Growing fiscal indebtedness is raising concerns across global markets

Several factors may be contributing to the increase in term premiums across advanced economies. However, market intelligence gathered by the Bank during regular conversations with financial market participants suggests a key factor is a growing unease about the market’s ability to absorb the large volume of government debt being issued globally.

In recent years, government borrowing has increased markedly across many jurisdictions. Pandemic-era programs substantially raised public debt levels, which may rise further because of new spending pressures—most notably higher military and defence spending. As a result, governments across advanced economies are issuing large volumes of long-term bonds at a time when the supply of these bonds is already elevated.

At the same time, the investor base for government bonds has shifted in important ways.

During the pandemic, central banks absorbed a significant share of new issuance through asset purchase programs, which put downward pressure on yields. As these programs have been wound down, central banks have stepped back from purchasing government bonds and, in some cases, are actively reducing the size of their balance sheets by selling their purchased bonds on secondary markets.

Overall, this has left private investors to absorb a much larger share of government debt while the borrowing needs of governments have grown. These investors generally do not seem concerned about sovereign defaults and higher inflation based on the market prices for these risks—from credit-default or inflation swaps, for example. Instead, they appear to be seeking compensation for purchasing large amounts of government debt.

Tracking changes in the term premium helps inform monetary policy

Global financial markets are deeply integrated, meaning that forces in other countries can affect financial conditions in Canada. Policy-makers need to understand where these forces are coming from when making decisions about monetary policy. In this context, our work offers valuable perspectives by examining the different drivers of long-term interest rates in Canada.

The Bank will now publish measures of the term premium—using both the ACM and Shadow Rate models—on its financial stability indicators webpage and will update them every quarter.