Rising Government Debt and Its Impact on Global Fixed Income and Equity Markets

The global debt landscape in 2025 is marked by unprecedented challenges. Public debt is projected to exceed $100 trillion, or 93% of global GDP, by year-end, with the International Monetary Fund (IMF) warning that actual figures could be 20 percentage points higher in a severe adverse scenario [1]. This surge, driven by aging populations, climate adaptation costs, and geopolitical tensions, has strained fiscal sustainability and reshaped investor behavior. As central banks grapple with inflationary pressures and governments face rising debt servicing costs, the implications for fixed income and equity markets are profound—and demand a strategic reallocation toward inflation-protected and alternative assets.

The Fixed Income Dilemma: Yields, Spreads, and Fiscal Uncertainty

Rising government debt has directly inflated bond yields, with the U.S. 10-year Treasury yield surpassing 5% in Q2 2025 amid concerns over deficit spending and inflation persistence [2]. The term premium—the extra yield investors demand for holding long-term bonds—has spiked due to policy uncertainty and increased issuance to fund deficits [2]. For instance, 61 developing countries now allocate over 10% of government revenues to debt servicing, while 46 spend more on interest payments than on health or education [1]. This fiscal strain has pushed investors toward higher-yielding corporate bonds and emerging market debt, where credit quality has improved relative to sovereigns [3].

However, inflation-protected assets like Treasury Inflation-Protected Securities (TIPS) have underperformed compared to traditional Treasuries, returning just 0.38% in Q2 2025 versus 0.96% for their non-indexed counterparts [4]. This reflects the paradox of rising real interest rates, which diminish the relative appeal of TIPS despite their inflation-hedging properties. Meanwhile, credit spreads have tightened as investors seek diversification, with high-yield and investment-grade bonds posting positive returns amid a flight to quality [5].

Equity Market Volatility and Sector Rotation

Global equity markets have experienced heightened volatility in 2025, driven by trade uncertainties and inflationary pressures. The S&P 500 rebounded sharply in Q2 after a mid-quarter selloff triggered by President Trump’s “Liberation Day” tariff announcement, which disproportionately impacted technology and consumer discretionary sectors [6]. Conversely, defensive sectors like utilities and healthcare have gained traction as investors prioritize resilience over growth [5].

The “Magnificent 7” tech stocks, however, have maintained dominance, buoyed by AI-driven earnings and expectations of monetary easing. This divergence underscores the importance of sectoral reallocation: while growth equities thrive in low-inflation environments, defensive and inflation-linked sectors offer stability amid fiscal and geopolitical risks [6]. Emerging markets have also outperformed, with the MSCI EAFE index rising 12% in Q2 as currencies strengthened against the U.S. dollar [6].

Strategic Reallocation: Inflation-Protected and Alternative Assets

Investors are increasingly turning to inflation-protected and alternative assets to mitigate risks. Real estate, for example, has outperformed traditional hedges like gold, with 85% of investors viewing it as a reliable inflation buffer due to its tangible nature and rent-adjustment mechanisms [4]. Industrial and multifamily properties, in particular, have normalized as supply-demand imbalances resolve [2].

Commodities, though volatile, remain a critical component of diversified portfolios. Gold’s 5.2% gain in Q2 2025 highlights its role as a safe-haven asset, while energy prices face headwinds from OPEC+ production adjustments and demand concerns [4]. Meanwhile, alternatives like private credit and infrastructure investments are gaining traction. JPMorgan notes that 85% of institutional investors plan to increase allocations to alternatives in 2025, citing their uncorrelated returns and long-term growth potential [7].

Hedge funds and private equity are also attracting capital, particularly in a low-growth environment. BlackRock’s 2025 Spring Investment Directions report emphasizes the role of private credit in filling the gap left by shrinking public bond markets, while infrastructure projects offer stable cash flows amid rising interest rates [8].

Conclusion: Navigating the New Normal

The confluence of rising debt, inflation, and policy uncertainty demands a recalibration of investment strategies. Fixed income markets face elevated yields and fiscal risks, while equities remain polarized between growth and defensive sectors. Strategic reallocation toward inflation-protected assets and alternatives—real estate, commodities, private credit, and infrastructure—offers a path to resilience. As the IMF warns, long-term fiscal adjustments and structural reforms are essential to stabilize debt trajectories [1]. For now, investors must prioritize diversification, liquidity, and adaptability in an era of persistent macroeconomic turbulence.

Source:
[1] Global Public Debt Is Probably Worse Than it Looks, [https://www.imf.org/en/Blogs/Articles/2024/10/15/global-public-debt-is-probably-worse-than-it-looks]
[2] Fixed Income Outlook: Cool and Cloudy, [https://www.schwab.com/learn/story/fixed-income-outlook]
[3] Bonds with credit risk may outperform government debt, [https://www.troweprice.com/financial-intermediary/us/en/insights/articles/2025/q2/bonds-with-credit-risk-may-outperform-government-debt.html]
[4] Real assets insights: Q2 2025, [https://www.ssga.com/us/en/institutional/insights/real-assets-insights]
[5] Economic outlook: Third quarter 2025, [https://www.fidelity.com/viewpoints/market-and-economic-insights/quarterly-market-update]
[6] Q2 2025 Market Review: From Yippy to Yahoo!, [https://ballentinepartners.com/our-thinking/investment-insights/q2-2025-market-review-from-yippy-to-yahoo/]
[7] Alternative Investments in 2025: Our top five themes to watch, [https://privatebank.jpmorgan.com/nam/en/insights/markets-and-investing/ideas-and-insights/alternative-investments-in-2025-our-top-five-themes-to-watch]
[8] 2025 Spring Investment Directions | BlackRock, [https://www.blackrock.com/us/financial-professionals/insights/investment-directions-spring-2025]