Macro & Strategy - December 2025

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Comfortably Numb

“There is no pain, you are receding.” – Pink Floyd

Debt is rising, voices are worrying

Government debt is back in the spotlight, and this time, the chorus of concern is louder than ever. And the numbers do justify those voices.

The International Monetary Fund (IMF) projects that global public debt could reach 100% of global GDP by 2029, the highest level since 1948. Fiscal deficits for G7 countries should average 6% of GDP in 2025-2030, up from 4% between 2012 and 2019.

Canada is no exception. The Carney-Champagne budget tabled on November 4 confirmed what many suspected: There is no plan to bring the budget back to balance. Structural deficits are now entrenched. The debt-to-GDP ratio, which had stabilized following the COVID pandemic, is climbing again. Ottawa is borrowing more, not to counteract a recession, but to fund ongoing program spending while trying to steer the Canadian economy in times of geopolitical troubles. The fiscal cushion for future crises is thinning.

Even Germany, long a bastion of fiscal orthodoxy, is embracing debt to fund infrastructure and the energy transition. In the United States, debt has surpassed 120% of GDP, and the political theatre that comes with raising the debt ceiling has become a recurring feature. Meanwhile, France and the U.K. continue to wrestle with high debt and persistent deficits as political efforts at fiscal consolidation fall short. In other words, the mood is shifting, from complacency to concern.

Highlights

• Debt is surging, Ottawa’s flying blind, and caution is the new watchword.
• Markets smell inflation, rates climb, and government bonds lose their safe-haven status.
• Overweight equities (Asia, Europe), copper in focus, keeping a close eye on bond duration.

Why governments borrow: The good, the bad, and the crowded out

Governments borrow for many reasons. They are providers of public goods, stabilizers during crises, and architects of longterm investment. However, not all borrowing is created equal.

Good debt, is the kind that builds for the future, financing projects that enhance productivity and generate economic returns over time in areas such as infrastructure and innovation. Canada’s recent push to invest in its export and energy infrastructure, including ports, LNG terminals, and transmission lines, falls into this category. So does Germany’s infrastructure overhaul.

Bad debt, on the other hand, involves borrowing to fund current consumption. As aging populations cause rising pension and healthcare costs, Old Age Security and provincial health transfers are swallowing larger shares of Canadian federal spending. In the U.S., Medicare, Medicaid, and Social Security also dominate the fiscal landscape.

The distinction matters. Borrowing for investment can crowd in private capital, since public infrastructure often acts as a catalyst for private sector expansion. For example, a new transit line can unlock real estate development, while a digital backbone can spur tech entrepreneurship. But excessive borrowing for consumption can crowd out private investment. Higher government debt pushes up interest rates, making it more expensive for businesses to borrow and invest. The balance is delicate.

The IMF reckons that, as government expenditure has risen, the proportion of spending by advanced economies on public investment—the good kind of debt—has decreased1 . As Western democracies rearm and defence spending increases, this trend may continue. NATO member countries are now aiming to annually spend 3% of their GDP on defence. This comes on top of day-to-day spending on general public services, education, social protection, and so on.

These programs are essential, or at the very least politically popular, which makes them difficult to curtail. The problem is that their funding models increasingly rely on debt.

This is where the Carney-Champagne budget attempts to thread the needle: investing in productivity-enhancing sectors while managing the cost of increased defence spending and servicing legacy programs. The execution, however, will be key.

The global cushion: Excess savings and the sovereign debt magnet

Here’s the paradox: Despite rising debt, interest rates on sovereign bonds remain relatively well contained. Why? Because the world is still awash in savings. Emerging markets, particularly China, have historically saved more than they invest. The absence of robust social safety nets drives households to save aggressively.

Germany, too, is a net saver. However, these excess savings need a home—and sovereign bonds are the destination of choice

This global savings glut helps explain why demand for government debt remains strong, even as supply surges. It’s a classic case of equilibrium pricing: More debt doesn’t necessarily mean higher rates if demand keeps pace. Investors, especially institutional ones, continue to see sovereign bonds as safe havens.

