The first column in this series of three columns profiled the Moody’s downgrade of the US Treasury, provided a rudimentary theory of the relationship between the dollar’s reserve role and sovereign ratings, and distinguished sovereign risk from country risk (McCauley 2025a). The second column highlighted the empirical findings to date, finding that the rating agencies explicitly rely on the asserted privileged position of the US Treasury in global bond markets arising from the reserve role of the dollar (McCauley 2025b).
This third column asks what market prices reveal about market participants’ views of whether and how the dollar’s reserve role supports the US Treasury’s credit-worthiness. Market prices are sending mixed signals about the acceptance of the rating agencies’ opinions. Strong evidence points to the US Treasury’s no longer receiving special treatment in global bond markets.
The column closes with possible interpretations and a warning. Policy would err if it were set on the theory that the rest of the world must or will buy any amount of bonds that Treasury Secretary Bessent flogs. The risk is that market participants lend Uncle Sam enough rope for him to hang himself.
Does the dollar’s reserve role confer an exorbitant privilege? Market views
Market participants seem to be of two minds with respect to the Moody’s, S&P and and Fitch rating of the US Treasury. “Right on, right on,” says the spread between interbank rates and Treasury rates at the 30-year tenor. “No way José,” says the sovereign credit default swap market.
This killer graph (Figure 1) suggests that market participants strongly agree with Moody’s et al. It shows a tight cross-sectional relationship between credit rating levels on the horizontal axis, ranging from the best on the left to the worst on the right, and the spread that the government must pay on its debt over expected overnight interbank rates at the 30-year maturity. The US Treasury’s 30-year spread over interbank rates is very near the least squares line.
Figure 1 Sovereign credit ratings and asset swap spreads
Spreads between 30-year government bond and overnight index swap rate
Note: Figure uses bid side prices for Treasury bonds and a mid-swap rate for the overnight index swap (OIS). Average over the previous month. DM = developed markets covered by J.P. Morgan strategists.
Source: Barry et al. (2025).
The big outlier is the 30-year Japanese government bond, on which the Japanese government gets away with paying less than one would expect. This is probably owing to the Bank of Japan’s having bought about half of this Japanese government long bond.
By contrast, this killer graph by the energetic Torsten Slok (Figure 2) suggests that credit default swap (CDS) market participants strongly disagree with Moody’s assessment of the US Treasury’s credit. “U.S. sovereign spreads [are] at BBB levels,” headlines Torsten.
Figure 2 Sovereign credit ratings and credit default swap (CDS) spreads
Note: US rating counterfactually shown on the regression line; actual rating is AA+.
Source: Slok (2025).
The breadth, depth, and liquidity of the US Treasury and interest rate swap markets (Kreicher et al. 2017) compel us to give more weight to the thumbs-up on Moody’s rating in the asset swap market than to the thumbs-down in the CDS market. That said, a recent Chicago Fed study found that activity in US sovereign CDS quickened during the debt ceiling debate in 2023 (Benzoni et al. 2023).
And the Depository Trust Clearing Corporation (DTCC) reports that between 21 December 2024 and 21 March 2025, US sovereign CDSs traded $75 million per day. This was less than Mainland China at $500 million, Brazil at $450 million, Turkey at $325 million, South Africa at $300 million, Korea at $225 million, Saudi Arabia at $250 million, Italy at $200 million, Colombia and Indonesia at $175 million, Chile, France, Panama, Peru and the Philippines at $100 million, and was tied with Malaysia. Let’s keep an eye on side bets on a US Treasury credit event. A safe prediction is that volumes are up since late March!
Nangle argues that Moody’s cannot in all consistency long sustain the Aa1 rating for the US Treasury with anything like current policy settings. In Figure 3, the Congressional Budget Office projects the US Treasury’s debt-to-GDP ratio to rise to 118% of GDP by 2035, surpassing its WWII peak. Interest costs are rising rapidly as debt that was contracted during effectively zero short-term interest rates matures and is refinanced at 4–5%. Indeed, the US government interest payments exceeded its military spending in 2024, crashing through the ‘Ferguson limit’ taken to portend imperial decline (Ferguson 2025).
Figure 3 US federal debt held by the public (percentage of GDP)
Source: CBO (2025).
US Treasury debt growth is pushing it inexorably to the northeast on the Barry et al. and Slok graphs above. By contrast, Italy’s general government debt on one Ministry of Economy and Finance projection could decline to 118% of GDP in 2035 (Ministry of Economy and Finance 2024). Even with its recent upgrade of the outlook to positive for Italy (here), Moody’s continues to rate the Republic of Italy a Baa3 credit, eight notches below the US Treasury. Uncle Sam, meet La dolce vita.
Of course, given the euro (which US economists tend to consider a foreign currency to Italy despite Target2; Cecchetti et al. 2012), Italy’s government does not have access to the printing press, unlike, some say, the US Treasury. On Bloomberg, Professor Stefanie Kelton, leading exponent of Modern Monetary Theory (Epstein, 2019) dismissed the idea that the US government could have any problem with its ability to pay, given that its debt is entirely denominated in its sovereign currency. Similarly, widely followed New York University Stern School Professor Aswath Damodaran writes here:
Through time, governments have often been dependent on debt to finance themselves, some in the local currency and much in a foreign currency. A large proportion of sovereign defaults have occurred with foreign currency sovereign borrowing, as the borrowing country finds itself short of the foreign currency to meet its obligations. However, those defaults, and especially so in recent years, have been supplemented by countries that have chosen to default on local currency borrowings. I use the word “chosen” because most countries have the capacity to avoid default on local currency debt, being able to print money in that currency to pay off debt, but chose not to do so, because they feared the consequences of the inflation that would follow more than the consequences of default [italics added].
