Global Macro Views: Fiscal reckoning: When do bond markets blink?

Is the era of fiscal complacency nearing its end?

The era of fiscal complacency may be nearing its end. From Washington to Tokyo, bond markets are showing growing sensitivity to rising sovereign debt levels. The attempted passage of a multi-trillion-dollar U.S. budget deal pushed long-dated Treasury yields to multi-year highs. Japan’s weak 20-year government bond auction in May revealed how fragile even historically stable markets have become. In Europe, U.K. gilts remain under scrutiny as fiscal space narrows and Germany has drastically changed its “debt brake” to allow more defense spending.

Debt risk is back—and markets know it

Rising debt burdens are no longer theoretical. They are driving volatility, pushing up capital costs and crowding out public investment. As debt servicing costs climb, markets are actively repricing long-term fiscal risk. The consequences: steeper yield curves, a more vulnerable U.S. dollar and heightened sensitivity to policy missteps.

In the U.S., the proposed “Big Beautiful Bill” could add trillions to the national debt. Even a scaled-back version would front-load spending and push the budget deficit from around 6% of GDP currently to above 7% by 2028 — high by historical standards for a non-recessionary period.

The bigger concern is what follows. Budget forecasts rely on the expiration of tax cuts to improve the deficit trajectory beyond 2028. But if those cuts are extended, as seems likely, the shortfall could rise above 8% — much higher than the Congressional Budget Office’s projected annual average of around 6% of GDP over the next decade.

Bond investors are responding accordingly. The U.S. 10-year term premium — a measure of the extra yield investors demand to hold longer-term debt — has moved decisively back into positive territory, reflecting growing uncertainty over the long-term path of fiscal policy.

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