Robin Marshall, M.A., MPhil
Nelson Huang
- Investor concerns about govt. debt sustainability in the G20 have deepened since rates rose in 2022.
- The most widely used metrics for govt. debt sustainability are gross debt/GDP ratios, and debt service costs/GDP.
- The FTSE Debt Capacity WGBI (DCWGBI) captures relative differences in sovereign debt/GDP and debt/service costs, adjusting sovereign weights accordingly. This has driven substantial underweights in the US and Japan.
- The DCWGBI consistently outperformed the WGBI, during its first 10 yrs, particularly since Covid, reflecting US spread widening, and superior credit quality.
- If investor concerns about debt sustainability deepen, this may drive further outperformance by the DCWGBI, given its relative weights, and vice versa.
Gross govt. debt/GDP ratios and debt service costs have almost doubled since the GFC
Globally, govt. debt/GDP ratios and debt service costs have increased sharply since the GFC and Covid, raising the importance of sovereign bond indices like the FTSE Debt Capacity World Govt. Bond Index (DCWGBI), built in October 2015. It uses both gross debt/GDP ratios and debt service costs/GDP as metrics for debt capacity, and sustainability[1].
The DCWGBI weighting methodology differentiates fiscally healthier economies from less
The DCWGBI uses an S-shaped function rather than a linear function for country weights. This differentiates the fiscally healthier economies from the less healthy ones while not discriminating against the countries within each cluster (please see our longer paper for more details on weighting methodology[2]). Final country weights are derived from 3 factors – (1) the country’s market value, (2) the country’s debt/GDP, and (3) the country’s debt service/GDP. The component that deviates more will have higher impact on the final weight.
Transition to a higher interest rate regime transformed debt dynamics, adversely…
Weaker real growth, and higher yields create adverse dynamics for debt/GDP ratios, and debt service costs, unless current government expenditure falls sharply, relative to revenues. But this is difficult when growth is weak. Chart 1 shows how govt debt/GDP ratios in the G7 and China increased steadily since the early-2000s, after the twin shocks of the GFC and Covid.
Chart 1: Selected gross govt debt/GDP ratios.
Source: IMF, data to end-2024. Past performance is no guarantee of future returns. Please see the end for important legal disclosures.
…as nominal and real yields increased sharply across most WGBI constituents
Longer yields have increased to post-GFC highs since 2021-22 despite recent interest rate cuts (Chart 2). This follows a protracted period of low yields in which investors seemed prepared to give G7 sovereigns the benefit of the doubt for higher debt/GDP ratios, on the view they had increased because of the GFC and Covid shocks, and it was temporary. QE also suppressed nominal and real yields, and debt service costs.
Chart 2 : Selected G7 nominal yields since Covid
Source: FTSE Russell data to June 13, 2025. Past performance is no guarantee of future returns. Please see the end for important legal disclosures.
Curves have steepened and term premia have increased
Bearish curve steepening and increases in the term premium in govt bonds are also evident since 2022-23. This is notable in longer dated US Treasuries in the last 12 months, as Chart 3 shows.
Chart 3: US yield curve gradients since 2020
Source: FTSE Russell, LSEG. Data to June 13, 2025. Past performance is no guarantee of future returns. Please see the end for important legal disclosures.
Breakdown of monetary/fiscal policy co-ordination may help explain this…
Another key factor here may be the relationship between monetary and fiscal policy. Sargent and Wallace’s famous paper[3] explored scenarios in which the ability of a central bank to control inflation may be compromised by fiscal policy. But the modern orthodoxy is that independent central banks will be supported by passive fiscal policy; the so-called consensus assignment[4].
…with fiscal policy remaining stimulative even during recent monetary tightening
But this consensus assignment may be breaking down, with fiscal policy remaining stimulative, even in monetary tightening phases. So, investor uncertainty over fiscal regimes may have driven higher term premia and bear steepening, due to fears about higher debt issuance[5]. The US shows one of the sharpest increases in debt/GDP, despite stronger growth. Removal of the last US AAA-rating from Moody’s in May did not help investor sentiment either, but Chart 4 on Sovereign credit ratings shows AA is the new AAA, with AA now having a much higher weight than AAA in both indices. The DCWGBI also has higher credit quality than WGBI, consistent with underweighting riskier sovereign debt.
Chart 4: Sovereign Credit Rating weights in DC WGBI and WGBI
Source: FTSE Russell, as of May 31. Past performance is no guarantee of future returns. Please see the end for important legal disclosures.
Sovereign weights show a 15% US underweight in the DCWGBI
Relative changes in debt/GDP ratios and debt service costs drive country weights in the DCWGBI index, so higher US rates versus Europe and APAC and a higher US debt/GDP ratio drove a US underweight of 15%, versus WGBI. This far exceeds the 3% underweight of JGBs. In contrast, Scandinavian govt. bonds have an overweight in the DCWGBI of 6%, reflecting lower gross debt/GDP and debt service costs. China’s weight in both indexes grew sharply since WGBI inclusion in 2021, and exceeds 10% in the WGBI, but the increase in gross debt/GDP since Covid means the DCWGBI weight is 2% lower than the WGBI weight. Other DCWGBI weights are much closer to the WGBI weights, as Table 1 shows.
Table 1: Selected DCWGBI country weights versus WGBI
| Index | Effective duration | Wghtd. average life | US weight | Japan weight | UK weight | China weight | France weight | Combined Sweden, Norway & Denmark weight |
|---|---|---|---|---|---|---|---|---|
| Debt capacity WGBI | 6.97 | 9.4 yrs | 26.50% | 6.96% | 4.60% | 8.10% | 5.10% | 6.30% |
| WGBI | 6.95 | 9.5 yrs | 41% | 10.10% | 5% | 10.15% | 6.70% | 0.50% |
Performance returns show DCWGBI delivering stronger returns versus WGBI over 5 yrs…
Finally, since the beginning of 2025, DCWGBI has outperformed WGBI by about 1.5% in USD, as the Table 2 shows. This owes very little to duration as the Table 2 shows. If debt sustainability concerns deepen, the relatively short average life of the US Treasury market may raise concerns about refinancing costs with higher coupons and maturity walls. Another important factor is a weakening US dollar since DCWGBI underweights the dollar by 15% against WGBI, due to the lower Treasury weighting.
Table 2: Performance of WGBI versus DCWGBI.
Source: FTSE Russell, as of May 31. Past performance is no guarantee of future returns. Please see the end for important legal disclosures.
….and DCWGBI also outperformed on a longer time horizon
DCWGBI has outperformed WGBI by about 70 bps annually in the last 5 yrs, and the outperformance has widened since 2025, perhaps due to increased investor concern about debt sustainability, and default risks, as in the 2010 Eurozone sovereign debt crisis. This outperformance is shown in Chart 5.
Chart 5: Longer run performance of WGBI versus DCWGBI.
Source: FTSE Russell, as of May 31. Past performance is no guarantee of future returns. Please see the end for important legal disclosures.
Flexibility to capture relative changes in debt sustainability symmetrically important
Finally, the advantage of indices like the DCWGBI is their flexibility to capture both deterioration and improvement in gross debt/GDP ratios and debt service costs by adjusting weightings. In the pre-GFC era, when gross debt/GDP ratios were nearer 50% than 100%, this capacity was less important, since sovereign debt sustainability was a less critical issue for investors.
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