Understanding Current Treasury Market Volatility
For decades, the United States has enjoyed low borrowing costs largely due to the U.S. dollar’s role as the world’s reserve currency. Since a significant portion of global trade is conducted in U.S. dollars, countries have held large reserves of dollars, and consequently, U.S. debt, to mitigate exchange rate risks. Additionally, U.S. Treasuries have historically been viewed as low-risk investments, especially in times of economic uncertainty. However, this dynamic appears to be shifting in recent weeks as treasury yields have risen, even during a period typically associated with risk-off sentiment.
As of the end of Q3 2024, approximately 24% of U.S. debt was held by foreign entities, including governments, banks, and sovereign wealth funds[1]. As of March 2025, the largest foreign holders of U.S. debt were Japan ($1.13 trillion), the United Kingdom ($779 billion), and China ($765.4 billion)[2]. While international ownership of sovereign debt is standard, and the U.S. share is lower than in countries like France, where foreign investors hold around 50%[3], it nonetheless introduces risk. A significant sell-off by a large holder could drive yields higher. Analysts estimate that a $300 billion reduction in foreign holdings could raise the five-year yield by about 33 basis points[4].
Geopolitical tensions add to this vulnerability. Foreign bondholders might leverage their positions as bargaining chips. Additionally, foreign countries will undoubtedly prioritize their national interest if need be. Current concern centers around Japan, which recently experienced a surge in domestic yields and weak auction demand amid concerns about increased government spending[5]. To stabilize its bond market, Japan may need to sell U.S. Treasuries, potentially pushing U.S. yields higher and weakening the dollar, impacts that would also ripple through equity markets, especially in the U.S. and emerging economies.
On May 16, Moody’s downgraded the U.S.’s credit rating from Aaa to Aa1. The move was largely expected as they’re the last of the three major credit rating agencies to do so and comes after they changed their outlook on U.S. debt to negative in November 2023. Standards and Poor was the first to downgrade the U.S back in 2011, when it did so in response to a dispute over the rising debt ceiling, followed by Fitch in 2023[6]. Moody’s cited the U.S.’s growing debt, large budget deficit and inaction in response to it, as well as high interest payments as reasons for the move[7].
Rising interest payments have been a growing concern in recent years as rates have risen from the pre-COVID low-rate environment, now exceeding GDP growth. Unsurprisingly, this dynamic is unsustainable over a prolonged period of time due to the unprofitable nature of paying more to borrow than you produce. Moreover, Moody’s projects that federal interest payments could take roughly 30% of revenue by 2035, up from 18% in 2024 and 9% in 2021[8]. Meanwhile, the budget deficit continues to increase. In 2024, the deficit reached $1.8 trillion, the fifth consecutive year it exceeded $1 trillion[9]. The Government Accountability Office projects that unless there’s a change in spending habits, public debt will be double the size of the national economy by 2047[10].
When looking to explain recent treasury volatility, we could initially assume that the market’s reaction was policy driven. Yields on 3-year notes, in particular, saw large week-over-week increases. However, while some tariffs have been rolled back and markets have stabilized, credit default swaps on U.S. debt (essentially insurance against default) have not significantly improved[11]. This suggests that investors remain concerned with long-term fiscal solvency beyond short-term economic policy.
Complicating the picture further, current moves in the treasury market are directly counterproductive to Treasury Secretary Scott Bessent’s 3-3-3 goal which seeks to reduce the fiscal deficit to 3% of GDP, increase oil production by 3 million barrels per day, and sustain economic growth at 3%[12].
With this in mind, U.S. debt nonetheless remains firmly in the high-quality category and a safe investment. Overall, treasuries still play an essential role in a diversified portfolio due to their liquidity, safety, and strong diversification benefits. Importantly, demand for U.S. Treasuries is closely tied to the global demand for U.S. dollars[13] for which there’s no realistic alternative in global trade, reinforcing their position as a foundational asset in global markets. For these reasons, Treasuries remain a reliable tool for risk management and portfolio construction, even in the face of evolving fiscal and geopolitical concerns.