Home Insights Macro views Higher yields signal fiscal considerations may be back in the spotlight
Aerial view of a shipping yard at sunset.

Higher yields signal fiscal considerations may be back in the spotlight

October 1, 2025 | 5 min read
Christian Floro, CFA, CMT
Market Strategist
Marcela Rocha
Chief Economist, Asset Allocation
linkedin icon link icon

As global long-dated bond yields have trended higher over the past few years—a clear shift from pre-pandemic norms—markets have increasingly pointed to fiscal concerns as a possible reason behind the move. However, the recent softening in U.S. labor market data and subsequent dovish repricing of Federal Reserve policy have sparked a rally in Treasurys and abroad, but this relief has only masked a deeper issue.

Underneath, global sovereign bond risk premiums remain historically elevated, particularly on the long end. While an easier Fed policy may trim U.S. yields, its spillover to other developed markets looks limited. Lower U.S. policy rates will do little to meaningfully address underlying fiscal strains in other advanced economies, where, amongst other issues, deficits are significant and rising. For investors, this suggests that risk premiums are unlikely to fade quickly, potentially keeping global ex-U.S. bond market volatility elevated and long-dated yields sticky.

Global bond markets are more sensitive to fiscal dynamics

Beyond the U.S., most major advanced economies’ central banks have cut rates since 2024, with some potential for further easing in the quarters ahead. This has been especially evident in the U.K. and the Eurozone, with Japan the notable exception. Yet long-end yields remain elevated, signaling the long end may be “listening” to fiscal dynamics, more than policy rates.

This unusual dynamic has been evident in the rise of the term spread, or the difference between the 10- and 2-year bond yield, which measures the interaction between monetary policy expectations in the short-end of the curve, versus longer-term economic expectations and risk premiums in the long-end of the curve. Steeper yield curves across developed markets potentially signal that fiscal concerns may finally become a greater focus for international investors. More importantly, global central bank rate cuts may not lead to lower government borrowing costs over the next few years, potentially further exacerbating existing fiscal concerns.

Common fiscal challenges in advanced economies

Separate from the trends impacting the fiscal situation in the U.S., across other advanced economies, a common fiscal pattern is emerging:

  • Debt-to-GDP levels at multi-decade highs: Gross public debt as a share of GDP is well above historical averages after successive shocks, including the 2008 global financial crisis (GFC), the 2020 pandemic, and the 2022 invasion of Ukraine.
  • Growing pressure for more spending: Aging populations, enhancing national security via increased defense spending, and the green transition point to higher public spending ahead.
  • Rising borrowing costs: A regime shift post-GFC suggests that interest rates will likely remain “higher for longer,” making it more difficult to reduce deficits and stabilize or reduce the overall stock of public debt.
  • Changing buyer base amid record levels of supply: The reverse of quantitative easing has resulted in more price-sensitive buyers of public debt, while issuance, driven by the need to fund ever expanding deficits, remains elevated.

Local factors matter

Although concerns about fiscal sustainability are increasingly widespread globally, country-specific fiscal considerations may also trigger growth risks or eventually lead to financial stability concerns:

  • France: After the 2024 snap elections delivered a hung parliament, France has again struggled to translate fiscal reform plans into policy. The September 8 confidence vote points to yet another leadership reshuffle, putting the country on course for a fifth Prime Minister in under two years, and reinforces the sense of stop-start governance. That political churn is meeting a deteriorating fiscal backdrop: the deficit has widened, and debt now sits well above pre-pandemic levels. While an ambitious 2026 budget outlines a path to reduce the deficit, both passage and execution remain uncertain.
  • Germany: Germany is moving from fiscal restraint to a once-in-a-generation push on defense, infrastructure, and the green transition—a necessary attempt to refresh its growth model. The open question is whether this investment will lift productivity fast enough to offset higher funding costs in a low-potential-growth environment. If the payoff proves slow or uneven, borrowing needs will rise just as the market demands more compensation for term risk, and the debt-to-GDP path would become harder to stabilize.
  • United Kingdom: The UK faces a familiar but tighter calculus: debt near its highest since 1960, a still-elevated interest bill, and modest potential growth. As a result, fiscal policymakers are stuck in a challenging place, with planned spending cuts facing expectations of downward revisions to domestic growth. For markets, much will likely depend on whether the government approves a planned tax increase later in 2025.
  • Japan: The end of stagflation and higher GDP growth in the coming years should help stabilize already high debt levels. However, lofty borrowing costs due to monetary policy normalization and a recent pivot to a more expansionary government fiscal policy may offset any meaningful improvement. More importantly, with the decline in private savings rates, there are also doubts about the capacity of local private investors to continue to finance public debt.

Simultaneous country-specific stresses are reinforcing the global “fiscal risk premium” narrative and amplifying the upward trend in sovereign bond yields. This is a systematic departure from the post-GFC regime, which was marked by low interest rates amid a glut of savings that readily financed government deficits.

As a result, policy error risk is higher. Governments will need to navigate a difficult path as they balance fiscal sustainability versus economic growth considerations, treading carefully to avoid triggering a sharp slowdown in activity that inadvertently worsens historically elevated fiscal deficits. Additionally, to the extent global bond yields stay elevated or continue to trend higher, financial conditions are likely to tighten. In an environment of abundant leverage, this could increase the risk of financial system instability and magnify pockets of structural market vulnerabilities.

High sovereign bond yields are a global issue, no longer isolated to the U.S.

The rise in long-dated sovereign bond yields and steeper yield curves across major economies since 2022 reflects a shift: fiscal concerns are now a global market driver, not just a U.S. debate. The move higher has persisted even as global central banks ease monetary policy, challenging the assumption that policy rate cuts automatically reduce sovereign funding costs. While the Fed’s dovish pivot may have capped U.S. yields for now, it does little to address the fundamental fiscal challenges faced by many advanced economies elsewhere.

