High U.S. Public Debt Raises Risk of Treasury Market Stress
The estimated three-month probability of severe Treasury market disruption rises to 3.8% when public debt-to-GDP is high, versus 0.3% when it is low.
High government debt and the growing role of nonbank financial institutions are increasing the risk of dysfunction in sovereign bond markets, with the estimated probability of a severe U.S. Treasury market stress event rising to 3.8% within the following three months when public debt-to-GDP is high, compared with 0.3% when the ratio is low.
Nonbank financial institutions, including hedge funds, insurers, pension funds, money-market funds and open-ended bond funds, held 53% of sovereign debt in advanced economies in 2025, up from 44% in 2021. NBFIs became the largest holder group as government debt levels neared record highs.
A larger NBFI share is associated with higher market-dysfunction risk, but no separate probability was provided.
“High levels of government sector debt are expected to worsen future government debt market liquidity conditions in general, including by increasing the risk of market dysfunction,” Mathias Drehmann and Sonya Zhu wrote.
Some NBFIs provide stable, long-term demand for government bonds. But leveraged or liquidity-dependent institutions can intensify selling during periods of stress. A fiscal shock can push yields higher, while tighter margin requirements reduce intermediaries’ ability to take risk and forced deleveraging further damages market liquidity.
During the 2022 U.K. gilt episode, forced sales by liability-driven investment funds produced peak price discounts of about 7%. Roughly half of the post-announcement price decline reflected fire sales beyond the underlying fiscal surprise.
Hedge funds’ U.S. sovereign-debt exposures, measured relative to GDP, have more than doubled since 2022 as leveraged relative-value strategies expanded. Banks’ share of sovereign debt holdings remained broadly stable at about 20% over the five years through 2025.
In 2025, the median ratio of banks’ sovereign exposures to Tier 1 capital was about 180% in emerging markets and just under 100% in advanced economies. Banks’ direct sovereign exposures had become less important in explaining bank-sovereign risk co-movement, while their exposures to NBFIs had become a significant factor.
“A large non-bank financial institution footprint heightens the risk of market dysfunction while also making very favourable liquidity conditions more likely,” Drehmann and Zhu wrote. The estimates describe potential risks and probabilities but do not predict that a stress event will occur or identify a specific trigger.
