Deficits, debt and bond yields: Separating headlines from signals

2. So what has driven U.S. yields up recently?

We point to three factors.

First, and what is most encouraging, economic growth has proved to be resilient. Global economic surprises have been consistently positive over the last few months. In the United States, recent economic news has been mixed, but for the year as a whole, the economy has been growing at a solid pace.

In an environment of higher nominal growth that results from resilient underlying real activity trends and higher inflation, investors usually expect a higher path for interest rates and a higher equilibrium level of yields.

Third, risk premia have increased. Investors appear to be demanding more compensation for holding longer-duration bonds. This likely reflects uncertainty around inflation, Federal Reserve policy, Treasury supply and the fiscal outlook. And bond markets often move together globally, so many of these considerations are global in scope.

We note one unusual element in the current landscape. While there has been relatively little movement in public debt and deficit expectations over the last year, private borrowing in the United States has been picking up. Michael Cembalest recently highlighted that U.S. hyperscalers and Nvidia have jointly issued long-duration debt that is equivalent to nearly half of new Treasury long-duration borrowing this year. The rise in private borrowing (in addition to issuance in credit markets, private loan growth is also rising) is pushing up yields via a “crowding out” effect (i.e., private borrowers are displacing public borrowers).

3. Has the U.S. fiscal position worsened in 2026, and if so, by how much?

The fiscal position has deteriorated modestly, but the shift does not, in itself, change the market story.

According to the Bipartisan Policy Center, unforeseen developments this year—including the conflict in Iran and the Supreme Court’s ruling on the U.S. administration’s International Emergency Economic Powers Act (IEEPA) tariffs—widened the deficit by roughly $250 billion more than was expected at the start of the year. That is a meaningful change, but small in the context of a ＄32 trillion U.S. economy. The fiscal position has worsened somewhat in 2026, but not enough to explain the rise in yields.

Investors are certainly concerned about the U.S. structural fiscal trajectory, which features large primary deficits, rising interest costs and what would appear to be limited appetite in either political party for deficit reduction. When U.S. debt crossed the $40 trillion mark this summer, it attracted attention. But a headline is not an economic threshold. Ultimately, the trajectory of U.S. debt and financing conditions in the overall economy will matter more to investors than the absolute level of the debt at a specific moment in time.

Importantly, when we look at the structural deficit outlook, it appears to be more of a revenue problem than a spending problem, as the Congressional Budget Office's (CBO) projections from 25 years ago make clear. In 2000, the CBO projected that U.S. government spending in 2026 would be about 22.5% of GDP—close to where it actually is, at roughly 23%. In other words, the spending projections were broadly on target. Budget analysts understood decades ago that an aging population would result in higher entitlement spending.

But the CBO’s revenue projections proved wide of the mark. In 2000, it forecast total government revenue in 2026 of 19.2% of GDP, versus today’s level of roughly 17%. That loss of ~2 percentage points of GDP in federal revenue—the result of a succession of Congressional tax cuts over the decades—helps contextualize today's elevated structural deficit. Factoring in the associated debt-servicing costs, today's deficit would be about 3 percentage points of GDP lower had those tax cuts not occurred. Simply put, tax cuts account for the key difference between a U.S. debt-to-GDP ratio that is rising (as it currently is) versus one that is not. The revenue side of the equation is also the likely solution for fixing the deficit problem; at some point in the future, the government will need to increase revenues if cutting entitlements proves too politically difficult.

4. What kind of U.S. fiscal episode could spark a sudden rise in yields?

In recent years, public debt markets have undergone a major transition. Public sector debt and deficit levels are meaningfully higher than they used to be, both in the United States and across many other countries. In addition, the demand for sovereign bonds has become much more interest-rate sensitive, as central banks moved from the largest buyers of public debt to marginal sellers. Together, these two factors imply that public debt markets can be sensitive to changes in the supply of, or demand for, Treasuries.

We’re keeping an eye on two broad categories of policy developments.

In the first category are policies that increase Treasury supply. Large deficit-financed stimulus, unfunded tax cuts or spending programs could push yields higher if investors conclude that future Treasury issuance will be meaningfully larger. Investors have seen this play before.

For example, in late 2024, U.S. yields moved higher around investor expectations of tax cuts. In 2022, a major fiscal surprise—the announcement of a U.K. “mini-budget” that included unfunded tax cuts—sparked a sharp selloff in U.K. gilts. After a few days of volatility, the Bank of England stepped in to stabilize the market.

