Outcasts have become favorites: why investors are buying government bonds of peripheral countries

The scramble over the U.S. budget bill, which greatly increases the deficit and government debt, is just a special case of investor concern over rising debt burdens around the world. Long-term bond yields of major developed countries have recently jumped to multi-year highs, jeopardizing budgets and economic growth. But countries that only a decade ago were considered outcasts in the debt market have suddenly emerged as winners.

In the aftermath of the 2008 global financial crisis, many governments, having cut interest rates to zero (and some to negative rates), aggressively increased borrowing to stimulate the economy and support the population. The same thing happened during the coronavirus pandemic in 2020-2021. The growth of public debt did not particularly bother governments and market participants, as the cost of servicing it remained record low;

Quantitative easing (QE) - the massive buying of government, as well as mortgage and corporate bonds by central banks, which pushed their prices up and yields down - also contributed to this.

Even against this background, Japan stood out, where the central bank, trying to pull the economy out of three lost decades after the massive crisis of 1990, not only pioneered QE, but also purposefully controlled the yield on 10-year government bonds, keeping it no higher than 1%. 

This changed when the economic impact of the pandemic created a spike in inflation: central banks began to raise interest rates dramatically. It became much more expensive to refinance old debts and raise new ones. As a result, the share of government expenditures spent on interest payments increased dramatically;

In the U.S., for example, nearly one out of every seven dollars in the budget is spent on it: this $881 billion spending item went to the top spot, overtaking defense appropriations of $855 billion. 

France will spend 62 billion euros on debt interest payments this year, roughly equal to its combined defense and education spending. Last year, then-Prime Minister Michel Barnier called the country's debt burden a «sword of Damocles.»

Investors are beginning to view the debt situation as unsustainable in the long term and demand an additional premium when buying very «long» bonds. The yield on 30-year U.S. Treasuries reached 5.15% in May, almost the highest level since 2007 (it was slightly higher in 2023 at the peak of interest rates);

Moody's was the last of the three major credit agencies to strip the U.S. of its maximum credit rating, believing that a growing budget deficit would increase government debt at a faster pace, which in turn would lead to higher interest rates in the long term. 

Further cause for concern was the «big beautiful bill» approved by the House of Representatives, which the Congressional Budget Office estimates will increase the national debt by $2.4 trillion by 2034.

In Britain, yields on 30-year government bonds have reached their highest point this year since 1998 (and the highest of any developed country) due to investor concerns about rising debt that is depriving the Treasury Department of fiscal policy space, wrote the Financial Times. 

In Germany, which has long pursued a tight fiscal policy, investors staged a bond sale in March that lifted the yield on 10-year securities to nearly 3%;

Market participants were preparing for a large-scale issue after the CDU/CSU bloc led by current Chancellor Friedrich Merz, which won the February election, passed a law to partially lift budgetary restrictions, involving up to $1 trillion in new investments in defense and infrastructure;

Even Japan was not spared from the sale of long-term bonds, where the yield on 30-year securities rose to a record 3.14%. At the same time, its government debt is about 240% of GDP.

In May, the auctions in the U.S. and Japan on placement of 20-year securities, where the demand turned out to be insufficient, added to the anxiety. However, traders breathed a sigh of relief when on June 12 the U.S. Ministry of Finance successfully placed 30-year bonds for $22 billion at 4.84%;

Market participants now fear that individual country «strikes» by investors could develop into a global trend;

«The bond market has never been so influential because there has never been so much debt,» Ed Yardeni, head of Yardeni Research, who coined the term «bond vigilantes» in the 1980s to describe investors whose hard market actions were forcing governments to pursue more responsible fiscal policies, told the FT. - Now [the debt problem] needs to be looked at globally.» 

The main risk, he said, is now, to paraphrase Marx and Engels, «Bond vigilantes of all countries, unite.»

Global debt reached $324 trillion, or 325% of global GDP, in the first quarter of 2025, according to data from the Institute of International Finance (IIF). It increased by $7.5 trillion, more than four times the average quarterly increase of $1.7 trillion seen since the end of 2022, IIF noted.

