Sovereign debt

Securities issued by a national government to fund its spending, sold at auction to primary dealers and investors and then traded in a secondary market. Short dated issues are bills, longer ones are notes and bonds, and the return demanded by the market is the yield, which moves inversely to the price. Whether the government borrows in its own currency or in a foreign one is the single most important distinction in the asset class, because only in the first case can it always create the means of repayment.

Yields are set by four things pulling at once: the central bank's policy rate and the path expected for it, expected inflation over the life of the bond, the extra return demanded for committing money for a long period, and the market's assessment of the issuer's creditworthiness. Rating agencies grade that last component, and the boundary between investment grade and below is mechanical for some holders, whose mandates prevent them from holding what falls beneath it. The whole set of yields across maturities is the yield curve, and it is the reference from which corporate borrowing, mortgages and swap rates in that currency are priced.

Government debt is described as risk free in models, and that phrase is a convention, not a finding. Sovereigns have defaulted, restructured and inflated their obligations away, and a government that can create its own currency has exchanged default risk for inflation and exchange rate risk rather than eliminated risk. How much government borrowing pushes yields up, and at what level of debt it starts to matter, is one of the genuinely unsettled arguments in economics, which is why forecasts built on it disagree so widely.