Bridgewater Associates has warned that rising government spending and near-term inflation pressures linked to AI are creating an increasingly challenging outlook for global bond markets, prompting the hedge fund to favour equities over fixed income, according to a report by Bloomberg.

The report cites the Connecticut-based macro manager’s co-chief investment officers — Bob Prince, Greg Jensen and Karen Karniol-Tambour — as saying in a recent investor note that a surge in sovereign debt issuance to fund national priorities such as defence, infrastructure and economic self-sufficiency risks overwhelming investor demand.

The CIOs cautioned that while there is no fixed threshold that determines when government debt levels become unsustainable, several developed economies are “getting dangerously close” to the limits of what markets are willing to absorb.

“It depends on how willing buyers are to hold an ever-expanding supply of debt and what it takes to entice the next marginal buyer,” the trio wrote, highlighting growing concerns around supply-driven pressure on sovereign bond markets.

The warning follows recent volatility in Japanese government bonds, which sold off sharply as Prime Minister Sanae Takaichi advanced plans for fiscal stimulus. Bridgewater noted, however, that Japan is not an outlier, with many governments globally pursuing debt-financed expansionary policies.

The firm also flagged renewed inflation risks, arguing that inflation may be underestimated by investors despite easing price pressures in recent quarters. While large-scale investment in artificial intelligence could prove disinflationary over the longer term, Bridgewater believes it is adding inflationary pressure in the near term through rising demand for semiconductors, energy, specialist labour and infrastructure.

According to the Co-CIOs, stronger growth linked to AI investment is supportive for corporate earnings, but simultaneously risks pushing inflation higher at a time when governments are issuing increasing volumes of debt — a combination likely to drive bond yields upward.

“With limited room for central banks to lower rates proactively, and with quantitative tightening continuing in Europe and Japan, with global spillovers, we see a challenging environment for bonds and favour equities,” the note said.