The global market for public debt is entering a phase of strain shaped by war spending, pandemic-era stimulus, and persistent inflation, with developed economies moving toward debt levels last seen in the aftermath of the Second World War. What once appeared as a relatively stable pillar of modern financial systems is now being tested by rising interest rates, expanding deficits, and shifting investor confidence, forcing governments and central banks into a delicate balancing act.
The scale of recent military and geopolitical expenditure is often used as a stark illustration of the broader financial pressures. Each Tomahawk missile is valued at roughly two million dollars in inventory, but its replacement cost now ranges between three and 3.5 million dollars. Patriot systems cost between four and five million dollars per unit. According to estimates cited from Harvard Kennedy School expert Linda Bilmes, the direct cost of war has reached around two billion dollars per day, with total eventual spending projected to exceed one trillion dollars. These figures have emerged after years of extraordinary fiscal intervention designed to cushion economies from the pandemic shock and the energy crisis triggered by Russia’s invasion of Ukraine.
Those successive crises have left a lasting imprint on sovereign balance sheets. Public debt across advanced economies has expanded significantly, while inflation and sustained geopolitical uncertainty have pushed borrowing costs higher. In some cases, yields on government bonds have reached their highest levels in decades. Data from Apollo Management indicates that the average yield on 10-year bonds across G7 economies, including the United States, Japan, Germany, Italy, the United Kingdom, France, and Canada, reached its highest level since 2004 as of May. There is little indication that this trend is reversing in the near term.
The mechanics behind this shift are rooted in both inflation and fiscal pressure. Inflation erodes the real value of fixed-income returns, reducing the attractiveness of long-term government bonds. At the same time, persistent deficits in major economies continue to require large volumes of new debt issuance. The United States, for example, runs a deficit of around 7 percent of GDP, while France stands at approximately 5 percent. With growth remaining modest, investors are demanding higher yields to compensate for perceived risk and reduced purchasing power.
The International Monetary Fund has warned that global public debt could reach 100 percent of global GDP by 2029, a level not seen since the end of the Second World War. In the United States, federal debt has already returned to levels comparable to the 1940s, although interest payments today are significantly higher relative to output. In a related shift, a recent European Central Bank assessment noted that gold has overtaken U.S. Treasuries as the primary global reserve asset, reflecting changing perceptions of sovereign risk and stability.
Monetary policy is also contributing to the evolving landscape. As central banks raise interest rates to contain inflation, the cost of issuing new debt rises further. The European Central Bank became the first among the G7 central banks to tighten policy again this week, increasing rates by a quarter point in a widely anticipated move. While markets had largely priced in the decision, the implication is clear: maturing debt will increasingly be refinanced at higher rates, gradually lifting government interest burdens across the board.
The European Central Bank and the International Monetary Fund have both issued warnings about elevated public indebtedness and the need for fiscal rebuilding. Pierre-Olivier Gourinchas of the IMF has stressed that while public stimulus can be highly effective in crises, it depends on governments having sufficient fiscal space to act, a condition that may no longer be guaranteed in all cases. He warned that if countries were required to deploy support equivalent to 10 to 15 percent of GDP, as during the Covid-19 pandemic, markets might not respond in the same way.
Not all economists agree on the scale of the risk. Ángel Talavera of Oxford Economics argues that focusing solely on debt-to-GDP ratios can be misleading. He notes that interest payments relative to GDP remain lower than in previous decades and that central banks are now more active in stabilizing markets through asset purchases during periods of stress. He also highlights that strong fiscal responses during crises such as the pandemic and the energy shock of 2022 may ultimately support both growth and public finances by avoiding deeper recessions.
Still, governments are aware of the limits of fiscal expansion. According to Talavera, recent policy responses have been more restrained compared with earlier crisis periods, reflecting caution about further increasing debt loads. The tension between providing economic support and maintaining fiscal credibility remains central to policy decisions across advanced economies.
Similar nuance is echoed by Santiago Carbó of CUNEF Universidad, who points to Japan as an example of sustained high debt levels—around 200 percent of GDP—without immediate financial collapse. However, he emphasizes that risks emerge when high debt coincides with rising interest rates and weak economic growth. In such conditions, governments may struggle to generate sufficient revenue, particularly when persistent primary deficits reduce fiscal flexibility.
Carbó also notes that governments often have more fiscal room than traditional models assume, although this flexibility is not unlimited and varies by country. Market discipline, he suggests, is unevenly applied, with investor confidence shifting depending on national circumstances.
That discipline is ultimately reflected in borrowing costs. The United Kingdom experienced a severe market shock in 2022 after an unfunded tax cut announcement triggered a sharp rise in yields, forcing a political reversal. Today, British 10-year yields hover near 5 percent, compared with just 0.70 percent before the pandemic. Germany has moved from negative yields in 2019 to around 3 percent, while France and Italy have also seen significant increases.
Despite these rises, current conditions remain far removed from previous crises. During the eurozone debt crisis, Spain’s 10-year bond yields reached 7 percent, with risk premiums far above Germany. Today, Spain’s spread over German bonds is below 50 basis points, reflecting a calmer market environment despite recent global shocks including the pandemic, energy crisis, and geopolitical tensions.
Investors and analysts frequently attribute this relative stability to the legacy of European Central Bank intervention under Mario Draghi, particularly the 2012 commitment to do “whatever it takes” to preserve the euro. Cristina Gavín of Ibercaja Gestión argues that this expectation of central bank support continues to anchor market confidence, with policy credibility playing as much of a role as actual intervention.
Yet uncertainty remains around the future direction of monetary policy. Recent statements from the European Central Bank suggest that inflation pressures, particularly in energy, could still pass through to food and services. Markets largely expect no further rate increases before September, but attention is increasingly focused on the leadership of the United States Federal Reserve, where Kevin Warsh has been selected by Donald Trump amid reported pressure to encourage lower interest rates to support economic activity.
From Washington, Joseph Gagnon of the Peterson Institute for International Economics stresses that while debt-to-GDP ratios matter, they must be assessed alongside demographic trends and broader economic forces. He notes that central banks face no fixed limits in their ability to raise or cut rates to control inflation and recession, while governments, by contrast, face clearer constraints on debt accumulation. The precise threshold at which debt becomes unsustainable, however, remains uncertain.
As global borrowing costs rise and public debt levels approach historic highs, the relationship between governments, markets, and central banks is entering a more complex phase. With interest rates, inflation, and geopolitical risk converging, sovereign debt markets are once again at the centre of economic uncertainty, where each policy decision reshapes the cost of financing the state.
