DM Government Debt: 2026 Supply & Voters’ Resistance To Fiscal Consolidation

hat key fiscal issues matter for DM government debt markets in 2026 and 2027?  

Figure 1: 2026 Budget Deficit and QT to GDP (%)

Source: IMF/Continuum Economics  

Our most persistent concern for 2026 is large supply, which is a function of budget deficits and also large QT outside of the U.S.  This is most acute in Japan (Figure 1), where we continue to highlight the risk of 10yr JGB yields spiking to 2.5% and above, which can cause a BOJ U-turn to switch from decreasing to increased monthly bond buying (DM Rates Outlook here).  We also see the ECB cutting the pace of QT by 25%, given that financial conditions are tighter than suggested by the policy rate alone.  The BOE should also slow QT to around £45-50bln per annum in September 2026 and then to circa £30bln pa in September 2027.  The Fed balance sheet expansion in line with nominal GDP should see the Fed buying USD25bln pm in contrast.  Overall, we see more Fed, ECB and BOE rate cuts pushing 2yr yields down and heavy supply keeping 10yr yields elevated and thus further 2026 yield curve steepening. 2027 should see yield curve flattening, as 2yr yields rise on future tightening fears and 10yr yields remain broadly around current levels. 

The other main fiscal issues for 2026 and 2027 is the need for multi-year fiscal consolidation due to high government debt/GDP and rising debt servicing costs.  However, this is running into resistant voters.    

Resistant Voters

Government debt/GDP trajectories jumped during COVID due to tax shortfalls and emergency payments to workers.  In Europe, the gas price shock after the start of the Ukraine war in 2022, also prompted fiscal transfers to household and businesses. This has left net government debt trajectories (Figure 2) on a higher profile than in 2019.  Meanwhile, the end of ultra-low interest rate means that government debt servicing costs (Figure 3) have risen and are projected to rise still further by 2030.   

Figure 2: Net General Government Debt/GDP (%)

Source: IMF October 2025 Fiscal Monitor

Figure 3: General Government Debt Servicing/GDP (%)

Source: IMF October 2025 Fiscal Monitor  

This all means reducing primary deficits or larger primary surpluses in some countries (e.g. Italy) via growing expenditure slower or increasing taxes.  This is tough for politicians.

The Biden and Trump administrations have not been interested in fiscal consolidation, despite the large primary budget deficit (Figure 4).  The U.S. has a low government revenue/GDP ratio compared to other DM countries (Figure 5) and the IMF keep saying that a national VAT introduction could cure most U.S. fiscal excesses at a stroke.  However, U.S. politics sees a great reluctance to increase or broaden taxes and the Republicans remain biased to lower taxes, with the Trump administration suggesting USD2000 cheque per person earning under USD100k before the mid-term elections – though Congress are not enthusiastic yet. Though the Supreme Court will likely curtail reciprocal tariff revenue, we see a partial replacement from other tariffs and codifying existing trade framework deals (here).  The Supreme Court ruling could add an extra 0.5% of GDP for the 2026 budget deficit to 6.5%, which we do not view as a game-changer for the long-end.  If the GOP lose the House of Representatives in November, then it would likely stop further fiscal slippage but not produce fiscal consolidation.  A jump in inflation and hence debt servicing costs is also not our baseline.  Inflation expectations are also unlikely to increase due to the Fed.  The new Fed chair will also not be able to radically change FOMC rate setting behavior with all the district Fed presidents having been reappointed until Feb 2031. The U.S. could continue to muddle through with 10yr real yields around 2% and the privilege of the global reserve currency helping the U.S. with high debt and a large budget deficit.  However, any U.S. fiscal crisis in future years could get ugly, as average debt maturity is the lowest among major DM countries at 5.8 years and high gross annual financing needs (Figure 6).  

Figure 4: Big DM Primary Deficit/GDP (%)

Source: IMF

Figure 5: General Government Revenue to GDP (%)

Source: IMF

Figure 6: Key Fiscal Metrics  

Source: IMF

Japan voters have also pushed the LDP government towards some fiscal easing and away from consolidation, which is a risk given that QT in 2026 will likely be 6% of GDP.  We expect a partial QT U turn from the BOJ when 10yr JGB yields spike to 2.5% and beyond (as soon as H1 2026). However, unless the BOJ slows QT to 2-3% of GDP per annum, the combination of budget deficit and QT could return to push 10yr JGB yields higher in 2027-28.  PM Takaichi is also considering holding an early election to strengthen the LDP position, but this may have to bought with more fiscal easing promises.  Meanwhile, it is worth noting that end investor interest in 30yr bonds in major DM government bond markets has decreased and this is prompting some steepening of 30-10yr (Figure 7), but has become acute in Japan.    

