US debt vulnerability: how does the US compare to emerging markets?
Schroders has spent decades developing a successful model to spot early warning signs of a debt crisis in emerging markets. Here the same analysis is applied to the US.
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Upward pressures on US Treasury yields have intensified, although the repricing has remained orderly so far. We continue to assess the risk that these pressures could develop into a more disorderly adjustment, potentially triggering severe dislocations across global financial markets.
The encouraging news is that emerging market (EM) bonds and currencies have continued to demonstrate remarkable resilience despite the headwinds emanating from the US government bond market (Figure 1). We have previously outlined the factors underpinning this resilience and explained why EM debt, particularly the local currency debt sector, should continue to outperform strongly. As EM investors, we continue to assess the risk that upward pressures on US yields could spill over into EM assets. We view this as the main exogenous risk on the horizon that has not challenged so far our sanguine view on the outlook for several emerging markets, thanks to their favourable policy frameworks, stable macroeconomic conditions and with still appealing valuations on offer in some segments of the asset class.
Figure 1 – Developed Markets and EM yields
Source: LSEG DataStream, Schroders Economics Group, 7 September 2026
We are clearly now approaching a critical stage in the cycle for US and developed market government bonds. Traditional valuation metrics suggest that Treasuries have become significantly undervalued, with ex-ante real yields at historically elevated levels.
Our technical indicators also point to oversold and extremely under-owned US long-dated Treasury bonds. At the same time, recent US and global growth trends remain resilient, but show no clear signs of the overheating that would normally trigger another major bond market scare. Against this backdrop, US and developed market government bonds should arguably begin to stabilise, especially given the possibility of a short squeeze (a brief counter-trend rally in US bonds) potentially triggered by ongoing efforts by the US Treasury to contain the rise in yields.
Beyond these short-term technical dynamics, the key longer-term worrying issue is the market’s decisive shift towards scrutinising US policy credibility with the rapidly increasing risk that current developments could evolve into a fully-fledged fiscal crisis. In the absence of credible measures to consolidate the fiscal position, recent efforts by the US Treasury Secretary to stabilise yields are unlikely to succeed beyond the next few weeks at most. Indeed, without a convincing fiscal policy framework, these efforts may instead draw greater attention to the extremely unfavourable supply–demand dynamics at the long end of the US bond market, further undermining confidence in both the Treasury and the Federal Reserve.
In this report, drawing on our long-standing Schroders Country Vulnerability Model, we reassess the current situation in the US and compare it with that of key emerging markets. This comparison provides a useful framework for identifying and monitoring the early warning signs of a potential crisis.
It should be emphasised that the threshold for a balance of payments and/or fiscal crisis in the US is undoubtedly significantly higher than in any other country, given the reserve currency status of the US dollar. The dollar itself also provides a powerful adjustment mechanism: it can weaken or be weakened, with relatively limited immediate consequences for the US, to help rebalance the country’s external accounts, while debt could ultimately be monetised through renewed large-scale money creation. In our view, this is likely to be the eventual outcome of the current fiscal and monetary dynamics in the US.
Applying Schroders’ emerging market debt analysis to the US
In the late 1990s, drawing on our experience of the emerging market crises of that period, our team began developing a Country Vulnerability Model designed to identify and score early warning indicators of balance of payments and/or debt crises. Over the past 26 years, this framework has provided valuable insights and helped us navigate several EM sovereign crises and market dislocations, including the Global Financial Crisis and the Eurozone debt scares.
Our Country Vulnerability Model focuses primarily on the liquidity dynamics facing sovereign and private sector issuers. History shows that high debt-to-GDP ratios alone are not necessarily reliable predictors of a crisis. Based solely on this metric, the US and several developed economies would already have experienced deep fiscal crises by now. We have experience of many countries that have sustained very high debt levels for prolonged periods and, in certain cases, have even grown out of these difficulties through a combination of stronger and more balanced growth combined with restored trade competitiveness.
Conversely, some countries with relatively low debt-to-GDP ratios have surprisingly sometimes been drawn into debt and balance of payments crises as a result of short-term sovereign liquidity squeezes, often compounded by a heavy reliance on short-term foreign funding (Hot Money).
Figure 2 - Schroders' Country Vulnerability Model: how vulnerable is the US?
Source: Schroders, Bloomberg, LSEG Data and Analysis, 31 August 2026
As shown in figure 2, when assessing sovereign vulnerability, we therefore focus on six early warning factors that we believe are more reliable indicators of crisis. Each factor is scored from -2, indicating very high vulnerability, to +2, indicating low vulnerability, producing a total risk score ranging from -12 to +12.
