G7 debt costs surge $16 billion as yields climb on war

G7 governments have absorbed $16 billion in extra sovereign financing costs since the U.S.-Iran war began in February, a figure projected to reach $34 billion by the end of the first quarter of 2027 if elevated yields persist, according to Financial Times analysis of treasury issuance data.

"Rising rates are among the biggest risks to equity and credit markets," said Mohit Kumar, chief European economist at Jefferies. Further increases would likely trigger a negative reaction in equities while squeezing corporate profits through higher borrowing costs, he said.

The U.S. accounts for the largest share of the increase at $10.6 billion, reflecting its position as the world's largest sovereign bond market. If yields stay at current levels, the U.S. is set to pay a further $21.7 billion in additional interest costs by the end of Q1 2027. Nearly every G7 government bond issue across maturities now trades at a higher rate than in February, raising the cost of selling new debt across the UK, Italy, Germany, and Japan, where the closure of the Strait of Hormuz has driven up energy prices and inflation expectations.

The added costs remain small relative to overall public spending, but economists warn they are straining government balance sheets at a time of expanding deficits and heavier spending demands. If the U.S. 10-year Treasury yield moves above 5 percent, equity and credit markets face broader risk, while U.S. mortgage rates are at risk of rising above 7 percent, further stalling the housing market.

The FT's analysis compares actual borrowing costs with prewar rates and incorporates each country's treasury issuance plans and maturity mix. The $34 billion projection assumes current yield levels persist through the end of Q1 2027. The remaining G7 members combined account for more than one-third of the additional cost increase.

U.S. bond yields have risen sharply in recent weeks as investors grow more concerned about the country's debt burden and whether policymakers can contain inflation linked to the war. Treasury Secretary Scott Bessent's efforts to increase long-duration bond buybacks have done little to reverse the upward trend, with the 30-year Treasury recently reaching its highest yield since 2007.

Structural Pressures Keep Yields Elevated

Beyond the war, economists point to multiple forces that may keep yields under upward pressure. Adam Posen, president of the Peterson Institute for International Economics, cited political instability risks in the U.S., France, Japan, the UK, and possibly Germany, alongside higher defense, infrastructure, demographic, and green spending demands. "Beyond inflation risk, there are real risks to political stability in the U.S., France, Japan, the UK and possibly Germany, combined with geopolitical factors — that's another real risk," he said.

AI infrastructure investment is also competing for capital. Michel Martinez, chief European economist at Société Générale, said sovereign issuers are increasingly competing for savings with AI-driven investment and structural spending needs, reflecting a world where capital is no longer abundant being repriced. Strong growth expectations are also supporting riskier assets and reducing demand for haven bonds such as Treasuries.

James Knightley, chief global economist at ING, said higher borrowing costs are already weighing on U.S. economic activity through household and corporate financing channels. The housing market has stalled, and a steeper yield curve means mortgage rates could rise above 7 percent. "This is not just a fiscal sustainability issue — in the U.S., it's already constraining economic activity through higher household and corporate borrowing costs," he said.

Morgan Stanley's Gianluca Salford, head of European rates strategy, offered a more measured view, arguing the shift may represent a return to a more normal pre-2010s rate environment rather than an unmanageable structural break. "This is not a clearly unmanageable situation... sometimes crises are needed, but countries usually take the right measures to stay on track because there is essentially no viable alternative," he said.

Kumar warned that reducing fiscal deficits becomes even harder in a higher-rate environment as governments pursue expansionary and potentially more populist policies ahead of elections. With U.S. midterm elections and multiple European parliamentary contests approaching, the incentive for expansionary fiscal policy remains strong, adding to debt management challenges.

The last time 30-year Treasury yields traded at current levels was 2007, before the global financial crisis reset the rate environment. The current trajectory suggests a structural shift rather than a cyclical spike, with implications for government debt service, corporate financing costs, and household mortgage rates across the developed world.

This article is for informational purposes only and does not constitute investment advice.