The stability of US and European markets as the global interest rate benchmark needs to be reassessed, and this is precisely the core meaning of the idea that the US and Europe are replacing emerging markets as the source of financial risk.
In the past, discussions of Federal Reserve rate hikes and tighter dollar liquidity usually started with capital flowing back to the United States and then looked for emerging market economies with high external debt and insufficient reserves.
The biggest difference this time is that emerging markets have strengthened their traditional external financing buffers against a strong dollar, while developed economies are under greater pressure.
Looking back at the policy cycle since 2022, from the UK pension crisis to problems at US regional banks and then to France鈥檚 fiscal tightening dilemma, the interest rate and balance sheet risks of developed economies themselves have been repeatedly exposed.
Now, the more notable marginal change lies in the fiscal burden.
After the pandemic, expansionary fiscal policy that could not be reversed left behind a higher stock of debt, while primary deficits have not converged, and high interest rates continue to consume overall fiscal space through debt service pressure.
As US and European government bond yields remain elevated, and with concerns about a Federal Reserve tightening cycle, financing constraints on core developed economies are increasingly strengthening, and the tightening effect will be transmitted outward along the chain of financing costs and collateral.
In addition, the pressure from the actual price level caused by high inflation still drives the global populist cycle that has continued since 2008.
Opposition parties, riding public opinion, promote welfare plans whose harms outweigh their benefits, making it even harder for ruling parties to substantially advance deficit reduction.
As a bureaucratic institution, the monetary authority is extremely small in the face of the rolling pressure to refinance existing debt in an era of low interest rates, the unstoppable trend of technological development, and intensifying populism.
Overall, the stability of US and European markets as the global interest rate benchmark needs to be reassessed, and this is precisely the core meaning of the idea that the US and Europe are replacing emerging markets as the source of financial risk.
Fiscal pressure is common, but it is more obvious in developed economies because of worsening primary deficits
Fiscal pressure in both developed and emerging economies is already higher than before the pandemic.
Based on 2026 forecasts, the G7 composite fiscal index, covering total debt, interest burden, and primary deficit, is about 0.67 points higher than in 2019, slightly above the 0.59 point increase for EME13.
What deserves more attention is the source of deterioration: primary deficits contributed about half of the increase for the G7, while pressure in EME13 mainly came from debt and debt service burdens.
Although fiscal pressure in the G7 has not exceeded the highs of 2010 and the pre-pandemic range, it has remained above the average level for a long time, and the problem of slow withdrawal from fiscal expansion has become very prominent.
To some extent, the market has become used to occasional fiscal risks and interest rate pressure in countries such as India, Brazil, and Turkey, but it reacts as if facing a major threat to 10-year US Treasuries above 5% and 30-year US Treasuries at 5.5% 鈥?the core reason is that high interest rates in developed economies can transmit downward, while high interest rates in emerging economies can hardly flow upward.
Rising US Treasury yields directly raise the benchmark for bond financing and amplify selling pressure through margin calls and leverage contraction.
High credit quality does not prevent developed country government bonds from becoming the starting point of a liquidity shock.
On the other hand, the resilience of developed markets also means that no substantial sovereign risk is needed for pure market risk to constrain other assets.
The decline in the stability of core developed economy government bond yields, as well as changes in stock-bond correlation, are themselves very much worth reexamining.
Therefore, it must be emphasized that emerging markets are still the pressured side, and new shocks still come from the global financing benchmark rate itself 鈥?including both the higher bond yields traded by the market and the higher policy rates set by central banks.
Easing inflation can lower expectations for short-term policy rates, but fiscal financing and gradually diminishing duration absorption capacity still require higher long-term compensation.
A very important part of this comes from the excessive indulgence of 鈥減rimary deficits.鈥?If debt service pressure still has some degree of passive character, namely linkage with the global interest rate and monetary policy cycle, then the 鈥減rimary deficit鈥?is almost the result of active choices by governments 鈥?rate cuts can ease debt service pressure, but they cannot replace adjustments to fiscal revenue and expenditure themselves.
