Comparing debt with the size of the economy is more meaningful, but it doesn’t change the basic story. Government debt-to-GDP ratios have increased across many of the world's largest economies, and fiscal deficits are generally expected to remain elevated, with the notable exception of the UK.
The key question for investors is whether this growing debt load will eventually act as a brake on economic activity or create stress that disrupts today's relatively calm market environment.
Public Debt Hasn't Slowed Consumers and Companies
So far, the evidence suggests the bar for those outcomes remains high.
While government balance sheets have become more leveraged, private-sector finances have generally moved in the opposite direction. In many cases, rising public debt has coincided with improving corporate and household balance sheets.
Corporate borrowing is increasing, driven by a surge in technology spending and a recovery in merger and acquisition activity. Morgan Stanley's credit strategists expect record issuance this year. Yet this debt can still be absorbed with only modest widening in credit spreads. Corporate balance sheets remain in relatively good shape, with U.S. corporate debt as a share of GDP broadly unchanged over the past decade and lower than immediately after the pandemic.
The household sector also appears relatively healthy. U.S. household debt is about 67% of GDP, lower than it was in 2000 (around 70%) and roughly 6 percentage points below its 2019 level (74%). Many households also locked in mortgages at historically low rates, helping insulate them from recent increases in borrowing costs.
As a result, both consumers and businesses have remained more resilient than many expected despite higher interest rates and energy prices.
A Global Trend, Not Just a U.S. Story
These patterns are not unique to the U.S. Europe has generally seen higher government debt offset by private-sector deleveraging, while Japan has experienced rising public borrowing alongside relatively stable private-sector leverage.
To some extent, this dichotomy reflects policy choices. Governments determine how to balance taxation and spending, and many countries have reduced tax rates over the last decade while allowing public borrowing to increase. A deterioration in public-sector balance sheets relative to private-sector balance sheets is therefore not especially surprising.
The Signal Investors Should Watch
If households and companies are proving less sensitive to higher rates, investors may need to look elsewhere for signs that debt levels are becoming problematic.
Recent moves in yields have coincided with interventions affecting long-term U.S. rates and Japanese currency markets. However, current market indicators do not suggest a loss of confidence. Inflation expectations, yield-curve positioning and rate volatility remain broadly consistent with orderly market conditions.
A more important signal may come from investor asset allocation.
Thirty-year U.S. Treasury bonds currently offer roughly 300 basis points above expected inflation, while long-dated U.S. investment-grade bonds yield around 6.2%. The point where higher yields begin to matter may be less about whether businesses stop borrowing or consumers stop spending, and more about when investors decide bonds offer better value than stocks.
So far, Morgan Stanley Research is not seeing clear evidence of that shift. Fund-flow data and market correlations do not suggest a significant reallocation away from equities.
Strong Earnings Are Helping Stocks Compete
One reason for that resilience is earnings growth.
Year to date, the S&P 500 has posted strong gains even as Treasury yields have risen. According to Morgan Stanley's equity strategists, earnings growth has largely offset the impact of higher rates, keeping the equity risk premium broadly unchanged.
That dynamic makes future earnings growth increasingly important. If corporate profits continue to expand, equities may remain competitive despite higher yields. If growth slows, investors could take a fresh look at fixed income opportunities.
For investors, there may also be opportunities in markets with comparatively stronger fiscal positions. We continue to see value in UK inflation-linked bonds, where the fiscal deficit is one of the few expected to narrow, and in the Australian dollar, which offers relatively attractive carry alongside government debt of roughly 49% of GDP.
The world has accumulated a great deal more government debt without producing many of the consequences investors once feared. That doesn’t mean debt no longer matters. But the mechanism may be different from the one markets have spent much of the last decade anticipating.
The key question may not be when higher yields force borrowers to retreat. It may be when they finally persuade investors to move their money.