In the second category are government policies that reduce demand for Treasuries. Measures that discourage foreign or institutional buyers from holding U.S. assets could raise the risk premium that investors demand to buy Treasuries. Examples include policies perceived as hostile to foreign holders of U.S. assets or proposals to tax foreign investors in U.S. securities.

Bond markets can be fickle. So the predictability and consistency of policy and also the way that policy is communicated (which all fall under the rubric of policy ”credibility”) can affect the demand for sovereign bonds as much as the details of any specific policy measure.

We do not currently expect any major near-term changes to U.S. fiscal policy or the treatment of foreign investors. But we acknowledge that bond markets are more sensitive to fiscal news than they were when U.S. debt and deficits were lower.

5. Are Treasuries still a good safe haven asset and portfolio diversifier?

Yes, but the environment is very different than it was in the post-global financial crisis (GFC) era when policy rates and yields were near zero.

U.S. Treasuries remain the deepest, most liquid government bond market in the world, and they are still likely to perform well in a classic recession or deflationary shock. Higher starting yields also make them more attractive than they were when yields were close to zero, because investors now receive more income and have more cushion against moderate price declines.

But the diversification benefit is less reliable in an environment where inflation is structurally more volatile. If stocks are falling because growth is weakening, Treasuries will likely serve as an effective portfolio diversifier. If stocks are falling because inflation or inflation uncertainty is rising, Treasuries may not rally in the same way.

Similarly, if investors perceive a risk in the way that U.S. institutions function that may reduce structural demand, and Treasuries may become less effective as portfolio diversifiers. Despite headline noise, overall demand remains robust.

So yes, Treasuries remain an important part of portfolio diversification, but investors should not assume they hedge every kind of risk equally well.

6. At what point would U.S. fiscal risk become more concerning?

As we’ve said, the threshold is not a specific debt level, such as $40 trillion. In our view, fiscal risk would become more concerning if ballooning fiscal deficit led to such large debt-servicing costs that they forced the Fed to keep policy loose and/or crowded out private sector activity.

Let’s dig into the issues in play.

We turn first to the issue of ‘fiscal dominance.’ This is the risk that deficits and debt-servicing costs become such a burden that the Fed can no longer set policy primarily to meet its inflation mandate. In practice, this is a situation in which raising rates or tightening policy makes the government’s debt-servicing costs and refinancing risks too large, forcing policy to remain easier than would otherwise be warranted. Fiscal dominance is not an imminent risk today. But if Congress made no meaningful effort to reduce the structural deficit while interest costs continued to rise, investors might well focus more on the specter of fiscal dominance.

The second issue is “crowding out”—the scenario in which government spending (facilitated by significant borrowing) makes it harder for private sector firms looking to raise capital. Large public borrowing can require the Fed to keep policy tighter than it otherwise would or require markets to absorb more government debt at higher yields. That can raise the cost of capital for households and companies. The risk becomes more acute if private investment proves more rate sensitive than expected.

The third issue we examine is productivity. The fiscal outlook looks much more manageable if capital investment in artificial intelligence (AI) generates a sustained productivity boom. On the other hand, if productivity data disappoint and the economy grows too slowly to absorb higher debt-servicing costs, the outlook is more concerning.

We’re not alarmists. An emerging-market-style U.S. fiscal crisis—the sudden reversal of capital flows, currency collapse and an import-price inflation spiral—is unlikely. We think a more plausible scenario is a steady deterioration of the fiscal outlook, with higher real rates, higher debt-servicing costs, less fiscal space and more pressure on private investment.

7. How much debt is too much debt?

There is no magic number.

Compared to the United States, Japan has much higher gross debt and net government debt, and it has avoided a classic debt crisis. Other countries have run into trouble with lower debt ratios because they lacked monetary sovereignty, reserve currency status, institutional credibility or a stable domestic investor base.

Even though the U.S. debt level is high, it is not extreme relative to other large, advanced economies. Distinguishing between the level of debt and the trajectory of debt is important. While the current debt level is manageable, as we’ve discussed, the long-term trajectory is a real concern.

The right question, therefore, is not whether $40 trillion debt is too much, but whether the United States can stabilize debt relative to GDP without requiring persistently higher inflation, materially higher taxes, large spending cuts or a sustained rise in real interest rates.

