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Rising government debt levels will cause turbulence in the global economy and financial markets unless political leaders start tackling them soon, the body that advises the world’s central banks has warned.
High levels of sovereign borrowing were “one of the biggest threats, if not the biggest threat going forward for the global economy”, Claudio Borio, head of the monetary and economic department of the Bank for International Settlements, told reporters this week.
A recent spike in the cost of insuring against default of US Treasuries and a rise in French government borrowing costs were “signs that financial markets realise they are going to have to absorb this increased volume of government debt”, he added.
Borio, presenting the BIS quarterly review of financial markets for the final time before he retires, warned that if governments “wait for markets to wake up it is going to be too late”.
Brazil’s currency dropped to a record low last month as investors grew increasingly anxious over the public finances of Latin America’s largest economy, despite government promises to cut spending and reduce its soaring budget deficit.
French borrowing costs rose above those of Greece for the first time recently as investors responded to this month’s collapse of Michel Barnier’s government over its failed attempt to pass a belt-tightening budget.
Global public debt is set to exceed $100tn by the end of this year, the IMF estimates, with total government borrowing set to approach 100 per cent of global GDP by the end of the decade.
However, equity markets have shrugged off any debt concerns. The S&P 500 index of US blue-chip stocks has continued to set new record highs in recent weeks.
“Despite lingering risks, investor optimism about the near-term outlook set the tone for financial markets,” the BIS said, adding that the global economy “seemed to be heading for a smooth landing, and the results of the US presidential election were conclusive”.
Financial markets need to absorb more of the rising issuance of government debt as central banks reverse the massive bond purchases carried out in response to the Covid-19 pandemic by selling them in so-called quantitative tightening operations.
“Re-emerging concerns about the fiscal situation in several jurisdictions, and quantitative tightening in others, added to the upward pressure on yields,” the BIS said in the report.
“Rising term premia, more negative swap spreads and widening sovereign spreads suggested that investors demanded a higher compensation to absorb additional debt supply,” it added.
Pimco, the world’s biggest active bond fund manager, said this week it was hesitant to buy more long-term US debt after the federal budget deficit reached $1.8tn for the fiscal year ending September 30. That is equivalent to 7 per cent of GDP — almost double the average of the past 50 years — according to the Congressional Budget Office.
Pimco said in a note to investors on Monday there were “sustainability questions” over the high US deficit and the prospect of rising inflation under president-elect Donald Trump.
Borio said there was “a certain US exceptionalism because of the outsized role of the dollar in the financial system”. But he warned that although it might take longer for concerns to materialise, “once they do show up, the impact on the global financial system will be greater”.
The BIS has been pointing to the risks for financial markets from elevated government debt levels for years. Its warnings intensified after the crisis in UK debt markets two years ago caused by problems with derivative-linked strategies in pension funds.
These concerns increased further after a period of volatility in financial markets in August, when investors responded to shifts in interest rate policy by unwinding the yen “carry trade” through sales of assets they bought with the Japanese currency.
https://www.ft.com/content/a19ce0f3-6160-4b8a-b9f4-e0b53266bca1
