- Fiscal credibility sits at the heart of the recent repricing in global long-dated government bond yields.
- The UK is experiencing a more pronounced version of this global repricing, driven by large sovereign debt burdens, increased bond supply and a more uncertain inflation backdrop.
- For fixed income portfolios, the opportunity lies in combining a cautious approach to duration with the compelling real yield and carry available at short and intermediate maturities.
Borrowing costs in focus ahead of Autumn Budget
Renewed pressure on gilt yields has placed fiscal credibility firmly on the agenda for UK investors. As the Autumn Budget approaches, markets are looking for policies based on sound assumptions for growth, inflation and future spending restraint. The UK’s long-dated borrowing costs remain close to 6%, leaving gilts particularly sensitive to concerns about government finances.
This is not simply a UK story, however, as recent market moves reflect a broader reassessment of global sovereign risk. While the 2022 gilt crisis was driven by a specific loss of confidence in UK policymaking, the recent selloff reflects growing concerns over how governments will manage higher debt burdens and rising refinancing costs while making only limited progress towards stabilising debt levels in an environment of structurally higher inflation.
Bond markets grapple with persistent inflation risks
Bond market volatility has also been shaped by changing expectations for interest rates. Markets have increasingly priced the possibility that policy rates may remain higher for longer in both the UK and the US, as the BoE and the Fed continue their efforts to bring inflation under control. While those expectations (up to 4 hikes over the next 12 months) may ultimately prove too aggressive, particularly in the US, investors remain sensitive to inflation risks.
Rising oil prices, driven by geopolitical tensions in the Middle East, have pushed inflation expectations higher and contributed to renewed volatility across fixed income markets. UK 2-year gilt yields have risen sharply in September as investors reassess both the near-term path of interest rates and the outlook for inflation.
In many respects, these tighter financial conditions are already doing some of the heavy lifting that would ordinarily be associated with monetary policy action. Nevertheless, inflation remains policymakers’ principal concern, leaving scope for further volatility should price pressures prove more persistent than expected.
Rising yields are a global phenomenon
Across the G7, yields have risen as investors demand greater compensation for inflation uncertainty, longer-term lending and fiscal risk. Shorter-dated yields remain closely linked to expectations for central bank policy, while longer-dated yields are increasingly influenced by inflation persistence, future bond supply and confidence in governments’ ability to manage their finances with prudence.
France and Italy have larger gross debt-to-GDP burdens than the UK, at around 116% and 137%, respectively, compared with the UK’s 103%, yet both countries currently borrow at lower rates. Germany has also seen yields rise alongside its European peers, albeit from a lower debt base, while Japan continues to adjust to the gradual normalisation of interest rates after many years of exceptionally loose monetary policy.
Growth prospects and policy credibility vary between countries, but the direction of travel is clear. The UK is facing the same challenges as many developed economies, although in a more pronounced form.
Two decades of debt accumulation
IMF data shows average gross government debt across the G7 has risen from around 82% of GDP in 2005 to around 124% in 2026. Much of that increase occurred in two distinct phases: the first following the global financial crisis, increasing by roughly 30 percentage points between 2007 and 2012, and again as governments responded to the pandemic, rising by approximately 20 percentage points in 2020.1
Debt-to-GDP ratios alone, however, do not determine borrowing costs. Debt sustainability is shaped by nominal growth, interest costs, debt maturity profiles, primary balances and investor confidence. These factors help explain why countries with similarly elevated debt burdens can face markedly different levels of market scrutiny.
The US benefits from stronger economic growth, giving it greater capacity to sustain a high debt burden. By contrast, the UK’s weaker growth outlook leaves less room for policy missteps, a challenge recent moves in sovereign n debt markets have reinforced.
Why the long end remains under pressure
Rising government bond supply, shrinking central bank balance sheets through quantitative tightening and a structurally higher inflation environment are rebuilding the compensation (term premia) demanded from borrowers over a longer time frame. Defence and infrastructure spending commitments only add to borrowing requirements, while upcoming political events, from US mid-term elections to French budget negotiations, shape the pace of actual fiscal consolidation.
Higher term premia is therefore the market expression of these forces: investors are once again receiving returns commensurate with sovereign risk previously masked by the quantitative-easing era of large, price-insensitive debt demand. Even though adjustments to debt issuance by term structure, proposed long-dated buybacks and a slower pace of quantitative tightening can smooth the transition, durable fiscal reform offers the best route to lower borrowing costs. Softer energy prices, in the event of peaceful resolution to ongoing wars, accompanied by improving inflation data would most directly support the front end, while fiscal credibility will continue to guide yield levels on longer-dated maturities.
What this means for fixed income investors
Our approach combines discipline on duration with conviction in seizing on today’s investment opportunities. Across EdenTree’s fixed income range, we continue to favour short and intermediate maturities, diversified income and high credit quality.
The fact that public credit risk premia remain near to historic tights reinforces the value of a selective approach rather than broad exposure to credit beta. The Sustainable Short-Dated Bond Fund has increased floating-rate exposure to reduce interest-rate sensitivity, while the Sustainable Sterling Bond Fund has also been shifting its focus towards shorter tenors to lock in attractive yields and manage long-end risk.
Across the asset class, selectivity remains key
Fixed income markets offer meaningful compensation for macroeconomic risk. Real yields and carry stand at some of their most attractive levels of the past decade, providing more income, valuation buffer and resilience against uncertainty.
For fund buyers and institutional investors in the asset class, this strengthens the case for reassessing allocations after years in which sovereign risk was inadequately rewarded. Selectivity remains central to seizing on investment opportunity: robust credit assessment, diversified income and disciplined calibration of duration can convert higher market yields into more resilient portfolio outcomes.
In our view, these characteristics leave EdenTree’s funds well placed to manage further long-end volatility while still participating in the improved return potential available across the asset class.
Important Information
This document has been prepared by EdenTree Investment Management Limited and has been produced for information purposes only. As such the views contained herein are not to be taken as advice or recommendation to buy or sell any investment or interest thereto. These are the views of the author at the time of publication and may differ from the views of other individuals/teams at EdenTree Investment Management. The views presented are as of the date published.
References to specific holdings are for illustrative purposes only and do not represent a recommendation to buy or sell. The holdings referenced are part of a broader, diversified portfolio and do not represent the full portfolio.
No forecasts can be guaranteed and there is no guarantee that the information supplied is complete or timely, nor are there any warranties with regard to the results obtained from its use. Edentree is the source of data unless otherwise indicated.
Capital at risk. The value of an investment and the income from it may go down as well as up and the investor may not get back the amount initially invested. Selecting holdings due to our ethical criteria means that the choice of holdings is limited to a subset of the market and this could lead to greater volatility.
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