What If Everyone Loses Confidence in US Dollar Treasury Bonds?
The special role of the Treasury market is in peril
Government debt, inflation and unpredictable policymaking are putting the world’s most important asset under threat, argues Mike Bird in a special report
What follows are extensive excerpts from Special Report: The US Treasury Market, a supplement in the June 6 2026 issue of The Economist. The report is well-written and illustrates its points with clear examples. The author is economist Mike Bird, currently the Wall Street editor at The Economist. A book review that I read recently suggests that Bird's The Land Trap: A New History of the World's Oldest Asset is worth buying (advice that I am following myself). And regardless of your politics you should consider subscribing to The Economist, if you have not done so already.
It is the nightmare scenario for any market: everyone rushes for the exits at the same time and trading seizes up. That kind of crunch was not thought to be possible in the most liquid market in the world. But in early 2020, as the covid-19 pandemic took hold and the global economy faltered, many companies, governments and individuals found themselves in need of immediate cash as their regular income dried up. The easiest asset to sell, precisely because of the supposed liquidity of the market, was American Treasury bonds.
Although Treasury prices usually rise in times of sudden stress in riskier markets, they instead began to slump, with few buyers on the other side of the wave of selling. Big banks, usually the biggest dealers in Treasury bonds, were feeling the pinch themselves, and so did not step in to facilitate the “dash for cash”. Suddenly, an investment considered to be the ultimate safe asset, against which many of the world’s other financial assets are priced, was becoming hard to sell. To stop the market from freezing up completely, the Federal Reserve had to start buying, eventually acquiring trillions of dollars in American government debt.
The episode was the opposite of what Alexander Hamilton had in mind in 1790 when, as America’s first Secretary of the Treasury, he convinced sceptical colleagues that the federal government should take on the war debts of the new country’s 13 states. The United States duly issued open-ended securities that paid 6% a year in interest—the first true Treasury bonds.
Discussions of how to price risk begin with the Treasury market
At the time, British government bonds were the world’s most easily traded financial asset, and Hamilton looked at London’s debt market with envy. Public debt, he felt, had to be secure and transferable. Such a market, he argued, attracts investors, and so reduces interest rates for everyone, not just the government. In modern terms, Hamilton dreamed of liquidity.
A market is liquid when an investor can buy or sell an asset whenever they want, safely and cheaply, with full knowledge of prevailing prices. In normal times no market on Earth promises more liquidity than the one for securities issued by the US Treasury. It is a near-$32trn colossus—vastly bigger than any other market for sovereign debt. The bonds are not just America’s safe asset, but the world’s. Discussions of how to price risk begin by comparison with the Treasury market. It is the lodestar of the global financial system.
Given its exalted status, it is striking how fast the Treasury market is changing. Over the past three years, the value of Treasuries outstanding has grown by 8% a year on average (see chart). Two decades ago America accounted for 38% of the government debt of the G7, a club of the world’s biggest rich economies. Now it accounts for 60%. In less than ten years the Treasury market is projected to grow to $50trn, over 60% bigger than today.
As the market has ballooned, the participants have changed, too. The most dependable investors—banks buying to satisfy regulatory requirements, foreign central banks building warchests for currency crises, or the Federal Reserve itself—own less than a third of Treasuries, the lowest share in 30 years. They have been supplanted by buyers seeking returns rather than security. Hedge funds borrow against Treasury bonds to turn tiny opportunities for arbitrage into bigger gains. Insurers and pension funds are also big buyers, but their appetite depends on yields elsewhere, fluctuating exchange rates and the cost of currency hedges.
A bonding moment
The return of inflation in recent years, meanwhile, has dimmed the appeal of Treasuries for investors who want protection from stockmarket sell-offs. Since 2021 the prices of stocks and bonds have often fallen at the same time, driven by fears of rising interest rates. It happened again this year. Between the start of America’s strikes on Iran and March 30th, the S&P 500 dropped by 8%, while yields on ten-year bonds rose from 4% to 4.3% (bond yields rise as their prices fall).
