independent budget expert, said Australia’s government indebtedness wasn’t “bad by world standards”. “But it’s still a lot of debt. And the higher cost of money means the difficult choices that were there already are that much harder.”
For developing countries, these issues are all the more urgent. The International Monetary Fund warned earlier this year that these economies had become more exposed to the risk of higher interest rates, because of the growing importance of lending from short-term investors such as hedge funds, which tend to be more flighty during periods of market volatility.
Matthew Martin, of the advocacy group Development Finance International, said: “A lot of these countries are very near the edge, and if they have to go back to the markets and refinance another bond at 1% or 2% higher than it was before, that will mean even less money to spend on climate action, health and education.”
If higher yields are sustained, the effects will be felt far beyond the world’s treasuries, muddying the maths for corporate investments and putting upward pressure on mortgage rates, which in the UK have already started to rise.
Aikman argued corporate balance sheets worldwide looked less shaky than before the global financial crisis. “We’re not in the place we were in the run-up to 2008,” he said. But he pointed to “pockets” of concern, including the huge scale of debt-fuelled private equity projects that could prove vulnerable in a world of higher rates.
By the end of the week, the sell-off sweeping global bond markets appeared to have eased, for now. But it left yields at levels significantly higher than three months ago – and delivered a painful reminder to policymakers, including Burnham, that in globalised financial markets their plans can be buffeted by forces far beyond their control.