But the cushion is thinning. Although the IMF forecasts point to a continued savings glut into the next decade, global excess savings turned negative in 2023, a first in 15 years. Meanwhile, future investment spending could surpass the IMF’s expectations. The pressures are mounting: Energy transition, AI infrastructure, geopolitical rearmament, and supply chain reshoring all require massive investment.

In fact, interest rates globally are on the uptrend, especially those on longer-term government bonds. Interest rates are lower than they were during the ’90s, but the 2010s era of near-zero rates is well behind us. As governments compete for capital, the uptrend observed since 2022 may only be beginning.

While this rise is partly attributed to higher central bank policy rates, markets are growing concerned about fiscal risks. Bond investors are increasingly skittish about the fiscal outlook for the U.K., from the 2022 mini-budget to the ongoing saga surrounding the Autumn 2025 Budget. France’s 10-year sovereign bond yield is now higher than Greece’s—a country that defaulted on its debt a decade ago—as its fractious national assembly struggles to agree on a budget framework. Meanwhile, long-term interest rates are also up in Japan, as new leadership works on a substantial fiscal stimulus.

The message is clear: Sovereign bonds might not be safe havens after all.

The limits of the model: When debt becomes a problem

So, should we worry? The answer lies not just in the level of debt, but in the ability to service it.

Debt service ratios—interest payments as a share of government revenues—are creeping up across most major economies. In Canada, this ratio remains well below 1990s levels, but the trend is upward. In 2025, roughly 10% of federal revenues are allocated to interest payments, up from 7% five years ago. With rising interest rates and higher debt issuance, the math is unforgiving. As we discussed a few months ago (see here), the U.S. is the poster child for spiraling debt servicing costs, with around a quarter of its revenues spent on interest.

A rising debt service ratio can have serious consequences, as this money cannot be allocated to public services, the military, or other productive areas. Additionally, it may indicate a fiscally unsustainable situation, eroding confidence and prompting investors to demand higher premiums for the country’s debt.

This scenario can quickly spiral into a self-reinforcing cycle that is difficult to break without significant, and often painful, adjustments.

For example, in the late ’80s and early ’90s, Canada spent more than 30% of its revenue on interest costs. Faced with a situation threatening to become unsustainable, policymakers acted forcefully, setting the table for a decade of reforms and painful fiscal consolidation. That said, these adjustments came at the right moment, and Canada managed to regain its credibility.

A less rosy example comes from Argentina, which defaulted on its debt in the early 2000s after interest costs reached more than 40% of fiscal revenues. However, in this case, decisive actions were not taken, and global investors fled the country, triggering an economic crisis.

We are neither here nor there, but the direction of travel is concerning.

Canada’s AAA rating: Still intact, but under pressure

The reforms of the ’90s allowed the Canadian federal government to hold a AAA credit rating from S&P Global, a distinction shared by only a few nations on the strength of its relatively sound fiscal standing and robust institutions, including its world-renowned pension system.

But how long can it keep it? Canada’s gross debt-to-GDP ratio is comparable to that of other G7 nations with questionable fiscal prospects and stands considerably higher than the average for other AAA-rated countries. Its low net debt-to-GDP ratio, largely due to pension assets, aligns it more closely with top-tier peers. Still, both its deficit and debt service ratio exceed those of the AAA group.

Canada’s November budget exacerbated these trends. There is a silver lining, as noted earlier: Much of the fiscal deterioration stems from investment spending, which could support long-term growth. At the same time, operational expenditures should be restrained. That is the plan — rating agencies are monitoring closely to see if the government follows through.

A downgrade would bring immediate impacts: increased borrowing costs, reduced fiscal flexibility, and diminished credibility in global markets. To prevent this, the federal government is relying on a combination of stronger growth and modest fiscal consolidation to restore a more sustainable fiscal trajectory. To assess the risk of a downgrade, investors can evaluate the success of cost control measures and whether the government pivots to a more populist approach, including policies such as handouts. Growth will also need to improve, not from higher consumption, but as a result of rising investment.

