Are major economies just one step away from pulling the pin on a massive debt hand grenade?

A global financial crisis seems to be brewing far away from the mainstream discourse dominated by geopolitical tensions and trade tariff uncertainties.

Unfortunately, the trigger this time is the exploding public debt of advanced economies, which is threatening to hurl the world economy over a cliff any moment.

Notwithstanding the repeated warnings of multilateral agencies, governments are piling on sovereign debt, which some refer to as the ‘global bond glut.’ Driven by unstoppable bond issuances, anxiety is gripping the bond land amid concerns of falling fiscal health of major economies from Japan to Britain to France and the US. In response, long-dated sovereign bonds yields are pushing past decadal and even multi-decadal highs.

According to the OECD’s global debt monitor, the global sovereign and corporate bond borrowing touched $100 trillion in 2024. Interestingly, last year alone saw bond issuances of $25 trillion, which is nearly three times the 2007 level. If France’s public debt is over 114% of GDP, US’s is about 121% and Japan’s stood at over 230% of GDP. The IMF and its peers often exhort governments to put their fiscal house in order by raising taxes, cutting spending and acting decisively to boost growth. But efforts on the ground are rather limited or none at all.

In other words, the precarious nature of sovereign debt has reached gigantic proportions, and as the debt super cycle reaches its final leg, it’s feared that all it takes to burn down the whole house is a drop of oil.

In fact, the likelihood of such a possibility was in display this week when unrelated developments in the US, UK, France and Japan were one step away from pulling the pin on the debt hand-grenade. The French 30-year bond yields rose to their highest level since the 2011 sovereign debt crisis to 4.5%, while in the UK, the 30-year gilt spiked to 5.68% — the highest level since 1998. The selloff spilled over across Europe taking down even fiscally sound countries with it. Consequently, the 30-year German yields rose to 3.40%, the highest level in over 10 years, and Italy’s 30-year yields jumped to 4.68% — a 14-year-high.

The situation isn’t any different across the Atlantic. Pressure on bond markets increased on September 3, when yields on 30-year US Treasuries touched 5% for the first time since July on fears of rising debt and high inflation. Within Asia, Japan, long considered as the ticking time bomb, is fighting its own fiscal and political battles.

Now, as interest rates rise, the rising cost of government debt amid unsustainable budget deficits is troubling both governments and investors. Central banks, known for their whatever-it-takes-approach indulging in massive asset purchases to manage yields, seem to have limited appetite going forward. For instance, the European Central Bank (ECB) is feared to have accumulated in excess with its unrealized paper losses estimated at euro 800 billion by one count.

Even as rising debt costs are a major worry, political instability and unmanageable debt is causing governments further distress. Last week, the crisis in European bond markets was led by the sell-off in French 10-year bonds, called OATS, which in turn became cranky citing fears of a political vacuum. Likewise, in the UK, government bond yields surged to unimaginable proportions, as the Labour government is to plug a multibillion fiscal hole in the upcoming autumn budget. Meanwhile, the US 30-year yields — which is the effective interest rate of what it would cost the US government to borrow money over three decades — shot past 5% as courts declared trade tariffs illegal, calling into question the hundreds of billions of dollars of revenue generated since their imposition in April.

The US Treasury market, considered the bedrock of the global financial system, is fighting multiple battles from high debt to the impact of tariffs on inflation and concerns about the independence of the US Federal Reserve. Besides, the US yield curve is also steepening with the spread between 2-year and 30-year bonds around 130 bps, suggesting that inflationary expectations are becoming unanchored. Worst of all, the 10-year yield is now below its average level since 1800, according to Deutsche Bank, which also believes that this is the worst decade ever for government bonds.

That’s because long-term global yields are at multiyear highs, and in some instances multidecade highs, for many governments. The reasons aren’t hard to fathom and much has to do with rising government debt and inflation. Steepening yield curves, where long-term rates rise further than short-term bonds, are the path of least resistance. US deficits are on a path to 9% within a decade, according to Moody’s.

As political and fiscal uncertainties make investors nervous about investing in long-term government bonds, they are demanding additional return for the risk of holding longer duration bonds. But rising yields are a strain on government finances, which are already getting crushed under higher spending and rising interest payments.

