Please see below article received from EPIC Investment Partners this morning, which explains the link between defense spending and the bond market.
The size of militaries
According to the World Population review China has the largest military with 2m people. India has 1.5m, the US and North Korea each with 1.3m, Russia 1.1m and Ukraine 730,000. When it comes to military spending power the US is dominant, accounting for 37% of the world total, three times the amount of China in second place.
Ukraine has the largest military in Europe because it is fighting a war. Russia is on a war footing. Both these economies are spending large proportions of their budgets on defence equipment and are increasing their weapon making capacities. China is building a large military capability to be able to intervene widely, with figures that may be understated. Germany, France, Italy, UK and Canada are all under pressure to increase spending as NATO members whilst Japan and South Korea are raising their budgets as allies of the US seeking to deter Chinese expansion.
In 2024 the US spent $1 trillion on defence, followed by China at $314bn and Russia at $149bn. All others were each under 9% of the US total spend. The US continues to lead in technology and development of new weapons, though China is now a serious rival with her own ability to innovate.
Defence shares have boomed on the back of planned expansion of budgets, with companies now needing to translate the increased order books into higher turnover and profits to justify the advances. Meanwhile bond markets are factoring in substantial increases in some defence budgets at a time when most countries need to cut their high deficits to reassure savers lending them money.
Defence budgets
The US, EU and UK are all embarking on further growth in their defence budgets. NATO has set a new target of 3.5% of GDP by 2035, with related expenditures on relevant national infrastructure at an extra 1.5%. Most countries will struggle with hitting these new targets.
The US President is seeking a 13% budget increase for 2026 over 2025. He wishes to strengthen US industrial capabilities to make weapons, improve US defences against missile and drone attack (Golden Dome), start the F-47 new fighter plane and improve nuclear capabilities. He is also scaling back the F-35 programme and demanding various efficiency improvements.
Germany is doing the most to increase its spending, starting from a low base and with a lower stock of state debt to GDP. The German government set up a €500bn fund to supplement annual defence spending over a period of years. The current German government removed the debt brake from borrowing needed to boost defence spending. As a result, it plans to raise spending to 3.5% by 2029, when it was only 1.4% in 2022. It plans €649bn over 5 years, ramping up from €86bn this year. It will continue to provide weapons to Ukraine.
France is very constrained by its excessive debts and large deficit. The President has recently announced his wish to increase the spending set out by the Loi de programmation militaire in 2026 and 2027. The budget allows modest growth in defence against a background of the last PM seeking overall budget cuts of Euro 43.8bn hitting welfare and the civil service. The defence increase is not helping get the budget through as the government seeks to confront the Parliament with the need to cut the deficit. Given the budget pressures there is not going to be much increase in the €53bn budget for defence, keeping it around 2% of GDP.
The UK has always stayed above the 2%. 23 out of 32 NATO states have now got to that level or above. The UK government plans to increase spend to 2.4% of GDP this year and 2.5% next year. It is leaving it until the next decade to get to 3% and above. Current plans see the £56.9bn budget of last year rising to £59.8bn this.
Deficits and bond issuance
The UK and US have to pay more interest on new borrowings than the Europeans or Japanese.
The UK has the highest long term borrowing rates as fears are more pronounced over the state of the national finances. The Chancellor raised substantial money in extra taxes last year in the budget, only to see the deficit go up again as a result of growth slowing and spending on welfare and public services rising by far more than the tax increases. With a policy for growth that depends on increased defence work, and a foreign policy based around the European wing of NATO taking on more responsibility for European defence and for assisting Ukraine, the government is having to look at other areas to cut back.
Germany with a lower debt to GDP is able to borrow more to pay for the shells. The USA continues to get away with a very high debt and deficit, and will be adding to it with extra defence, though seeking big cuts in some other areas like net zero policy. France is the most stressed of the major European economies, with a high debt and deficit. France has to pay considerably more to borrow than the Euro average given the budget risks. France will do the least to increase defence as a result.
Conclusion
The bond markets will continue to warn the UK and France that their governments need to take more action to rein in deficits. Both countries will find it is difficult to cut spending and will be looking to see what extra taxes they can impose without too much more damage to growth. Share markets have adjusted to the improved relative outlook for defence companies, whilst bond markets have made an understandable assessment of different levels of risk of budget strains. Both France and the UK have work to do to reassure more; while the US economy is slowing so it does allow rate cuts.
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Chloe
25/09/2025