It is not just rising rates, however, that are undermining Treasuries’ status as a safe haven; it is also policy-making caprice. Last year yields again rose as stocks declined when Donald Trump imposed swingeing tariffs on American allies and foes alike. Some foreign investors worry that one day, a similarly pugnacious administration might tax or otherwise meddle with their Treasury holdings. The theatrical dramas surrounding congressional budget negotiations, in which one or other of the two big parties regularly threatens to force an unnecessary default, reinforce such concerns. So does the slow deterioration of America’s credit rating: last year Moody’s demoted the federal government from triple-A, its highest rank. The firm’s big rivals had already done so.
The changes affecting the market are cause for alarm
America’s regulators, still a capable lot, have not been blind to the risks. They have opened permanent channels to allow banks and foreign central banks to borrow against the value of their Treasuries, boosting liquidity. Soon, much of the trading in Treasuries and borrowing against them will be conducted through a central clearing house, reducing the risk of sudden blow-ups. But like cartoon characters rapidly laying new railway tracks to keep a speeding train on course, regulators are making these rules as the market grows and changes. How well the rules work will become clear only during the next period of immense stress.
And stress is becoming more common. There have been several worrying episodes in recent years, in addition to the dash for cash. In September 2019 and in March 2023 the Federal Reserve intervened in funding markets to restore liquidity. Each of the individual changes affecting the market—the rapidly mounting debt, the resurgent inflation, the quixotic policymaking, the intermittent seizures—is a concern for global investors. Taken together, they are cause for alarm.
The risk is not so much, or not chiefly, that America might default on its debt. Rather, this special report will argue, the fear is that the Treasury market might gradually forfeit its status as the guiding light of global finance. That would make it more expensive for America’s government to borrow. And since there is no good alternative to Treasuries, it would make the entire global financial system wobblier and riskier. ■
In 1974, soon after the first oil shock, William Simon, America’s treasury secretary, flew to Jeddah to sign a secret deal with the king of Saudi Arabia. Among other things, he promised the Saudi government preferential access to American Treasury bonds. In exchange, the regime agreed to invest some of its immense oil revenue in American public debt.
Three years earlier Richard Nixon had ended the dollar’s convertibility to gold, ushering in an era of floating currencies. Central banks found themselves having to manage exchange rates. Foreign states stocked up on Treasury bonds in part to stop their currencies from appreciating against the dollar. America’s government needed foreign buyers, too: the more customers for its debt, the lower the interest it had to pay.
America’s financial bureaucrats offered a sweet deal: the chance to bid for Treasuries at private auctions, with favourable tax treatment. Although the Saudis never became big buyers, foreign states bought $2.3trn of Treasuries in the 2000s, bringing their holdings to $2.9trn, after currency crises convinced Asian governments in particular that they needed stockpiles of dollar-denominated assets. If their currencies started sliding, the logic ran, they could stem the decline by selling Treasuries to buy domestic assets.
The largest stash was in China, which at its peak in 2013 owned $1.3trn in Treasury bonds. They were mostly held by the People’s Bank of China, which used purchases and sales of American government bonds to manage the value of the yuan. Many other countries did the same. In 2008 the share of American federal debt held by foreign governments peaked at 38%.
These purchases were a big boon. Among the largest estimates of their effect comes from Rashad Ahmed of the Andersen Institute, a think-tank, and Alessandro Rebucci of Johns Hopkins University. They suggest that an unexpected $100bn investment by a foreign government can lower ten-year Treasury yields by a percentage point when it occurs, declining to about half a percentage point after a year.
What is more, foreign governments do not invest in Treasuries to make money, by and large. They want dollar assets simply as a precaution, to help defend their currencies if need be. That makes them an enviably staid, dependable source of funding.
