The bill for fiscal profligacy across the G-7 economies is coming due as the global bond selloff gains momentum.
Yields on government securities are increasing, led by France, as fiscal pressure mounts, inflation rises, and the global and European carry trade unwinds.
Get Joe Brusuelas’s Market Minute commentary every morning. Subscribe now.
Already, political unrest has engulfed France, but it might not end there if rates move much higher.
Nations like France could address the problem with a period of fiscal consolidation. But with little public support for such measures, global investors will continue to demand higher risk premiums on government debt.
This dynamic is happening across developed economies.
Trading on U.S. 10-year Treasuries is now centered on 5.3% while French and Italian 10-year government bonds are yielding 4.9% and 4.6%, respectively. Germany is at 3.5%.
There is little relief in sight. France will most likely join the 5% club of economies with 10-year rates at that level and will most likely soon join the U.K. in the 6% club with 30-year yields above that rate.
At the same time, yields in Japan have continued to rise, reaching 3.1%, as that country pursues its interest-rate normalization program.
The shift in Japan has had a dramatic impact on the carry trade—where investors borrow in low-yielding Japanese securities and invest in higher-yielding sovereign debt, like that of France.
France, just like the U.S., relies on investments in its sovereign debt to finance its operations. As the French government struggles to pay for its services, political unrest has erupted.
The unrest could spread beyond France. There is the possibility it will spread to Italy—reminiscent of the 2010 European debt crisis. In that case, the rising cost of capital would affect economic activity in both Europe and the U.S.
For now, though, we do not see a repeat of that crisis. Rather, the French government faces the need for a period of fiscal consolidation to assuage international investors.
While the European Central Bank can use its Transmission Protection Instrument—a bond purchase safety net to ensure steady monetary policy—to purchase French debt and drive down yields, that is not warranted at this point.
Rates in France and most likely Italy and elsewhere will continue to rise.
The takeaway
The combination of persistent inflation and fiscal imbalances is behind the global selloff of government bonds, adding to the cost of capital and the tightening of financial conditions that have become a drag on economic growth.
At the end of the day, the cost of capital to support economic expansion and in turn the creation of new jobs is predicated on that reality.
This means that small and medium-size businesses that do not have the capital depth to fund their own expansion are experiencing another round of an increase in the cost of doing business.
