Quora Answer: Is the Risk of Fiscal Crisis Due to the National Debt Priced into Current US Interest Rates?

The following is my answer to a Quora question: “Do you think the risk of a fiscal crisis due to the national debt is priced into current US interest rates?”

No.  US interest rates are not a risk premium on fiscal sustainability.  They are a response to inflation.  The Federal Reserve’s dual mandate is price stability and maximum employment.  Sovereign credit risk does not appear in that mandate.  When the Federal Open Market Committee sets the Federal Funds Rate, its primary input is the Consumer Price Index — not the Congressional Budget Office’s debt trajectory projections.

A market that prices fiscal risk into rates is a market making a judgement about the US government’s long-term ability to service its obligations.  The US rate market is doing something categorically different.  It is making a judgement about whether current monetary conditions are tight enough to bring inflation to 2 per cent.  The US$36 trillion national debt is background noise, not a pricing input.

The Federal Reserve raised the Federal Funds Rate from near zero in March 2022 to 5.25 to 5.50 per cent by July 2023.  This was a response to inflation reaching 9.1 per cent in June 2022 — the highest since November 1981.  The national debt was over US$30 trillion throughout this period.  The rate decisions did not reference the debt level.  They referenced CPI, PCE deflator, and labour market data.

The Federal Reserve then cut rates three times in the second half of 2024, reducing the Federal Funds Rate to 4.25 to 4.50 per cent.  At that point, the national debt had crossed US$36 trillion.  The cuts were made because inflation had declined toward target.  The fact that the debt had increased by trillions during the hiking cycle did not affect the cutting decision.  The Federal Reserve can, and does, set rates at levels inconsistent with what sovereign credit risk would demand if the market were pricing it.

The Moody’s Downgrade

Moody’s downgraded the United States from AAA to Aa1 in May 2025 — the last of the three major credit rating agencies to strip the US of its top rating, following Standard & Poor’s in 2011 and Fitch in 2023.  The rationale was the trajectory of the national debt and the government’s inability to agree on fiscal consolidation.

US Treasury yields moved modestly and briefly.  The dollar remained the world’s primary reserve currency.  Foreign central banks continued purchasing Treasuries.  The 10-year yield was 4.5 per cent before the downgrade and 4.5 per cent shortly after.  The S&P downgrade of 2011 produced a similar non-event.  Standard & Poor’s removed the AAA rating in August 2011 — and US Treasury yields fell, because investors fleeing equity market volatility ran into Treasuries as the haven.  The downgrade of the issuer caused investors to buy more of the issuer’s debt.  Credit risk theory does not cover this scenario.

It is not that the market trusts the US government’s fiscal discipline.  It is that the alternatives are worse.  The dollar’s reserve currency status means that global demand for dollar-denominated assets is structural and not driven by yield.  Central banks hold Treasuries because they need to hold something liquid, globally accepted, and available in sufficient scale — not because US fiscal policy is admirable.

The Doom Loop

The projection is that the US debt-to-GDP ratio will rise — it is currently approximately 122 per cent, and the CBO projects it reaching 122 per cent by 2034 on the current trajectory.  Investors demand a higher yield to compensate for the increasing risk.  Higher yields increase the cost of servicing the existing debt.  Higher debt service costs increase the deficit.  A larger deficit requires more borrowing.  More borrowing pushes yields higher.  The spiral continues until the fiscal position becomes unsustainable.

This doom loop has been predicted for the United States with remarkable consistency for approximately forty years.  It has not materialised.  The primary reason is the reserve currency mechanism.  The US can issue debt in its own currency to investors who need that currency.  A doom loop requires investors to lose confidence and demand compensation.  Structural demand from reserve managers who need dollar assets regardless of yield prevents the confidence loss from reaching the threshold required to trigger the spiral.

This does not mean the risk is zero.  It means the risk is deferred — and the deferral mechanism depends on the continued willingness of the world to treat dollar assets as the default store of value.

That willingness is eroding.  The dollar’s share of global foreign exchange reserves has fallen from 71 per cent in 1999 to approximately 56 per cent in mid-2025.  Central banks are diversifying into gold — purchasing over 1,000 tonnes annually for three consecutive years.  Gold overtook US Treasuries in total central bank foreign exchange reserve holdings in early 2026.  The weaponisation of dollar assets against Russia in 2022 accelerated this diversification among non-aligned central banks.

The erosion is slow.  It is measurable.  Each percentage point of reserve share lost reduces the structural demand for Treasuries and marginally increases the yield required to attract the marginal buyer.  Over a decade, those basis points compound.

The Inflation Mechanism versus the Solvency Mechanism

The critical distinction is between two different mechanisms by which fiscal stress could eventually manifest in rates.  The first is the solvency mechanism — markets conclude the US cannot or will not service its debt and demand a risk premium.  This is the fiscal crisis scenario.  It has not happened and, given the reserve currency architecture, is unlikely to happen suddenly.

The second is the inflation mechanism — the US government finances its deficit through money creation rather than borrowing; the monetary base expands, inflation rises, and the Federal Reserve responds by raising rates.  This is not fiscal risk being priced into rates.  This is fiscal irresponsibility causing inflation, which the Federal Reserve then addresses through its standard inflation mandate.

The United States has been operating closer to the second mechanism than the first.  The fiscal stimulus of 2020 and 2021 — US$5 trillion deployed in response to COVID-19 — contributed materially to the inflation surge of 2022.  The Federal Reserve’s subsequent rate hikes were the inflation response, not the fiscal risk response.  The distinction is not semantic.  It determines whether the rate increases represent a market assessment of US sovereign creditworthiness or simply a central bank doing its job.

The answer is the latter.  US interest rates reflect inflation, not fiscal risk.  The fiscal risk will eventually manifest — but it will most likely do so through the inflation channel rather than through a sudden repricing of sovereign credit.  The Federal Reserve will raise rates.  It will call it fighting inflation.  The underlying cause will be fiscal.  The mechanism will remain monetary.

By the time the market prices fiscal risk into Treasury yields — if it ever does — the question of whether it was priced in will be academic.  The more useful question, for investors positioning today, is whether they have sufficient non-dollar, non-Treasury exposure to absorb the adjustment when the inflation mechanism runs its course.  The answer, for most retail portfolios, is no.

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Terence Nunis | Executive Chairman, Equinox Zenith | Author, The 1% Playbook: The Billionaire Cheat Code