More critically, the side effects of debt rollover are gradually appearing.
As long as maturing debt from the low-rate era carries coupons below current levels, even if market rates stop rising, the average debt service cost will continue to increase; if primary deficits do not converge, new financing and maturing refinancing will continue to pile up.
The sensitivity of high debt to the difference between financing costs and nominal growth will also be amplified.
US Treasuries best illustrate this chronic pressure: from 2019 to the present, with 2026 as an estimated level, the debt ratio rose from 108.8% to 125.8%, an increase of about 17 percentage points; net interest payments as a share of fiscal revenue rose from 7.6% to 12.6%, an increase of about 5 percentage points, but the primary deficit has remained essentially flat at around 3.5% of GDP 鈥?the economy and tax revenue still need to digest the existing interest burden, while future fiscal flows still need financing at the same time.
Major European economies show clear differences, and these differences precisely show that, beyond stock debt pressure, the ability to adjust revenue and expenditure also determines the direction of pressure.
France faces simultaneous increases in primary deficit, debt, and debt service burden; Italy still has a primary surplus, but its high debt stock makes it more sensitive to the combination of financing costs and nominal growth.
Spain improved its primary balance, and its debt ratio changed relatively little from 2019, so it performed better.
For high-debt countries, whether a sustained primary surplus can be achieved directly affects fiscal maneuvering space after financing costs rise 鈥?but to achieve a primary surplus, some degree of fiscal tightening must be realized, and for developed economies this seems to fall into an unsolvable loop.
It is worth mentioning that the above indices measure each country鈥檚 level of pressure relative to its own history.
A flattening score does not mean the actual situation has stopped deteriorating.
The US fiscal index is only 0.07 points higher than in 2019, but in reality the US debt component has already hit the scoring ceiling, and the debt service component is also close to the ceiling, making it difficult for new burdens to push the score higher.
At this point, it is more important to return to absolute levels, namely the $40 trillion level of total federal debt and the annual $1 trillion net interest expense burden.
Today, the fiscal problem in developed economies is not only that debt is large, but also that deficits are increasingly difficult to cut.
However, whether raising revenue or cutting spending, both affect household income and are easily opposed by voters.
Moreover, as populism strengthened again after the public health event, political resistance to fiscal tightening has also increased.
The reason is that populism is mainly related to income distribution.
As income and wealth gaps widened, voters began to demand more protection from the government, forming different populist agendas 鈥?the left expanding welfare and the right protecting domestic industries 鈥?and since then populism has gradually become a factor affecting economic activity.
Although the policies proposed by the left and right differ, both make fiscal adjustment harder, mainly reflected in the intertwining of left-wing and right-wing populism from the 21st century to now.
The left pays more attention to income gaps, so it advocates raising the minimum wage and expanding social welfare.
But to cover related spending, the left usually supports higher taxes on high-income groups and companies.
By contrast, the right pays more attention to immigration and industrial relocation, so it often advocates restricting immigration and protecting domestic companies through tariffs; at the same time, the right usually supports tax and fee cuts.
The two types of policies appear opposite, yet they share one thing in common.
Whether expanding welfare or reducing tax burdens, both easily win support from specific voters.
Populism makes it harder for governments to solve debt problems.
Because spending cuts face electoral pressure, short-term fiscal support is more easily converted into long-term burdens.
Emerging markets鈥?buffers have clearly increased, and broad vulnerability has remained stable
The reason a strong dollar easily triggers external financing crises is that it simultaneously tightens financing conditions and, when there is a mismatch in foreign currency liabilities, increases repayment pressure on overseas entities.
If domestic credit is still expanding and the current account depends on continued capital inflows, currency depreciation will worsen refinancing constraints.
The most dangerous combination in past crises was the simultaneous imbalance of external debt, credit expansion, and external financing gaps, but that is not happening now.
