Here’s Why a Debt Doom Loop Is Brewing | Here's Why

Added: 2026-05-30

[00:00:00][music] >> Bloomberg Audio Studios. Podcasts, radio, news.

[00:00:09]>> I'm Caroline Hepker, and this is Here's Why, where we take one [music] big story and explain it in just a few minutes with our experts here at Bloomberg.

[00:00:17]>> [music] >> We've had this global bond slump that really picked up pace at the end of last week.

[00:00:24]>> People who own bonds, they tend to look at these things and both inflation and you know, demands for capital can push up rates.

[00:00:30]>> It starts to look a lot more interesting with 30-year real yields at levels that we haven't seen since the GFC.

[00:00:35]>> Yields are already high, curves are relatively steep, and central banks are probably going to be relatively slow to address the inflation problem. That's a perfect storm.

[00:00:43]>> [music] >> Bond vigilantes love it.

[00:00:46]>> Bond markets are sending a warning.

[00:00:49]Long-term borrowing costs have climbed across major economies.

[00:00:53]The pressure has been fueled by inflation fears linked to the Iran war.

[00:00:59]At the same time, countries are adding to, rather than cutting, their [music] debt.

[00:01:05]It's a combination that is rattling confidence.

[00:01:08]>> [music] >> Because as borrowing costs rise, governments may need to borrow even more, and a vicious cycle could now be on the horizon.

[00:01:18]So, here's why a bond market doom loop is brewing.

[00:01:23]>> [music] >> Stephanie Flanders is Bloomberg's head of economics and government and host of the Trumpanomics podcast, and she joins me now. What are bond markets trying to tell governments and central banks right now?

[00:01:37]>> I think there's a mixture of things. I mean, we're seeing the implied cost of borrowing, if you're a government, go up quite significantly. That's when you see the value of the government debt, the bond price goes down, and what they have to offer in terms of their interest rate goes up. That's how bond markets work, and there has been quite a steep increase, And I think that's associated with in the short term realizing that this crisis in Iran and the closure of the Strait of Hormuz is going to have a significant effect on inflation for longer than people thought. It's also going to mean that central banks maybe have to respond to higher inflation.

[00:02:13]There's that short-term thing going on, but I think also longer term, investors are just looking at these governments that are sitting on a lot of debt, are sitting on rising costs of servicing that debt, and some a lot of voters and populations who don't seem very keen on doing anything to bring that debt down.

[00:02:29]So, I think there's also just bigger question marks about government's fiscal sustainability, if you like.

[00:02:35]>> Investors are increasingly worried about government debt and in a lot of different developed economies. But I suppose I wonder why they are becoming so much more concerned about what has actually been a long-running issue with government debt. Why the concern particularly now?

[00:02:53]>> Something very unusual happened after the global financial crisis that you had a big increase in debt as countries responded to their sort of slowdown and the recession in the economies at that time. Actually doubling of government debt in most of the advanced economies.

[00:03:09]But the cost of servicing that debt, because interest rates were falling lower and lower as central banks were trying to stimulate their economies, the cost of servicing that debt actually fell overall. So, that was kind of a free lunch for governments. That's gone completely in the reverse in the years since COVID. Interest rates have been creeping up and the cost of servicing that debt for governments have been creeping up. So, suddenly in the UK, for example, instead of paying around 50 billion pounds a year interest costs on the debt, you're paying closer to 100 billion, maybe higher, which starts to be, you know, more than defense, more than many other important bits of the economy. And then investors say, "Well, hang on a minute. How are they going to keep paying that bill when those bills for education, defense, and health are also rising.

[00:03:54]>> Central banks also, as you sort of mentioned, spent years helping to keep those borrowing costs low. So, I suppose are we now about to see a new era of rising interest rates? You say they've been creeping up. Is this a sort of new moment for central banks?

[00:04:11]>> Yeah, in a way we're going back to a normal time. You remember, Caroline, we had a lot of time where people were worried that central banks had sort of run out of ammunition because interest rates were at rock bottom and they had nowhere to go. Well, I guess the good news about the current situation is that with higher interest rates, they've got a lot more room for maneuver both on the upside and on the downside. But, of course, the the bad news is that means we're in a sort of slightly higher inflation, higher interest rate environment. And, you know, that I think we certainly the research that we've done about the sort of long-term drivers of the cost of money, of that long-term interest rate, we think it is going up for a whole bunch of reasons, but in part because this is just becoming a more expensive world with all these shocks that we're seeing coming down the track and rising commodity prices and things like that.

[00:05:01]>> So, then, we've used this term doom loop. Can you explain how a doom loop between debt and borrowing costs would actually work? I mean, one of the concerns has been also about a kind of disorderly bond market.

[00:05:15]>> The more that investors worry about government's ability to repay that debt, the more they demand a higher interest rate, maybe a higher risk premium on that debt, then the bill goes up further, so they look at it again and say, "Wow, that really is going to be hard to cover." So, you can see how that is a sort of negative spiral that is quite hard to break if governments haven't persuaded investors that they really do have a handle on that long-term path for debt. And I think that's why a lot of people, certainly a lot of investors and the sort of ratings agencies, they look at whether a government has It doesn't matter It doesn't matter [clears throat] so much if the borrowing is going up now or debt's going up now, but do they have a credible plan for putting it on a stable path and potentially even having debt fall relative to the size of the economy. And I think in quite a few countries, certainly in the US and potentially in the UK, that's just not the case now.

[00:06:10]>> If we are in this kind of new normal or maybe as you say, you know, back to a more normal situation in terms of the cost of borrowing, what does that mean?

[00:06:20]>> There's many things to like about a world in which interest rates are a bit higher. Remember when we had very low interest rates, there was a lot of concerns about pensioners and others living off their savings couldn't get high interest rates. You know, some people like high interest rates. They want to be able to earn a high return from a safe asset like a government bond. That's a world that's happier for them. You also in a sense have higher opportunity cost to money. So maybe people take more care, investors take more care about where they're putting their money cuz there's no there's no easy returns to be had. You have to really think about, okay, if I need to make a 5% or 6% return on this, am I investing it in the right place? I think that's quite healthy. And as I said before, there's also the kind of central banks having more room for maneuver, not being stuck at the bottom where we were when interest rates were sort of not percent, 1%. That's fine once you get there potentially and everyone's got used to that different world. I think the challenge always is how do you make that adjustment and what gets broken on the way there? So there'll be lots of people currently, we see this in mortgage markets over the last few years, people have borrowed at very low rates and then they get real sticker shock when they go to refinance their mortgages, particularly in places like the UK where people are doing that on a regular basis. So I think what we worry about most as economists is not necessarily that sort of steady state where we've gone back to normal, if you like, kind of historically normal interest rates, but what's going to happen on the way there and who's going to get burned in the process?

[00:07:49]>> It's always about the speed of change, isn't it? Bloomberg's head of economics and government, Stephanie Flanders, [music] thank you. For more explanations like this from our team of 3,000 journalists and analysts around the world, go to bloomberg.com/explainers.

[00:08:01][music] I'm Caroline Hepker. This is Here's Why.

[00:08:07]We'll be back with more [music] next week. Thanks for listening.