Government debt levels don’t drive yields
There has been a lot of talk in the press recently about how government debt influences interest rates. However, the data tells a different story. Government borrowing affects the shape of the yield curve more than the absolute level of yields.
Debt size doesn’t seem to matter!
Major government borrowing events have typically been triggered by one-off crisis like the Global Financial Crisis (GFC) and COVID-19, not by interest rates. Before 2008, debt-to-GDP ratios were stable or even declining in many economies, suggesting governments borrow based on necessity, not borrowing costs.
Looking at the US, Australia, Germany, and the UK (refer Chart 1), debt levels have risen, yet interest rates haven’t followed suit. Germany, for instance, has kept debt-to-GDP in check, yet its bond yields have moved in line with other developed economies.
Chart 1 – Debt-to-GDP vs. 10-year yields
Source: IMF, Bloomberg, Yarra Capital Management.
What does matter?
The rate of change in debt-to-GDP, rather than its size, has a stronger link to the slope of the yield curve (the difference between the 10-year and 2-year yield). When debt rises, 10-year yields trend higher than 2-year yields, steepening the yield curve. When debt growth stabilises or falls, the curve flattens (refer to Chart 2).
Since the GFC in 2008, this pattern has been distorted by central Quantitative Easing (QE). As QE is unwound, we expect this relationship to reassert itself. With debt-to-GDP projected to rise through 2029, yield curves are likely to steepen, keeping longer-term bond yields elevated even If cash rates fall.
Chart 2: Debt-to-GDP vs. yield curve slope (US, Australia, Germany and UK)
Source: IMF, Bloomberg, Yarra Capital Management.
Why it matters for investors
Active bond managers can adjust portfolio positioning based on shifts in the yield curve, potentially generating excess returns compared to passive strategies. Index funds, by design, follow fixed bond weightings and lack the flexibility to exploit relative value opportunities, meaning they may miss out on potential excess returns.
For example, the Yarra Australian Bond Fund actively manages duration, sector allocation, and security selection to capture mispricing and navigate interest rate changes. This dynamic approach enhances return potential while managing risk in evolving market conditions.
Managed Fund
Yarra Australian Bond Fund
Australian Fixed Income
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Darren is highly regarded in the fixed income industry and is regularly featured in the press. He is also co-host of the popular Australian podcast series The Rate Debate. He has more than 30 years’ experience in fixed income markets and 25 years managing multi-sector fixed income portfolios. Prior to his role at Yarra Capital Management, he was Head of Fixed Income at Nikko AM (Nikko AM was acquired by Yarra Capital Management in April 2021), and a Senior Portfolio Manager at Perpetual, where he held the position for 12 years. Darren has co-responsibility for the Australian Fixed Income team at Yarra Capital Management and is co-portfolio manager of the highly-rated Nikko AM Australian Bond Fund and the Nikko AM insurance mandates.
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Darren is highly regarded in the fixed income industry and is regularly featured in the press. He is also co-host of the popular Australian podcast series The Rate Debate. He has more than 30 years’ experience in fixed income markets and 25 years...
Expertise
Darren is highly regarded in the fixed income industry and is regularly featured in the press. He is also co-host of the popular Australian podcast series The Rate Debate. He has more than 30 years’ experience in fixed income markets and 25 years...
Expertise
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