However, for almost 20 years, the role of foreign governments in the Treasury market has been slowly shrivelling. They now hold just 13% of Treasuries, the lowest share in 30 years. In part, that reflects central banks’ diversification. The dollar’s share in global foreign-exchange reserves has slipped from 71% in 2001 to around 57% last year. Some of the drop stems from the long-term strength of the dollar, since central banks tend to buy dollars when they are cheap and sell when they are expensive, to keep their currencies from appreciating or depreciating too much. But the fall is also a function of the broader range of currencies central banks now hold. Their hoards include more Swiss francs and Canadian dollars these days, in addition to their stash of euros, yen and pounds.
Some private investors are cutting their holdings of Treasuries
Foreign central banks have also become more hesitant to invest in Treasuries after witnessing the freezing of the Russian central bank’s foreign assets in the wake of Russia’s invasion of Ukraine. “It’s a Rubicon that’s been crossed,” says a member of the Treasury Borrowing Advisory Committee, a private-sector panel that advises the Treasury. “They’re afraid of the US government effectively confiscating their assets.” In a survey last year by UBS, a Swiss bank, 49% of reserve managers expressed concern about the weaponisation of foreign-currency reserves, up from 14% in 2023….
Debt of a salesman
The biggest reason for the fall in central banks’ share of Treasuries, however, has been the enormous expansion in the Treasury market. Over the past decade the world’s stock of foreign-exchange reserves has grown by a little more than $2trn; America’s federal debt has grown by $17trn. Even if every penny of new reserves had been held in dollars, America would still have needed to find lots of new customers for its debt.
Since 2023 foreign commercial investors have had bigger holdings of Treasuries than have foreign governments. They now own a little more than $5trn-worth, or about 17% of the market (see chart). Last year alone they added $545bn to their stash.
But private investors, naturally, are far more interested in returns than governments, and so make far more capricious investors. For most of the past 15 years, yields on Treasuries have been higher than on their equivalents in Britain, continental Europe and Japan, which generated prodigious appetite for American debt. That is no longer quite so true. Rising long-term yields have made government bonds elsewhere in the world an increasingly competitive alternative………
The scale of the Treasury market is mind-boggling. Some $1trn in securities change hands each day. Trillions more are used as collateral for short-term loans. Financial institutions of all stripes are involved: banks, central banks, high-speed traders, insurers, endowments, pension funds, hedge funds and so on.
It used to be that banks were the main facilitators of all this, acting as “market-makers” for other financial firms. As recently as 2009 about half of Treasuries with maturities of a year or more were bought at auction by the brokerage arms of investment banks, which then sold them on. But new regulations introduced after the financial crisis diminished banks’ role as intermediaries in the Treasury market, by requiring them to fund themselves with more capital to underpin such mundane transactions. Dealer banks now buy just 12% of Treasuries maturing in over a year at auction.
Another prolific buyer has helped to fill the void: hedge funds…..
NO FINANCIAL institution or government agency matters more to the Treasury market than does the Federal Reserve. The central bank’s responsibility for financial stability and monetary policy has made it a mammoth buyer of Treasuries in this century, snapping up trillions of dollars’ worth after the global financial crisis in 2007-09 and again during the covid-19 pandemic. As a result, the Fed’s balance-sheet is far larger than it once was: it held less than $1trn in assets two decades ago, but now wallows in around $6.7trn.
Kevin Warsh, who became chairman of the Fed in May, considers this an unhealthy aberration…. In Scott Bessent, the treasury secretary, Mr Warsh finds a partner with similar views….
Mr Bessent currently hopes for the Treasury to issue more short-term debt (known as bills), since the interest the Treasury has to pay on such bonds is typically lower. That might help with the interest bill, but it would make America’s debt far more vulnerable to changes in interest rates, known as “rollover risk”….