Figure 2 shows that the US has currently an overall vulnerability score of -1, placing it firmly in the “blind run” phase of the macro-economic cycle, although not yet at the -2 to -4 score range that our historical analysis has associated with a very high risk of crisis. The factors contributing to this overall vulnerability score are shown in Figure 2 and can be summarised as follows:
- Growth dynamics: Our model currently places the US in the “imbalanced” stage of the growth cycle, while most emerging market economies are in either the adjustment or equilibrium phases. The “imbalanced” phase that the US is currently in describes a situation in which growth remains strong but is increasingly dependent on the rapid accumulation of large twin deficits. At a certain point, the build-up of these imbalances begins to undermine growth itself. We are approaching that stage in the US, and we estimate that any slowdown in nominal growth by more than 1.5 percentage point (everything else being equal) would start to be particularly concerning for the sustainability of the US twin deficits.
- Sovereign external liquidity: Our model assesses a country’s ability to meet its external obligations without resorting to debt monetisation. These obligations include foreign-owned maturing debt and the short-term financing also required to cover the current account deficit. On this measure, the US also scores poorly, reflecting its substantial external financing requirements that have accumulated over the years into a gigantic net international investment position now representing nearly -80% of GDP.
- Reliance on foreign “hot money” funding: A high level of foreign ownership of domestic financial assets can increase a country’s vulnerability to shifts in non-resident investor sentiment and capital outflows. The US scores at the weakest end of the scale on this measure given that it has been in recent years the biggest net recipient of global portfolio flows.
- Banking-system liquidity: The US banking system is highly liquid and has very limited reliance on foreign wholesale funding. This has been a major source of support in recent years, helping the US sustain its current imbalances.
- Competitiveness: The US dollar remains significantly overvalued despite the 8-10% real effective exchange rate depreciation of the last 18 months. A significantly weaker dollar could ultimately act as an important adjustment mechanism, improving the price competitiveness of US and supporting the rebalancing of the economy.
- Stage of the credit cycle: US private sector balance sheets remain exceptionally strong. This is another important mitigating factor, providing the US with greater capacity to sustain its current imbalances.
Conclusion: key takeaways from our scoring and analysis of these vulnerability indicators for the US
1. The risks of a fiscal and/or balance of payments crisis in the US are rising rapidly, although the country has not yet entered the danger zone. This reflects still resilient nominal growth, ample financial system liquidity and a credit cycle that does not appear overextended, with private-sector balance sheets remaining in exceptionally strong condition despite the surge in hyperscalers’ issuance. However, any deterioration in these metrics would shift the balance sharply towards a potential fiscal crisis, given that the US already scores very poorly on growth imbalances, sovereign external liquidity, reliance on foreign “hot money” and still poor real effective exchange rate competitiveness (Figure 2). It is therefore important to monitor closely the momentum of growth and financial liquidity, as any signs that these metrics are peaking could provide an early indication that a major market scare (i.e. a disorderly move in yields) is approaching.
2. In contrast, emerging markets are in considerably better shape, reflecting the substantial adjustments achieved in recent years and the experience gained by EM policymakers through successive crises. Even Brazil, one of the more vulnerable EM countries from a debt and fiscal perspective, currently faces a relatively low risk of crisis according to our Country Vulnerability Model. This reflects its reasonably strong balance of payments and, by extension, its limited reliance on foreign funding. Foreign investors now only own around 10% of the Brazilian local bond market, while the country remains capable of attracting investors with real bond yields of approximately 10% and a currency that has shown remarkable stability (and even strong appreciation) in the face of recent global dislocations.
3. The US dollar, supported by the “exorbitant privilege” that the United States still enjoys, has enabled the country to meet its financing needs for many years by absorbing the recycling of global surpluses. The dollar can now also act as a useful pressure valve, supporting the adjustment process by improving US price competitiveness and helping to reduce external imbalances. This is why we maintained, since last year, the view that a major cyclical downturn in the dollar is firmly under way and still has further to run.
4. In an era of fiscal dominance, the Federal Reserve’s ability to enforce monetary and fiscal credibility will be severely constrained, if not ultimately futile. Past emerging market crises taught us that, once fiscal sustainability comes into question, markets increasingly focus on the actions of fiscal authorities rather than on central bank policy rates. Under such circumstances, interest rate hikes can become ineffective or even counterproductive, particularly when the monetary policy transmission mechanism is impaired. With private sector balance sheets still in strong shape in the US, higher rates could even add to system liquidity by increasing income flows on the large stock of bank deposits and short-term government debt held by the public. Therefore, the only viable policy response must come from fiscal authorities. Without credible fiscal action, it may only be a matter of time before the Federal Reserve is forced to resume large scale debt monetisation. A loss of momentum in economic growth and a peak in financial system liquidity would likely be the key triggers for such a shift. We continue to monitor these metrics closely, as any deterioration could push the US country vulnerability score shown in Figure 2 into the crisis phase of the cycle.
5. While the country vulnerability analysis in this report has focused on the US, similar trends are also evident in other developed market economies with persistent twin deficits, such as France. Drawing again on our experience of emerging markets, the potential fiscal scare would likely initially emerge in a smaller sovereign issuer within the DM bloc (the “canary in the coal mine”) before spreading to the largest and most systemically important vulnerable issuer. In the current situation, one of the smaller DM sovereign issuers could potentially play this “canary” role before market pressures and the fiscal scare spreads to the US.
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