The fiscal deterioration in emerging economies in recent years has not significantly pushed up their broad vulnerability, mainly because fiscal conditions are only one component of risk.
Using the complete six-indicator set for 13 countries, the index is about 2.61, slightly below the 2015鈥?019 average of 2.66 鈥?at that time, the Fed policy rate was only as high as 2.5%, and 10-year US Treasury yields were only just above 3%.
It can be said that the harsher financial environment of the past few years has in effect forged stronger risk resistance in emerging market countries.
For weaker fiscal conditions to turn into an external financing crisis, balance sheet amplification mechanisms are still needed.
Now financing gaps are smaller, credit expansion is slower, and reserves are thicker, so the same strong dollar shock is less likely to turn into comprehensive debt pressure and a refinancing crisis.
These buffers are the key to understanding the resilience of emerging markets in this cycle.
Compared with 1997, the change in buffers is especially striking.
For EME13, the average external debt to exports ratio fell from 170.4% to 127.6%, foreign reserves to GDP rose from 8.9% to 18.5%, and the current account deficit to GDP narrowed from 1.8% to 0.8%.
On one hand, the gap that needs to be filled by external funds has shrunk; on the other hand, resources to cope with capital outflows and external debt repayment have increased 鈥?a strong dollar is no longer simply 鈥渁n emerging market problem,鈥?but rather 鈥渁 US, Europe, and Japan problem.鈥?br>
But this does not mean emerging market countries are without risk.
A further breakdown of EME broad vulnerability shows that pressure is not uniform across different economic factors.
From 2017 to 2024, general government debt, average inflation, and foreign exchange reserves still pointed to greater vulnerability, but bank credit levels, current account balances, and external debt scale formed buffers.
Directly extrapolating the current Fed tightening into a precursor of some emerging market crisis ignores these real buffers and improvements in financial risk resistance.
Global fiscal deterioration is common, but the strengthening financing constraints of core developed economies are the more important marginal change.
Overall, the US and Europe need to reassess the stability of their role as the global interest rate benchmark, and this is precisely the core meaning of the idea that the US and Europe are replacing emerging markets as the source of financial risk.
Risk warning
Macroeconomic data are published at low frequency, so estimates for cross-border industry data may lag; US industrial policy is clearly affected by party politics, and a change in the ruling party may lead to reversals in industrial policy; there is significant uncertainty in AI technology development and industrial investment.
Team introduction
Song Xuetao: PhD in Economics from North Carolina State University, with publications including a CF40 monograph, academic papers, and central bank working papers.
Ranked in selections including Golden Bull, 21st Century, Wind, SSE, Sina, IAMAC, and Crystal Ball, and ranked 5th in New Fortune in 2023.
Policy research: Zhao Honghe, Master of Finance from Central University of Finance and Economics, responsible for major strategic policy and international relations research.
Zhang Xinyue, Master of Applied Economics from Renmin University of China, responsible for economic policy and fiscal research.
Macroeconomic research: Sun Yongle, Master of Industrial Economics from Central University of Finance and Economics, responsible for domestic macroeconomic and monetary liquidity research.
Zhong Tian, Master of Economics from the University of Chicago, responsible for overseas economic and global monetary policy research.
Industry research: Li Mengying, Master of Regional Planning from the University of British Columbia, responsible for trade policy, corporate overseas expansion, industry trends, and macro ESG research.
Asset allocation: Chen Hanxue, Master of Finance from the University of California, Riverside, responsible for overseas market analysis and major asset class research.
Report information
Securities research report: 鈥淲hen the US and Europe Become the Source of Financial Risk鈥?br>
External publication date: October 16, 2026
Report publishing institution: Sinolink Securities Co., Ltd.
Securities analyst: Song Xuetao, SAC practice number: S1130525030001, email: songxuetao@gjzq.com.cn
Securities analyst: Zhong Tian, SAC practice number: S1130526020001, email: zhongtian@gjzq.com.cn
Comments