For the UK, the 2022 fiscal crisis forced the Conservative government and then the current Labour government to undertake multi-year fiscal consolidation. The difference in primary deficits between the UK and U.S. is striking (Figure 4). However, UK voters are not happy with this fiscal consolidation, especially higher taxes and ill thought out measures, and where policy U-turns have undermined the government’s fiscal credibility.  While the UK does not have a general election until 2029, local elections in May 2026 could increase pressure to weaken PM Starmer and Chancellor Reeves’ fiscal rules!    This is an event risk that needs to be watched and can stop 10yr Gilts trading below U.S. Treasuries, despite a further 75bps of BOE rate cuts in 2026.

Figure 7: 30-10yr Government Bond Yield Spread (%)

Source: Datastream/Continuum Economics  

Germany is pushing to larger primary deficits (Figure 8) with its military and infrastructure commitments over the remainder of the decade, but Germany’s good net government debt/GDP means that it can achieve this will only modest yield concession.  We are forecast 10yr Bund yields to settle around 3.0% later this year, as we also see the ECB cutting by a further 50bps in 2026 (DM Rates Outlook here).  Italy has removed COVID and Ukraine war era expenditure that have helped prompt a push back to a primary surplus.  The 2027 Italian election will also likely see PM Meloni stay in power, though with a different coalition and this will help reduce nerves over Italy fiscal trajectory.  However, Italy’s government debt/GDP ratio is bad and any recession or other major adverse shock could end up lifting Italian debt to dizzy levels.  10yr Italian-Bund spreads may not get a shock in 2026, but look too narrow multi-year once the French story is included.

Figure 8: Big EZ DM Primary Deficit/GDP (%)

Source: IMF

France’s fiscal situation looks ugly.  The primary deficit is too high; debt servicing costs will climb in the coming years (Figure 3) and net government debt/GDP is set to hit 120% by 2030 (Figure 1).  Additionally, non-residents own a large portion of existing debt (Figure 6) and though most are from other EZ countries, they could still reduce exposure as occurred in other countries 2010-12 in the EZ debt crisis.  French voters are resistant to expenditure cuts or restraint and government revenue/GDP is already very high (Figure 5).  French politicians know this and hence the lack of political momentum on fiscal consolidation, which is only amplified by the three way split in parliament that is likely to persist.  Indeed, although the presidential election is in May 2027, it is not clear whether Macron will call assembly elections at the same time.  May 2027 assembly elections could leave a new president with a continued lack of consensus for fiscal consolidation. This can all produce ongoing fiscal tension, but rating agency downgrades could turn this into a crisis if non-resident reduce current high holdings.   While the risks are greatest political in 2027, fiscal tensions around France could ignite in 2026. 

Worse the ECB could find it difficult to use its Transmission Protection Instrument (TPI) without committed French fiscal consolidation and instead the main option would be to slow QT (APP and PEPP) in 2027 and defer any even hint of reversing conventional policy.    

Why are DM voters resistant to fiscal consolidation? One reason is that GDP growth rates are slower since the 2008 GFC in DM economies while income and wealth inequality has also increased. Alongside slow real wage growth this means that a large portion of voters are perceiving less improvement in their lives.  A 2nd reason is demographics. Most growth in spending is on old people and they vote in larger numbers than younger voters, which leads to political bias but also old/young tensions. A 3rd reason could be social media, which has caused less balance in debate and amplifying negative views.  In turn this is hurting mainstream parties at the expense of populists that promise fiscal magic. We shall return with a separate article on this important issue.     

Could an AI productivity boom rescue tax revenue and fiscal outcomes?  We did a deep dive on U.S. structural productivity and feel that the OECD forecast of around 0.5% per annum rise in productivity is the most realistic currently (here), but this is over a 10yr horizon.  However, some cyclical U.S. productivity and tax revenue benefit can occur from the 2025-2030 AI enabler boom (data centers/enterprise AI and semiconductors).  However, in other DM countries the productivity boost will likely be less (Figure 9), both as they lag U.S. AI adoption and also as running data centers in Europe and Japan is more expensive than the U.S. due to lower U.S. electricity and gas prices.   

Figure 9: Predicted Increase in Annual Productivity Growth over a 10-year Horizon Due to AI (%)

Source: OECD 2024 (here)