G7 debt is now a pressure point for anxious markets

Highlights:

• US, Japan debt worries at top of list
• France and UK still a concern but less so than last year
• Worries over high-debt Italy ebb, for now

Surging government debt levels are becoming a pressure point for big economies and bond investors have their sights on those not doing enough to improve their finances.

A Moody's decision to strip the United States of its last triple-A credit rating last month and weak demand for Japanese auctions moves attention to two of the world's biggest economies.

A debt crisis may not be the base case, but warning bells are starting to ring. Here's a look at who's in the spotlight for markets and why:

USA

The United States has shot to the top of the worry list after a sharp bond sell off in April. Adding to concerns is President Donald Trump's tax and spending bill, which could add roughly $3.3 trillion to debt by 2034, according to nonpartisan think tank the Committee for a Responsible Federal Budget.

The Moody's decision is another blow, while JP Morgan CEO Jamie Dimon warns of a "crack in the bond market" partly due to overspending.

Its status as the world's No.1. reserve currency offers the US some protection and Treasury Secretary Scott Bessent says the country will never default.

And investors reckon authorities will prevent 10-year yields, the benchmark for borrowing costs for companies and consumers, from rising too far above 4.5% .

The banking industry is optimistic that US regulators could soon revamp the supplementary leverage ratio, potentially reducing the cash reserves banks must hold and encouraging them to play a larger role in Treasury market intermediation.

Japan

For years Japan was the textbook case of how markets could shrug off a mammoth debt pile. Now that's changing.

Japan's public debt at more than twice its economy is the biggest among developed economies.

Its longer-dated bond yields hit record highs in May after a 20-year bond sale resulting in the worst auction result since 2012 cast doubt on demand. Thirty-year borrowing costs have jumped 60 basis points (bps) over the last three months, even faster than in the US

The culprit: waning demand for longer-dated paper from traditional buyers like life insurers and pension funds at a time when the bond holdings of the Bank of Japan, which holds roughly half the market, fell for the first time in 16 years.

Prime Minister Shigeru Ishiba meanwhile faces pressure for big spending and tax cuts. Policymakers are already considering trimming super-long bond sales, temporarily soothing market concerns.

Still, another poor auction last week suggests they may be deeper rooted.

"The weak Japanese auctions are a symptom that something is happening underneath," said Nordea chief market strategist Jan von Gerich.

UK

In Europe, Britain, with debt near 100% of GDP, remains vulnerable to global bond selloffs even as it stresses fiscal discipline.

Finance minister Rachel Reeves' multi-year spending review next week could be the next test for the only G7 economy with 30-year borrowing costs above 5% .

The government appears prepared to spend more on defense and health, among others, Rabobank strategist Jane Foley said, even as it pledges not to increase taxes and keep spending tight.

The IMF urged Reeves to stick to plans for lower public borrowing.

An earlier end to active Bank of England bond sales would potentially support the gilt market, said Sam Lynton-Brown, global head of macro strategy at BNP Paribas.

France

Pressure in France's bond market, driven last year by concern that political instability would hamper belt tightening efforts, has abated.

The risk premium investors demand for holding French debt over Germany's has eased to around 66 bps from 90 bps in November .

Furthermore, investors have positioned for a drop in euro area risk premiums, helped by expectations that European countries will step up cohesion on areas such as defense.

Still, caution is warranted. Prime Minister Francois Bayrou plans to announce a four-year deficit-cutting roadmap in July, which could set the scene for budgetary warfare in parliament.

"France has not had any improvement on the debt side since the COVID crisis," said Carmignac fixed income fund manager Eliezer Ben Zimra.

Italy

Italy has moved down the worry list thanks to increased political and economic stability and improved creditworthiness.

Its budget deficit dropped to 3.4% of output in 2024 from 7.2% in 2023, and is forecast to fall to 2.9% in 2026, matching projections for Germany, noted Kenneth Broux, head of corporate research FX and rates at Societe Generale.

"This was unheard of many years ago."

Broux said that while Italy still has challenging long-term debt dynamics, a relatively better performance compared to countries such as France and diversification in favour of European assets supported its bonds.

The Italy/German 10-year bonds yield gap is near its narrowest since 2021 at just under 100 bps.