3. Bond markets: Beware of shark-infested waters

Global economics and policy trends

2 min read

3. Bond markets: Beware of shark-infested waters

There are several markets – notably France and the UK – for which fiscal sustainability will be questioned in 2026. Pledges to bring government finances under control may pacify the sharks for a while but when confidence evaporates bond markets will look vulnerable once again. This may cause problems for government stability in some parts of the world.

Can the US change its debt path?
In the US, concern about debt sustainability is demonstrated by the latest projections which show US government debt rising from 100% of GDP in 2025 to 119% by 2035 (Figure 4) and continuing upwards to 156% in 2055, although developments over such a long period are subject to a great deal of uncertainty. In 2026, the sharks may be dissuaded from attacking the US bond market if the revenues generated from tariffs are sufficient to alleviate fears about debt sustainability. Most estimates forecast such revenues to be in the order of USD400bn per year.

Over the long-term, the extent to which Scott Bessent’s “3-3-3” plan (Theme 1) is successful will be key. It could markedly change the debt path, preventing an upward trend. In the late 1990s and early 2000s, the debt level fell rapidly and unexpectedly to 31% of GDP, primarily due to the strength of tax revenues and improving productivity. There was active discussion at the time about abandoning 30-year government bond issuance, regarding such debt as no longer necessary to finance the deficit. Although possible, such an extreme outcome seems unlikely to us. The more realistic outlook for 2026 is that the stabilisation in the level of debt expected under the Bessent plan as well as improving productivity due to AI implementation should be enough to alleviate fears about US debt sustainability.

Europe – sharks are circling
In Europe, concerns about fiscal sustainability will not be so easily quelled. “France could be the new Greece” is a concern held by some, but that comparison lacks credibility. France, unlike Greece in 2009–10, does not rely on foreign capital inflows to finance its current account deficit; economic growth remains positive; the European Central Bank has better procedures in place for averting a crisis; and the French bond market remains active and liquid. Yet President Macron has been through five prime ministers in the three years of his second term and none have been able to pass a budget to put fiscal policy on a sustainable track.

Support for an individual bond market could come from the European Central Bank, which has, in the past, modified its operating procedures to allow such action.⁶

Similarly, the credibility of the UK’s efforts to meet its self-imposed debt restrictions is low and could be tested in 2026. Parallels with the “Liz Truss moment” in 2022 are often drawn. That episode – when an unfunded reduction in taxation, which had not been assessed by the independent Office for Budget Responsibility was announced – led to a sharp fall in sterling and the gilt market. While the current UK government faces many challenges that will likely put pressure on sterling and gilts, for the time being we do not foresee a repeat of the sharp and sudden dislocation

Action for investors:

If bond yields have already discounted the worst, look to take advantage of high yields in the US, France and UK. This could be a risky strategy, especially for longer-duration bonds which have a high sensitivity to changing expectations of fiscal and interest rate trends.
The absolute level of short-term US yields is still high and it provides a safer habitat for nervous investors as sharks circle.
Focus should be on countries that have adequate finances to be able to pay off their debts. Net Foreign Assets (NFA) as a measure could provide a guide to long term debt sustainability.

⁶ In the past the European Central Bank has conducted various programs to support what they described as “disorderly market dynamics”. This was the case of the Transmission Protection Instrument (TPI) in 2022, the Asset Purchase Programme (APP) in 2015, and the Pandemic Emergency Purchase Programme (PEPP) in 2020.

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3. Bond markets: beware of shark-infested waters

3. Bond markets: Beware of shark-infested waters