How a global debt crisis starts

Falling short-term rates are masking a very scary global rise in long-term yields

I wrote yesterday’s post about a worrying dynamic in the US yield curve, whereby long-term yields - when you strip out the fall in short-term rates as US recession fears mount - aren’t falling much at all. In the aftermath of the COVID debt binge, markets are reluctant to absorb lots of long-dated issuance and are demanding high and rising yields to do so. The economics profession really has no idea at what level debt for an advanced and massive economy like the US becomes unsustainable, because we really don’t understand at what point markets panic and drive up long-term yields. But what’s going on at the very long end of the US yield curve is worrying.

After I published yesterday’s note, a number of readers made the good suggestion to check what’s going on with other countries’ yield curves and this is where things get really scary. Long-term yields - once you strip out the short end of the yield curve - are very high in Japan, France and the UK. Even a supposed safe haven like Germany has seen its long-term yields rise sharply. The bottom line is that we’re seeing a global rise in long-term government bond yields, which is spilling over into the long end of the US yield curve. This is what the start of a global debt crisis might look like.

The six charts above replicate what I did for the US (top left) for Germany (top middle), Japan (top right), the UK (bottom left), Italy (bottom middle) and France (bottom right). Each chart shows the 2-year government bond yield (black), the 10-year government bond yield (blue) and then also 10y10y (orange) and 10y20y (red) forward yields, which I back out from 10-, 20- and 30-year yields. The appeal of the latter two metrics is that they strip out what’s going on with very short-term yields, which are currently getting pulled down by mounting expectations of US recession. The 10y10y forward yield is what markets price for the 10-year yield in 10 years’ time, while the 10y20y forward is the 10-year yield in 20 years’ time. There should be much less noise in either measure from short-term cyclical fluctuations.

The charts paint a scary picture. Once you strip out the fall in short-term yields, what’s going on with long-term yields is thoroughly alarming in many places. Japan is perhaps the scariest picture, with the 10y20y forward yield at 4.5 percent, a yield level that’s unprecedented in recent history. The UK is at similarly unprecedented levels and France isn’t far behind. Even Germany has seen a sharp rise in its 10y20y forward yield, which is remarkable given that it usually gets safe haven inflows when global debt markets wobble. The US in this international comparison looks far less worrying. While long-term yields elsewhere have continued to rise, its 10y20y forward yield has fallen a bit. I put that down to safe haven inflows as the fiscal crisis in France once again reminds global markets that the debt crisis in the Euro zone still festers.

The bottom line is that we’re seeing a global rise in long-term yields. The rise in yields outside of the US is far more alarming than for Treasuries, but even Treasury yields are getting pulled up by what’s going on elsewhere. There’s no telling if this is the beginning of a global debt crisis, since that depends on many things, including if policy makers resort to financial repression to push yields back down. But the global nature of what’s going on is deeply alarming.