Thanks to Canada’s current position and lessons learned from the 1990s, this approach has a reasonable chance of succeeding. For other countries with much weaker fiscal conditions and no history of recent consolidation, the odds of such a benign outcome are much lower.

What can governments do?

For those countries facing an increasingly unsustainable fiscal situation, what comes next? The current drift towards higher debts and deficits may persist for some time. Sooner or later, however, governments will need to intervene, or an intervention will be forced upon them.

We identify three potential outcomes:

1. Governments may pursue fiscal consolidation through higher taxes or lower spending, following the example of Canada in the ’90s. Yet, achieving meaningful fiscal consolidation is rare because it is politically difficult; current events in France and the U.K. illustrate the challenge in cutting deficits without triggering strong popular pushback. Widespread austerity measures would likely result in slower economic growth. We should also pay attention to the lessons of history. Long-term investors should position their portfolio for higher risks of inflation surprises. It is the most likely solution to this rising debt puzzle — more likely than a productivity surge or successful efforts toward fiscal consolidation.

2. Another possibility is that countries outgrow their debt. Some leaders hope their nation’s debt-to-GDP ratio will drop, not due to lower debt levels but because GDP rises quickly enough to offset it. This may be more feasible if deficits fund investments that boost growth. However, historical evidence suggests these hopes are unrealistic. While some predict technologies like AI could drive extraordinary productivity growth, making fiscal worries irrelevant, a global recession could just as easily occur, forcing governments to accumulate even more debt. This was observed during the Global Financial Crisis and the COVID-19 pandemic. Overall, we believe countries growing out of their debt is very unlikely.

3. Finally, countries might reduce debt through inflation. Historically, rising sovereign debt has often been addressed by episodes of inflation, as seen in 2022-2023 after COVIDrelated debt increases. Inflation was also crucial for lowering debt-to-GDP ratios among Allied nations after WWII. In a world of fiat currency, central banks can buy government debt. In addition, regulations can be modified to cap interest rates or to force financial institutions to own more sovereign debt. These approaches, known as financial repression, ultimately result in inflation. It is the most politically expedient option, since its costs are usually deferred to future administrations.

Closing thought: Don’t mistake calm for safety

The world is comfortably numb to government debt. Rates remain well contained, demand is still strong, and the bond markets are stable. But comfort is not a strategy.

While debt is a powerful tool, it requires discipline and foresight. Investors must stay alert: Sovereign bonds that are issued to pay for ever-rising structural deficits are no safe havens.

We should also pay attention to the lessons of history. Longterm investors should position their portfolio for higher risks of inflation surprises. It is the most likely solution to this rising debt puzzle — more likely than a productivity surge or successful efforts toward fiscal consolidation.

There will eventually be consequences to governments’ growing pile of debt, but it seems that the ever-elusive debt limit is still a bit farther down the road. While we are not worried about an impending doom scenario, we do argue that, more than ever, global investors need to factor in sovereign risks when analyzing risk-adjusted returns.

Positioning

We remain overweight equities, anticipating a global growth rebound in early 2026, supported by a shift toward accommodative monetary policy and a more favourable fiscal backdrop. Within equities, Asia stands out: Attractive valuations, improving earnings revisions, and structural reforms underpin our constructive view.

Resilient domestic demand and better external conditions position the region to outperform as liquidity improves. We also see selective opportunities in Europe, where early-cycle dynamics and room for valuation expansion suggest a multiyear upswing.

Turning to government bonds, our stance remains neutral to slightly underweight on duration. Rising term premia, heavy issuance, and lingering inflation risks limit prospects for a sustained rally. While policy easing is expected next year, we anticipate yield curve steepening to persist, keeping us cautious on extending duration.

Finally, we have increased exposure to commodities, particularly copper. As global growth accelerates and reflation gains traction, industrial metals should benefit. Copper’s cyclical appeal and structural role in both electrification and the energy transition make it a compelling play in a reflationary environment.