Investors’ focus on Government debt

In recent days, one of the main themes across international financial markets was the movement in Government bond yields in Japan and also in the US.

The prices of the 30-year and 40-year bonds issued by the Government of Japan have fallen drastically over the past few weeks.

Due to the inverse relationship between a bond price and its yield (when bond prices fall, the yield rises because the same interest payments or coupons are now spread over a lower price and vice-versa), the sharp decline in prices of Japanese Government bonds led to surge in yields.

Since late 2019, the price of 30-year Japanese Government debt has fallen by almost 50 per cent with the yield rising to almost three per cent from as low as 0.2 per cent prior to the COVID-19 pandemic. The yield on a 40-year Japanese Government bond jumped to 3.7 per cent recently, representing a rise of 1 percentage point since the beginning of April and a sharp downturn in the price of this bond in a short period of time.

Movements in Government bond yields effectively reflect the trust of capital markets about the credibility of a Government’s finance plans. Investors are basically demanding greater compensation for mounting fiscal and policy uncertainties.

One of the reasons for the weak demand for new issues and the resultant movements in yields was the fact that Japanese life insurance companies, which have been among the largest buyers of domestic Government bonds, have virtually stopped purchasing very long-term sovereign bonds in order to satisfy new solvency ratios introduced recently.

Japan has been dealing with its fiscal problems for several years. The country has a massive debt burden with a debt-to-GDP ratio of over 250 per cent. Japan’s credit rating at ‘A+’ by Standard & Poor’s and ‘A’ at Fitch Ratings is three notches below that of the US. Recently, Japan’s Prime Minister described the country’s fiscal position “worse than Greece’s” – presumably referring to the problems of Greece during the European sovereign debt crisis some years ago.

Following the rise in yields in Japan, the Government’s debt servicing costs on its total debt (approaching USD8 trillion) will increase accordingly creating further pressures on Government finances and also their credit rating.

With Japan being the fourth largest economy in the world and the largest foreign holder of US Treasuries, the recent movements across the Japanese bond market have wide implications globally especially in the US.

In fact, yields in the US also climbed last week with the yield on the 30-year US treasury surpassing the five per cent level. It hit a high of 5.15 per cent (its highest level since 2023 and, before that, levels not seen since 2007) following a weak Treasury auction and renewed fiscal concerns.

The jump in long-term yields builds on momentum from earlier in the week after the recent announcement by Moody’s of the downgrade of its US credit rating (from ‘Aaa’ to ‘Aa1’ and changed its outlook for future ratings from stable to negative), citing rising deficits and political gridlock.

Although the other two major credit agencies had already downgraded the rating of the US in recent years, the commentary by Moody’s last week spooked the market as it proved to be a reminder of the weak state of the US Government’s finances.

Recent market commentators have reported that over the next 10 years, the debt level in the US will rise by a further USD20 trillion from the current level of just under USD37 trillion.

Moody’s is forecasting that the annual US deficit would grow from 6.4 per cent of GDP in 2024 to nine per cent by 2035. Total debt is estimated to grow over the same period from 98 per cent of GDP to 134 per cent in 10 years’ time. This translates into a larger proportion of income of the US Government being needed to finance interest payments on US Treasurys. In fact, in 2021, the debt servicing costs in the US accounted for nine per cent of the total federal spending. This increased to 13 per cent last year and is estimated to climb to 30 per cent by 2035.

The renewed concerns on the US Government’s finances are also due to Trump’s “big, beautiful bill”, which extends the tax cuts that were introduced during the President’s first term in office and will continue to place pressure on the debt burden. These new tax cuts are estimated to increase the US debt by at least USD3 trillion over the next decade.

While these two major economies are seeing a spike in their debt levels and facing challenges in their new offerings to support their deficits and their maturing bonds, it is worth commenting on the state of Malta’s finances for the benefit of the Maltese investing public.

Incidentally, among the retail investing community, exposure to Malta Government Stocks has started to increase once again following the lengthy period of very low interest rates. It is worth reminding investors that until the end of 2021 the yield on a 10-year MGS was only 0.7 per cent (following a low of 0.1 per cent in August 2019) compared to a current level in the region of 3.4 per cent.

Malta’s national debt stands at around €10.8 billion, with the debt to GDP ratio at just over 45 per cent. Most of the debt is made up of Malta Government Stocks which totalled €9.1 billion at the end of 2024, up from €4.9 billion in 2014. Over 80 per cent of MGS’s are held domestically between retail investors and ‘resident credit institutions’.

With medium to long-term yields likely to remain at elevated levels compared to the historically low levels until 2021, participation by retail investors for MGS’s offerings should continue to be healthy despite the increase in corporate bond issuance. Deployment of excess idle liquidity across the banking system into income-generating assets across the capital market is likely to continue in the months and years ahead.

Read more of Mr Rizzo’s insights at Rizzo Farrugia (Stockbrokers).

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