Public debt: the markets are rediscovering the risk of government debt

Grégoire Kounowski, Head of Advisory at Norman K., comments on how investors are increasingly shifting their focus from central bank support to governments’ fiscal credibility, as high public debt and persistently elevated interest rates make the cost of capital a more important driver of bond, equity and asset market performance.

For several years now, investors have become accustomed to operating in an environment where central banks have acted as a permanent buffer. Periods of economic or financial strain have generally resulted in greater monetary support and more accommodative financing conditions. However, a gradual shift appears to be taking place: the markets are once again paying close attention to the trajectory of public finances.

In both the United States and Europe, budget deficits remain high despite the phasing out of the exceptional measures introduced in recent years. In several developed economies, public debt continues to rise even as interest rates remain significantly higher than the levels seen during the 2010s. This combination creates a new constraint: refinancing debt is becoming progressively more costly, which reduces governments’ fiscal leeway.

This trend is beginning to be reflected in the bond markets. Investors are no longer content simply to analyse inflation prospects or central bank decisions; they are also questioning governments’ ability to stabilise their public finances in the medium term. In several countries, bond issuance is reaching record levels, automatically increasing the supply of debt available on the market. When this supply grows faster than demand, yields naturally tend to remain high.

For central banks, the situation is becoming particularly delicate. Even if disinflation continues, monetary authorities no longer necessarily have the same freedom to cut rates rapidly. Too sharp a cut could fuel a rebound in demand and reignite certain inflationary pressures, whilst maintaining high rates for too long increases the interest burden borne by governments.

In the equity markets, this environment is encouraging a return to more traditional selection criteria. During periods of abundant liquidity, investors have often favoured companies with the most ambitious growth prospects. Now, the ability to generate recurring cash flows, maintain high margins and finance growth without relying excessively on credit is once again becoming paramount. Companies with a solid balance sheet could benefit from an increasing premium in the current environment.

The implications also extend to real assets. Infrastructure, certain strategic commodities and companies able to pass on inflation to their prices remain of particular interest. Gold, despite occasional periods of consolidation, remains supported by its status as a store of value in a world where public debt levels are reaching historic highs. Conversely, assets most dependent on abundant and cheap financing could continue to experience heightened volatility.

In this context, a balanced approach still appears appropriate. High-quality bonds are gradually regaining their role as a source of return within portfolios, but active duration management remains essential whilst markets remain uncertain about the future path of interest rates. With inflation falling in the United States and unexpected disinflation in Europe, investors are hoping that the Fed and the ECB will opt for the status quo.

In the equity market, it seems prudent to favour profitable, low-debt companies with genuine pricing power. Moderate exposure to real assets and infrastructure can also help to strengthen the resilience of asset allocations. More broadly, the markets may be entering a new phase in which the cost of capital is no longer a secondary factor but a key determinant of investment. Having long focused their attention on inflation and central banks, investors are beginning to rediscover a factor that has sometimes been overlooked for nearly a decade: the fiscal credibility of governments.

This note reflects Grégoire’s current assessment as of 10th July 2026.