The Global Bond Sell-Off is Becoming a Fiscal Reckoning
Rising inflation and mounting public debt are pushing up borrowing costs across advanced economies — while China’s apparent escape comes with costs of its own. A commentary by Lorenzo Bini Smaghi
Government bond yields have risen sharply across most major advanced economies. Financial markets fear that, if this trend continues, investors may start cutting their exposure to government debt, triggering a destabilising feedback loop. At the same time, the cost of servicing public debt continues to rise, while governments are finding it increasingly difficult to implement corrective fiscal measures.
Japan is perhaps the most striking example. Its benchmark 10-year government bond yield has risen by about 90 basis points since the beginning of the year, briefly touching 3 per cent at the start of September — its highest level in 30 years. With gross public debt exceeding 200 per cent of GDP, the country’s debt-servicing burden is set to increase significantly over the coming years.
Developments in the US Treasury market are equally concerning. The 10-year yield has risen by roughly 60 basis points since the beginning of 2026. Federal debt-servicing costs continue to grow and have now surpassed defence spending.
In Europe, the most worrying case is the UK, where 10-year gilts have climbed above 5 per cent, their highest level since the 2008–09 financial crisis. In France and Italy, 10-year yields have risen by roughly 60–70 basis points since the beginning of the year.
One important driver is the rise in inflation expectations, amid fears that commodity prices will remain elevated for a prolonged period. Policy rates may therefore have to rise further and remain high for longer than previously expected before inflation can return sustainably to the 2 per cent target.
However, inflation is not the only factor. Investors are also demanding greater compensation for holding long-term debt as governments issue more bonds and their fiscal trajectories deteriorate.
Public debt dynamics are reinforcing these pressures. In the US, in particular, International Monetary Fund projections indicate that general government gross debt will reach 142 per cent of GDP by 2031.
Investors do not expect the US Treasury to default, as Greece did during the eurozone debt crisis. They do expect, however, that if the government encounters difficulties in refinancing its debt, the Federal Reserve will come under pressure from the White House to intervene by purchasing government bonds and restraining yields. Over time, such a policy would risk generating higher inflation.
In August, the US Treasury announced that it would at least double the size of its liquidity-support buybacks of longer-dated securities, beginning in September. The announcement initially brought yields down, but the relief proved temporary, with long-term rates subsequently rising again.
Rather than reassuring investors, such interventions may reinforce concerns that the authorities ultimately intend to hold borrowing costs below the level that markets would otherwise demand.
The connection between fiscal conditions and long-term yields is also suggested by the experience of countries with sounder public finances. Since the beginning of the year, 10-year yields have risen by only around 10–15 basis points in Switzerland, 30 basis points in Canada and Sweden, and about 50 basis points in Germany.
The most important exception to the relationship between rising public debt and higher interest rates is China.
Chinese debt is growing even faster than US debt. According to the IMF, China’s general government gross debt almost doubled in less than a decade, rising from about 50 per cent of GDP in 2016 to 99.2 per cent in 2025. It is projected to approach 127 per cent by 2031, as the fiscal deficit remains close to 8 per cent of GDP.
Despite this trajectory, China’s 10-year government bond yield has fallen by around 15–20 basis points since the beginning of the year, reaching approximately 1.7 per cent.
China’s very low inflation rate, currently below 1 per cent, provides part of the explanation. Moreover, economic growth is gradually slowing: the IMF expects it to decline from about 4.5 per cent in 2026 to around 4 per cent in 2027.
The main difference with advanced economies is that China avoids issuing government bonds on financial markets. Rather, its public debt is predominantly denominated in domestic currency and held by domestic financial institutions, with state-controlled banks playing a central role.
These banks are funded in large part through the deposits of Chinese households and companies, on which they pay relatively low interest rates. State influence over the banking system, restrictions on capital movements and the abundance of domestic savings therefore allow the government to finance itself cheaply while limiting its exposure to shifts in international market sentiment.
This system is not without costs. Financial repression restricts the range of investment options available to savers and keeps returns on their savings low. These conditions, together with population ageing, limited social spending, incomplete access to welfare benefits and uncertainty surrounding the property market encourage households to maintain high levels of savings.
The result is weaker household consumption and an economy that remains excessively dependent on investment and exports rather than domestic demand.
In short, China can suppress sovereign borrowing costs because its state-directed financial system channels a large share of domestic savings into low-return assets. This shields public finances from immediate market pressure, but it does so at the cost of weaker consumption and a more unbalanced growth model.
It is a different form of instability, rather than an escape from it.
A previous version of this article was published in the Italian daily Il Foglio
IEP Bocconi does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.