Particular attention is focused on the debt problem in the U.S., where a bill was added to the fire, in which, in an already difficult budget situation, Republicans tried to fulfill Trump's campaign promise to extend the 2017 tax cuts, which expire this year. Billionaire and former associate of the American president Ilon Musk even called the document «a disgusting abomination» in an outburst, but more restrained experts also issued warnings;

If the economy continues to grow at 2%, the budget «deficit will crush this country,» announced Larry Fink, head of the world's largest management company, BlackRock. 

«From a fiscal perspective, it's simply irresponsible» to run a deficit of 6-7% of GDP at full employment, added Ken Griffin, founder of hedge fund Citadel.

Jamie Dimon, CEO of JPMorgan Chase, called the government's approach to budget management «disastrous» and its tax-and-spend policies «completely unrealistic.» 

The bond market could «burst» if it fails to bring the ballooning budget deficit under control, he warned. 

Finance Minister Scott Bessent responded that Dimon has made many such warnings in his career, and «thankfully none of them have come true.»  

The U.S. national debt as a share of GDP will soon become the highest in history, since 1790, notes University of Chicago economics professor Konstantin Sonin: «In and of itself, this is not a problem. First, most of this debt is owed to Americans, so you can look at it as wealth. Secondly, and most importantly, debt in national currency is never a problem at all. But the politics of the national debt is getting interesting.

To some Trump promised tax cuts, to others - not to touch social programs, but in 2025 it turns out badly, Sonin continues, a part of health carealways sacrificed. Therefore, the «Trump coalition» is not yet falling apart, but it is already cracking at the seams. However, the problem will remain for the Democrats, if they come to power in the next election cycle, and the «democratic unity» will be at the seams, Sonin believes.

High debt levels and large financing needs, partly driven by tax cuts, could affect Treasury bond yields, IIF warns: a surge in their supply «... would significantly increase the government's interest costs, inflation risk would also increase in such a scenario.»  

Meanwhile, long-term bond yields are used to calculate the cost of many loans in the economy, including mortgage, consumer, and corporate loans. The high cost of borrowing hampers not only governments but also the private sector, hampering economic growth.

Additionally, yields are being pushed up by central bank policies, namely the effects of QE. 

Having bought bonds to keep yields low, Western central banks are now selling them off (and the Bank of Japan is winding down its QE policy by cutting purchases);

To manage debt and contain debt servicing costs, central banks may temporarily halt sales and finance ministries may reduce the allocation of long-term bonds and increase the allocation of short-term bonds with lower yields;

But in the absence of a significant acceleration in economic growth (which is now being undermined, in particular, by the trade war unleashed by Trump), cutting government spending is the only reliable solution in the long term, according to fund managers;

«The question is whether governments will have the resolve,» says Craig Inches, director of rates at Royal London Asset Management, adding that markets can't digest long-term debt precisely because there is too much of it.

«It's a classic supply-demand imbalance problem, but on a global scale,» adds Amanda Stitt, bond markets specialist at T Rowe Price, a $1.6 trillion asset manager, «The era of cheap long-term financing is over and now governments have to squeeze into a room crowded with sellers.

But some governments are welcome in this room. Surprisingly enough, it is those that 10-15 years ago were at the center of the eurozone debt crisis. Yields on government bonds in Greece, Italy and Spain - the eurozone's peripheral countries, as they were called - have fallen to the levels of the largest economies, according to FT and Bloomberg.

For example, the spread between yields on 10-year Italian government bonds and benchmark German government bonds narrowed to 0.96pc from 5.7pc a decade ago;

Spain now ranks cheaper than France, the eurozone's second-largest economy, and just 0.6pc more expensive than Germany. 

Greece, which started the debt crisis and which, as many predicted at its height, could leave the eurozone, has a spread of just 0.7p. 

And this is despite the fact that in all three countries government debt is close to or exceeds 100% of GDP. But, as in the case of the US, it is the dynamics that matter. After the crisis, forced into fiscal austerity, these countries began to implement more responsible policies and reforms that boosted their competitiveness and economic growth. In recent years, the service orientation of their economies has also helped: the countries benefited from the post-crisis tourism boom;

Additionally, the comparison factor worked in their favor;

With generally higher yields, there was demand just for bonds of the peripheral countries of the eurozone, explains Nick Hayes, director of bond markets at Axa Investment Managers: after all, amid fears of growing supply in the «core» markets - the U.S., Germany and Britain - their once considered a safe haven government bonds show instability.