These dynamics are unlikely to fade quickly. Elevated risk premia mean long yields outside the U.S. will likely remain sticky, and volatility will be more frequent. If they intersect with widening credit spreads or renewed banking stress, that would be a potential trigger for broader financial instability.

In short, fiscal sustainability has seemingly become the primary driver of long-end yields, and investors will need to adapt to a world where policy easing no longer guarantees cheaper funding. This environment argues for caution on the long end, a preference for shorter duration, and close attention to country-specific political and fiscal dynamics that can amplify global pressures. Ultimately, investors face a new regime where fiscal credibility, not central banks, anchors the long end.

Macro views
Disclosure

For Public Distribution in the U.S. For Institutional, Professional, Qualified and/or Wholesale Investor Use Only in other Permitted Jurisdictions as defined by local laws and regulations.

Risk considerations
Investing involves risk, including possible loss of principal. Past Performance does not guarantee future return. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed. Fixed Income investments are subject to interest rate risk; when interest rates rise, the price of debt typically declines.

Important information
This material covers general information only and does not take account of any investor’s investment objectives or financial situation and should not be construed as specific investment advice, a recommendation, or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding an investment or the markets in general. Information presented has been derived from sources believed to be accurate; however, we do not independently verify or guarantee its accuracy or validity. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, nor an indication that the investment manager or its affiliates has recommended a specific security for any client account. Subject to any contrary provisions of applicable law, the investment manager and its affiliates, and their officers, directors, employees, agents, disclaim any express or implied warranty of reliability or accuracy and any responsibility arising in any way (including by reason of negligence) for errors or omissions in the information or data provided.

This material may contain ‘forward‐looking’ information that is not purely historical in nature and may include, among other things, projections, and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

This material is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

This document is intended for use in:

  • The United States by Principal Global Investors, LLC, which is regulated by the U.S. Securities and Exchange Commission.
  • Europe by Principal Global Investors (Ireland) Limited, 70 Sir John Rogerson’s Quay, Dublin 2, D02 R296, Ireland. Principal Global Investors (Ireland) Limited is regulated by the Central Bank of Ireland. Clients that do not directly contract with Principal Global Investors (Europe) Limited (“PGIE”) or Principal Global Investors (Ireland) Limited (“PGII”) will not benefit from the protections offered by the rules and regulations of the Financial Conduct Authority or the Central Bank of Ireland, including those enacted under MiFID II. Further, where clients do contract with PGIE or PGII, PGIE or PGII may delegate management authority to affiliates that are not authorized and regulated within Europe and in any such case, the client may not benefit from all protections offered by the rules and regulations of the Financial Conduct Authority, or the Central Bank of Ireland. In Europe, this document is directed exclusively at Professional Clients and Eligible Counterparties and should not be relied upon by Retail Clients (all as defined by the MiFID).
  • United Kingdom by Principal Global Investors (Europe) Limited, Level 1, 1 Wood Street, London, EC2V 7 JB, registered in England, No. 03819986, which is authorized and regulated by the Financial Conduct Authority (“FCA”).
  • This document is marketing material and is issued in Switzerland by Principal Global Investors (Switzerland) GmbH.
  • United Arab Emirates by Principal Investor Management (DIFC) Limited, an entity registered in the Dubai International Financial Centre and authorized by the Dubai Financial Services Authority as an Authorised Firm, in its capacity as distributor / promoter of the products and services of Principal Asset Management. This document is delivered on an individual basis to the recipient and should not be passed on or otherwise distributed by the recipient to any other person or organisation.
  • Singapore by Principal Global Investors (Singapore) Limited (ACRA Reg. No.199603735H), which is regulated by the Monetary Authority of Singapore and is directed exclusively at institutional investors as defined by the Securities and Futures Act 2001. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore.
  • Australia by Principal Global Investors (Australia) Limited (ABN 45 102 488 068, AFS Licence No. 225385), which is regulated by the Australian Securities and Investments Commission and is only directed at wholesale clients as defined under Corporations Act 2001.
  • Hong Kong SAR by Principal Asset Management Company (Asia) Limited, which is regulated by the Securities and Futures Commission. This document has not been reviewed by the Securities and Futures Commission. This document may only be distributed, circulated or issued to persons who are Professional Investors under the Securities and Futures Ordinance and any rules made under that Ordinance or as otherwise permitted by that Ordinance.
  • Other APAC Countries/Jurisdictions. This material is issued for Institutional Investors only (or professional/sophisticated/qualified investors, as such term may apply in local jurisdictions) and is delivered on an individual basis to the recipient and should not be passed on, used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Principal Global Investors, LLC (PGI) is registered with the U.S. Commodity Futures Trading Commission (CFTC) as a commodity trading advisor (CTA), a commodity pool operator (CPO) and is a member of the National Futures Association (NFA). PGI advises qualified eligible persons (QEPs) under CFTC Regulation 4.7.

Principal Asset Management℠ is a trade name of Principal Global Investors, LLC.

Insurance products and plan administrative services provided through Principal Life Insurance Co. Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc. Securities are offered through Principal Securities, Inc., 800‐547‐7754, Member SIPC and/or independent broker/dealers. Principal Life, Principal Funds Distributor, Inc., and Principal Securities are members of the Principal Financial Group®, Des Moines, IA 50392.

© 2025 Principal Financial Services, Inc. Principal®, Principal Financial Group®, Principal Asset Management, and Principal and the logomark design are registered trademarks and service marks of Principal Financial Services, Inc., a Principal Financial Group company, in various countries around the world and may be used only with the permission of Principal Financial Services, Inc.

4861668
About the author