Is US Government Debt Getting Riskier?

Looking at the benchmark interest rate for 30-year US Treasury debt, long-term interest rates have been rising. Any price change might happen for a number of different reasons: 1) expectations of future inflation are causing investors in Treasury debt to demand a higher rate; 2) as US government debt continues to climb, the perceived risk of this debt is rising; 3) the surge in productivity that will come from recent developments in information technology is pushing up demand for capital, and thus pushing up interest rates; 4) The higher intereset rates aren’t a US phenomonon, but rather a global one, and thus need a global explanation; and more. Hanno Lustig makes the case for a risk-based explanation in “America’s Risky Debt: What Markets See That Policymakers Don’t (Aspen Economic Strategy Group, August 2026, forthcoming in The American Economy in a New Era, edited by Melissa S. Kearney and Luke Pardue).

Lustig lays out several pieces of evidence for a risk-based explanation. For example

If US Treasury bonds are perceived as safer than other assets, then the US government should be able to pay a lower interest rate than other borrowers. Up to about 2020, this pattern held true. But in recent years, investors seem to be viewing US Treasuries as very risky compared to alternatives; indeed, the Wall Street Journal reported last fall that some big US companies like Microsoft (MSFT) and Johnson & Johnson (JNJ) were able to borrow long-term at lower rates than the US government.

Another risk-related pattern is called “flight to safety”: basically, when stock market prices fall, or risk rises in some other way, investors head for the safe asset of US Treasury bonds. To put this another way, returns on stocks and bonds have a negative correlation. Again, this pattern held up to about 2020. Now the correlation has flipped, and returns on stocks and US Treasury bonds are moving together — which is what you expect of two assets exposed to similar risks.

Managers of reserves at central banks around the world used to treat US Treasury debt as the primary safe asset: “Foreign reserve managers treated US Treasurys as the dominant safe asset, allocating more than 70 percent of allocated world foreign-exchange reserves to dollar-denominated assets. … At longer maturities, global investors now seem to prefer the safety of foreign G10 bonds.” (The G10 is shorthand for a group of 11 high-income countries–they decided not to change the name after Switzerland joined many years ago.)

Behind the scenes, the effects are apparent. For example, as the US Treasury has had to pay higher interest rates on long-term borrowing, it’s been moving to shorter-term borrowing. A problem with shorter-term borrowing, of course, it that you are planning to roll it over–that is, borrow the money again and again. In doing that, the US government as a borrower is not locking in long-term rates as often, but instead is more exposed to fluctuations in short-term interest rates. An increasing share of US Treasury debt is being purchased by hedge funds, who in turn are using that debt as a basis for various strategies to make a buck, often with fairly short-term time horizons. These investors are not like, say, life insurance companies that have traditionally purchased long-term Treasury bonds as a way of making sure they could pay off long-term commitments to policyholders. If the hedge funds stop demanding as much Treasury debt, the interest rates on the debt will rise further.

As Lustig writes: “The marginal foreign holder of US Treasuries is no longer a central-bank reserve manager but a private, yield-sensitive investor: predominantly foreign banks, asset managers, and hedge funds … [T]hose Treasury investors with less price-sensitive demand have pulled back. The shortfall has been picked up by private leveraged investors whose demand is more elastic to yield and more fragile in stress.”

Lustig argues that the Federal Reserve has gradually, step by step, become entangled in keeping interest rates on Treasury borrowing lower than they would otherwise be. He argues that it’s time for the Fed to take a step back from the bond markets. If the US government is going to keep running enormous deficits, which means riskier borrowing, then the US government also faces the higher interest rates that result. None of Lustig’s evidence suggests that a catastrophe or crash in US Treasury debt is just around the corner. But it does suggest that some yellow warning lights are flashing in world financial markets about the rapid build-up of US government debt.