As trade tensions rise and reserve diversification accelerates, the bedrock demand for U.S. Treasuries—long sustained by global trade surpluses and reinvested dollar flows—is quietly shifting beneath the surface. This evolving dynamic carries important implications for market liquidity, Treasury auction outcomes, and the overnight funding ecosystem that underpins SOFR. The question now facing policymakers and market participants is clear: How can the financial system adapt to preserve stability, transparency, and credit transmission in a changing world?
The increasingly complex global trade landscape is prompting renewed focus on the long-term resiliency of U.S. funding benchmarks. For decades, the U.S. dollar’s status as the global reserve currency has been reinforced by its dominance in global trade invoicing—particularly U.S. imports—and the resulting reinvestment of USD surpluses by foreign trading partners into U.S. Treasuries (UST). This structure has historically supported deep liquidity in Treasury markets, contributing to the stability of the U.S. funding complex and anchoring key reference rates such as the Secured Overnight Financing Rate (SOFR).
Geopolitical Frictions Could Disrupt the U.S. Trade–Treasury Feedback Loop
However, recent geopolitical developments—including the reintroduction of tariffs, export controls, and a broader tone of strategic decoupling—are beginning to challenge the foundations of this long-standing trade and capital recycling model. As U.S. policy shifts toward a more confrontational stance with major trading partners such as China, and as global supply chains are realigned around geopolitical blocs, the traditional feedback loop between trade surpluses and Treasury demand is being tested.
Many of America’s largest trading partners, particularly in Asia and the Middle East, historically reinvested their dollar-denominated export earnings into U.S. Treasuries as a default reserve management strategy. However, as trade surpluses with the U.S. become less certain—or are politically constrained—those same countries may begin to diversify their reserve portfolios away from U.S. assets, reduce Treasury allocations, or prioritize bilateral trade in alternative currencies such as the euro, renminbi, or gold-linked contracts.
Sanctions Sensitivity and Fiscal Pressures Add to Structural Risk
In parallel, financial sanctions and asset freezes imposed in recent years have increased sensitivity among sovereign investors about the political risks associated with holding large quantities of U.S. financial assets. Taken together, these trends signal a possible slow erosion in the automatic, high-quality demand for Treasuries that has long been taken for granted.
“Rates traders are increasingly discussing the risk that volatility in Treasury prices—driven by weakening foreign demand or uneven auction outcomes—could become disruptive for repo markets and, by extension, SOFR itself. ”– Alex Roever and Marcus Burnett
Overlaying this is the structural reality of growing U.S. fiscal deficits, which require an ever-larger base of buyers to absorb increased Treasury issuance. If foreign official sector participation in auctions declines—even modestly—greater issuance would need to be absorbed by domestic institutions or the private sector at higher yields, potentially straining market liquidity and steepening the curve. These conditions may lead to more frequent bouts of price volatility in the Treasury market, particularly in the absence of strong, countercyclical demand.
Funding Market Fragility Could Affect SOFR-Based Pricing
Ultimately, a marginal but persistent reduction in foreign demand for Treasuries—when coupled with growing issuance needs—could have consequences for Treasury market functioning, repo market conditions, and overnight funding stability. These are critical infrastructure components of the financial system, and even small fractures in this structure can transmit volatility throughout global capital markets.
On the liquidity side, this has not gone unnoticed by market practitioners. Rates traders are increasingly discussing the risk that volatility in Treasury prices—driven by weakening foreign demand or uneven auction outcomes—could become disruptive for repo markets and, by extension, SOFR itself. While SOFR remains a robust, transaction-based benchmark grounded in the U.S. Treasury repo market, these discussions underscore a broader recognition that macro-financial conditions can influence overnight funding dynamics.
The Case for Complementing SOFR with Credit-Sensitive Tools
Importantly, these are not shortcomings of SOFR, but rather a reflection of the evolving market environment in which all funding benchmarks operate. As this environment shifts, there is a growing argument for benchmark frameworks that preserve SOFR’s transparency and integrity while supplementing it with standardized, credit-sensitive components.
Two such solutions are:
- SOFRx = SOFR + AXI, where the Across-the-Curve Credit Spread Index (AXI; Bloomberg: AXIIUNS Index) captures real-time, market-based bank credit spreads across the unsecured U.S. dollar funding curve.
- SOFRy = SOFR + FXI, where the Financial Conditions Credit Spread Index (FXI; Bloomberg: FXIXUNS Index) adjusts credit spreads based on prevailing macro-financial conditions.
These enhanced benchmarks are designed in alignment with relevant IOSCO Principles for Financial Benchmarks (IBM Promontory, 2024), and provide lenders, borrowers, and risk managers with tools that improve alignment with real-world funding conditions, especially during periods of market stress.
By incorporating AXI or FXI as a transparent add-on to SOFR, SOFRx and SOFRy can:
1. Support better alignment between loan pricing and bank funding conditions;
2. Facilitate risk-sensitive credit allocation within regulated institutions;
3. Enhance pricing discipline and transparency across lending markets;
4. Reduce reliance on bespoke, less-regulated private credit arrangements;
5. Maintain consistency with public sector financial stability objectives.
Bottom Line
SOFR continues to serve as the cornerstone of the post-LIBOR rate regime. But as global capital flows shift and Treasury market dynamics evolve, there is a growing case for credit-sensitive SOFR supplements such as SOFRx and SOFRy. These tools offer market participants a forward-looking way to manage credit risk, improve pricing alignment, and reinforce trust in benchmark-linked lending across the financial system.
SOFR Academy welcomes feedback from market participants and policymakers as this work progresses. For further information or to participate in industry discussions, please contact us at [email protected].
ABOUT THE AUTHORS
Alex Roever, CFA, is the former Head of U.S. Interest Rate Strategy at J.P. Morgan and currently serves as a Senior Advisor to SOFR Academy ([email protected]).
Marcus Burnett is the Chief Executive Officer of SOFR Academy ([email protected]).
This note is provided for informational purposes by SOFR Academy, Inc. (Sofr.org), an economic education and market information provider. This note is not designed to be taken as advice or a recommendation for any investment decision or strategy. Readers should make an independent assessment of relevant economic, legal, regulatory, tax, credit, and accounting considerations and determine, together with their own professionals and advisers, if the use of any index is appropriate to their goals. Neither the USD Across-the-Curve Credit Spread Index (AXI), nor the USD Financial Conditions Credit Spread Index (FXI) are associated with or sponsored by the Federal Reserve Bank of New York or any regulatory authority. Additional information about SOFR Academy, AXI and FXI can be found here.
Copyright 2025 SOFR Academy, Inc. All rights reserved