If risk premiums don’t increase, investors will lose trust in governments to pay back their loans, so research strategists are suggesting sales of long-term gilts to be suspended in order to relieve upward pressure on bond yields. Yields, which reflect the level of risk investors demand to hold a country’s debt, are on the rise across most Western economies, but the UK and France and most of Europe are seeing the sharpest swings.

While many European economies have a debt problem, with Greece and Spain barely escaping from the gates of hell, thanks to sovereign debt, lately, it’s France that’s on the brink of a collapse.

Its national debt stood at 114% of GDP — among the highest in Europe — and according to Eurostat, unfunded committed pension liabilities touched 400% of GDP. While the government pegged this year’s fiscal deficit at 5.4%, the market expects it to settle at 5.8% — far away from the 3% advocated by the European Union.

Compounding its woes, France is staring at a political deadlock with its centrist prime minister Francois Bayrou facing the exit over planned austerity. He proposed to cut everything to find $51 billion a year in savings, including doing away with two public holidays, but his proposals upset the bond markets with the 30-year-bond yield surging to levels not seen since the Greek debt crisis. France’s finance minister Eric Lombard stepped in with a suggestion of a potential IMF bailout, but it failed to reassure markets, forcing him to walk it back.

This is France’s second government in less than a year and sixth since 2020 and the political vacuum comes at a worse time with GDP growth pegged at just 0.8%. National debt has grown from euro 2.2 trillion during Macron’s election year of 2017 to euro 3.3 trillion and because interest rates are on the rise, Bayrou believes the cost of servicing the debt could become the single largest line item in the budget by 2029. Its debt levels are inching closer to that of Italy, which is traditionally known for weak finances and political instability.

Analysts reason that much of France’s troubles, or for that matter any other European economy, are due to the flawed policies of the European Central Bank (ECB). For instance, the ECB’s policy rates fell from over 4% in 2008 to negative and remained there for years. The negative nominal rates, along with the ECB’s asset purchase programme, pumped bond markets with central bank money. The ECB’s other measures to contain the spread between core and periphery country bonds too didn’t work as intended.

In short, most of the ECB’s policies destroyed the market mechanism, while encouraging governments to borrow at ultra-low rates. Instead of reining in debt, borrowing shot up, sowing the seeds of sovereign debt crises. A classic example is Greece, which was once hailed for boosting its GDP with massive government spending by none other than the IMF and the European Commission. But eventually it collapsed to the ground.

Meanwhile, within Asia, Japan is the flashpoint for global financial anxiety. Concerns over rising public debt, which soared to a record high of 230% of GDP, have been existing for a while, but seem to be coming to a boil amid political paralysis.

Further compounding the issue, the Bank of Japan’s abrupt shift toward tighter monetary policy, raising policy rates after 17 years, is rattling markets. With the country’s fiscal sustainability under intense scrutiny, Japan’s 30-year bond yields touched 3.286%, while yields on the 40-year bond reached their weakest level, hitting an all-time high of 3.689% in May and have remained volatile since.

Worryingly, Japan’s bond market turbulence is not confined to its borders alone. For decades now, Tokyo has been the ultra-magnet attracting all the world’s wealth with investors dipping into the country’s cheap capital to re-invest in high-yielding financial assets elsewhere. If Japanese government bond yields rise, it will spark a wave of capital flight, spilling trouble not just for Japan but also for global markets.

If the government continues to prioritize spending over fiscal consolidation, borrowing costs will continue to rise. For now, the market seems to be pricing in a worst-case scenario as there are no signs of rationalizing expenditure. Rather, it’s the opposite. According to reports, Japan’s budget requests for next fiscal have hit a record $831 billion to fund welfare programs and infrastructure to goose growth.

That said, not all believe that Japan’s fiscal situation is as bad and argue that its financial situation is often overstated, ignoring the domestic investor base comprising pension funds and insurers who provide a much-needed buffer against systemic risks.

While gross debt appears alarming, Japan’s status as a net creditor nation provides a buffer against immediate default. But that buffer is waning. As rising interest rates lead to higher borrowing costs, fiscal deficits will widen, and that alone should be a cause of concern.