The United States does not currently face an imminent debt crisis, but its fiscal path is not sustainable indefinitely without stronger growth, higher revenue, lower spending growth or some combination of the three.

8. Does the United States have an overall debt problem or mainly a government debt problem?

Mainly a government debt problem.

Total U.S. economy-wide debt has been fairly stable since the end of the GFC. Government debt increased alongside private sector deleveraging, particularly among households. Although corporate debt has increased in some sectors, it has not driven an overall increase in leverage as seen in many other economies.

China is a useful contrast. Post-GFC, its economy-wide debt has increased very significantly, reflecting large increases in corporate, local government and property-related borrowing.

This distinction between the two countries matters for investors. A country with high government debt but relatively healthier household and corporate balance sheets is in a different position than a country where leverage has risen across the entire economy. In other words, the U.S. fiscal trajectory is a problem, but the U.S. economy is not overleveraged.

9. How will the move higher in Treasury yields impact the economy and financial markets?

The economic impact should be limited, as long as Treasury yields continue to be range-bound.

U.S. Treasury yields—in particular the 10-year yield, to which the economy is most sensitive— have broadly traded within their current range since 2023. This year’s move touching 5% has not broken out of this range and the economy has shown that it can continue to grow at the prevailing level of yields. Thus, we don’t expect the year-to-date backup in yields to have much economic impact.

It would be another story if the 10-year Treasury were to move beyond today’s range and approach a 6% yield. But that is unlikely as long as long as the cyclical economy—and cyclical inflation—do not reaccelerate. We continue to see little evidence of a pickup in cyclical (demand-driven) inflation. In fact, the year-to-date rise in inflation has been concentrated primarily in acyclical, supply-driven sectors, while the cyclical, demand-driven contribution has remained tame. That stands in contrast to the 2021–2022 inflationary period, when the opposite pattern prevailed.

Lessons of history: If yields rise 20–30 basis points from here, markets could move

What level of yield might start to pressure equity prices? The answer depends on investor sentiment and market technicals. History is a useful guide.

The autumn of 2023 offers a clear example of a risk premium shock that pushed yields up and stocks down… bond risk premium can increase when investors suddenly demand greater compensation for holding longer-term bonds. The 2023 episode reflected a range of factors, including a heavy supply of long-dated debt and concerns about Fed policy and the fiscal outlook.

When we overlay BAA corporate yields on the S&P 500, we can see that in 2023, market tension emerged around the 6.5% level. Stocks fell roughly 10% peak to trough over this period. Currently, BAA corporate yields sit near 6.3%, about 20–30 basis points below the prior 6.5% stress point. The investor pain threshold may be somewhat higher than 6.5% this time, given the forces propelling the AI trade, AI capital expenditure and S&P 500 earnings growth.

For investors, it often matters why yields are moving higher. If rising yields are reflecting stronger growth, they can have a relatively more benign impact across equity markets. But it doesn’t always matter why yields are rising. Sometimes, whatever their cause, sharp changes in yields can adversely impact stock prices. In 2026, as yields have moved higher, volatility has remained contained.

What are the implications for investors? The headlines are louder than the signal. Despite rising yields and the $40 trillion debt milestone, there is little evidence that U.S. fiscal issues drove the recent move. Yields rose roughly in line with credit, swaps and other developed-market bonds; the curve flattened; and auctions stayed orderly—not the fingerprints of a fiscal scare. The real drivers are more benign: resilient growth, a modest inflation repricing, higher- duration risk premia and private sector "crowding out" as hyperscalers issue debt on a Treasury-like scale.

The genuine concern is the long-term trajectory, not the round number. The 2026 deficit widened by ~$250 billion—small against a $32 trillion economy—and the structural gap is more a revenue problem than a spending one. What matters for portfolios is direction and credibility, not the $40 trillion headline.

For investors, the practical takeaways are clear. Treasuries remain an effective hedge against growth shocks but a less reliable one against inflation-driven selloffs, so diversify beyond them. Yields have stayed range-bound since 2023, and a break toward 6% is unlikely absent cyclical inflation. Watch the ~6.5% BAA corporate yield "tension zone"—now just 20–30 basis points away—as the near-term equity trigger, though AI-driven earnings may lift that threshold.

Bottom line: There is no imminent crisis, but we may possibly see a steady deterioration of higher real rates, rising debt-servicing costs and pressure on private investment. Stay diversified, and treat fiscal headlines as noise until the trajectory truly shifts.