Does anyone really choose to go off the cliff playing the game of chicken, a game that the Congress intermittently plays with the debt limit (Geist 2021)?
Both monetary theorist and finance professor rely on central banking á la Hjalmar Schacht (1955) or Marriner Eccles (1951). These were respectively Hitler’s and Roosevelt’s central bank heads.
But would the Fed fund the US Treasury in an extreme situation? As a matter of fact, Chairman G. William Miller, Paul Volcker’s hapless, short-lived and shorter predecessor, did not prevent the US Treasury from defaulting on maturing Treasury bills in the spring of 1979, as recounted by Zivney and Marcus (1989).
In sum, Moody’s and S&P both seem to lean heavily on the dollar’s reserve role in rating the US Treasury. However, there is strong evidence that the global bond market stopped giving special treatment to the US Treasury’s credit some time ago.
Treasury bonds have lost their specialness
Let’s return to the asset swap market to see the powerful evidence of Uncle Sam’s loss of ‘specialness’. It used to be that if an investor swapped the bonds of a well-rated sovereign like His Majesty’s Government or the German Federal Republic into US dollars, then the investor would receive a higher interest rate than offered on the US Treasury bond of the same maturity. US Treasury bonds were special.
No more. Here is the late-breaking bulletin: “Long-term US Treasury bonds have lost their ‘specialness’”. So found Wenxin Du, Joanne Im and Jesse Schreger in a paper that deserves wider readership (Du et al. 2018). Here is their killer graph:
Figure 4 The US Treasury premium at the 5-year tenor, in percent
Average advanced economy swapped government bond yields less US Treasury yields
Source: Du et al. (2018).
On this showing, Treasury bonds used to command a premium, only to lose it sometime after the Great Financial Crisis. What is more, an update of the graph into 2021 (Figure 5) shows if anything that global bond market investors have lately often assigned a discount to 5-year US Treasury bonds. (Note that the graph shows that US Treasury bonds trade at a premium to those of emerging market (EM) governments, but by transitivity, other advanced economy government bonds trade at still larger premia to EM government bonds.) Why?
Figure 5 Updated US Treasury premium at the 5-year tenor, in basis points
Average swapped government bond yields less US Treasury yields
Note: EM = emerging markets. Entitled in the original “Mean five-year government bond CIP deviations”; CIP = covered interest parity.
Source: Du, Im and Schreger.
Du, Im and Schreger find that heavy relative issuance of debt by the US Treasury has kissed goodbye to the scarcity that heretofore allowed the US Treasury to command a premium. Their measure of relative supply sensibly nets out government bonds held by domestic central banks – relevant to the QT debate. But perhaps the concept should be the supply of bonds held by other than central banks (McCauley 2017) – so that bonds held in official reserve portfolios are excluded too. That a smaller fraction of US Treasury debt (17%) is held in official reserves now than in 2011 (40%; see Figure 6 and Bordo and McCauley 2025) is a finding that complements the one offered by Du, Im and Schreger.
Figure 6 Share of US Treasury debt ex-Fed held by foreign officials
Interpretation
One interpretation is that market participants, academic economists, and rating agencies alike grossly exaggerate the exorbitant privilege that the reserve role of the dollar conveys to the US economy. This was argued ten years ago (McCauley 2015), and the Du, Im and Schreger evidence has added weight to the argument. Similarly, the safe assets shortage hypothesis that foreign exchange reserve managers’ demand for US Treasury bonds has forced the US government to run large deficits has suffered a bad last ten years (Bordo and McCauley 2025).
Another interpretation is that exorbitant privilege operates in quantities rather than interest rates. Such is Stephen Miran‘s view, cited above. Figure 6 suggests that the reserve role of the dollar is doing the US Treasury less service than it has for a generation.
A final interpretation is that the exorbitant privilege lies elsewhere: in the Fed’s role as conductor of the international orchestra, leading central banks in setting global financial conditions. This is a soft version of Charles Kindleberger’s view of the dollar standard (Mehrling 2022), under which the Fed sets the global interest rate and other central banks set their policy rate as a spread. 1 There is some evidence, however, of the bond market current flowing from Europe to the United States in recent years (Borio 2019).
Grounds for caution
Whatever the right interpretation, it would be unwise to set policy on the theory that the rest of the world must or will buy any amount of bonds that Treasury Secretary Bessent flogs. If the safe assets version (Farhi et al. 2011) of the Triffin dilemma (Portes 2012, 2013; Bordo and McCauley 2019, 2025) holds that the reserve role of the dollar forces the US Treasury to run unsustainable deficits, then perhaps Moody’s and S&P are arguing that the reserve role of the dollar allows the US Treasury to run unsustainable deficits. To paraphrase who knows whom (Safire 1987), the risk is that bond investors lend Uncle Sam enough rope for him to hang himself.
Author’s note: I thank Claudio Borio and Frank Packer for discussion.
References
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