Having a less active buyer in the Fed also increases risks to financial stability should there be a selling panic in Treasuries. Funding markets seized up in September 2019, causing the interest rates on overnight loans between large financial firms (known as the repo market) to spike dramatically, a problem which some economists attributed to the shrinking of the Fed’s balance-sheet. And the same market looked stressed again in the final quarter of last year, after the Fed had stopped shrinking its balance-sheet….
But a pivot to short-term financing would carry risks for Mr Bessent too. For one, letting longer-term Treasury debt held by the Fed mature without replacing it will probably raise the crucial ten-year Treasury yield, the most monitored benchmark in the world for long-term interest rates. The rates of interest on America’s 30-year mortgages are driven by the ten-year Treasury yield. Mr Bessent would struggle politically with any accord that is seen as raising costs for homeowners.
A shorter-term borrowing schedule also means that far larger quantities of debt must be issued at regular intervals, raising the stakes during any moment of funding stress. And if a lot of government debt is funded with Treasury bills, any increase in interest rates feeds through immediately into interest payments. That rollover risk would expose the federal government to much larger payments if rates rise suddenly……..
Around the time The Beatles were setting the standard for pop music, a group of academics—many of them future rock stars of investment—were doing the same in finance. They developed the Capital Asset Pricing Model (CAPM), which estimates the return investors should expect for taking on risks.
To work out that return on risk, they realised, investors would need to know what a riskless investment earned. An economist named William Sharpe aimed to find a “pure interest rate”. Six decades later the CAPM drives trillions of dollars of investment decisions; the “Sharpe ratio”, measuring risk-adjusted performance, is still used everywhere in finance. The supposedly riskless asset underlying these influential calculations is almost always a Treasury security.
What happens, then, if Treasuries are no longer deemed riskless? A lot more than the theory underpinning portfolio construction would be in jeopardy. Treasury-market prices are to investors like water to a fish. The assets are so fundamental to global finance that it is tough to imagine a world without them. It would be a world with higher interest rates, greater uncertainty and more risk. It would be more dangerous and difficult to navigate for investors and taxpayers not just in America, but in the rest of the world, too.
The world’s safest assets encourage much risk-taking. If investors own an asset that they know will benefit during a sudden market spasm, a sell-off or a recession, they will be happy to take greater risk elsewhere. “If you don’t have a safe asset”, says Markus Brunnermeier, an economist at Princeton University, “it leads to less lending to risky projects, to a supply shock.
What happens if Treasuries are no longer deemed riskless?
The privileges of being judged risk-free are visible across the economy. Banks have to hold far less capital against Treasuries than against other assets. The bonds can be used as collateral for loans in the enormous repo market, or to hedge risk in currencies and interest rates. The yields on any other dollar-denominated bond, issued by a firm, a foreign government or an American state or city are judged by their spread—how much higher they are than on Treasury bonds…..
Pricing the risk of corporate bonds is getting more difficult, too. The spread between AAA-rated corporate bonds and Treasuries of the same maturity has dropped to just 0.34 percentage points on average since the beginning of 2024, compared with an average of 0.64 percentage points from 2010-19. In September two bonds issued by Microsoft offered lower yields than Treasuries of the same maturity.
Such performance is common where debt is seen as high and risky, and it is likely to become more common in America. JPMorgan Chase, a bank, reckons the coming increase in federal debt—from 100% to 120% of GDP by 2040—may reduce spreads with the most creditworthy firms by half a percentage point…….
A self-sabotage of Treasuries might seem crazy. But issuers of the world’s reserve assets have changed the rules before. The American government devalued the dollar against gold in 1934 and 1971, and the British government did the same with sterling, in 1931 and 1949. In each case foreign bondholders were sacrificed for the sake of domestic financial security.
If the Treasury market were to lose its special status, the consequences would be more extreme for much of the rest of the world than they would be for America. Foreign investors have relied on Treasuries as a safe asset in their portfolios, where their alternatives were far more volatile government bonds at home. They have nothing to replace Treasuries with.