Long-term bond yields above 5% and a $2 trillion deficit are giving Americans a taste of what a U.S. debt crisis looks like. If a real emergency were to occur, it would be much more devastating, and we don’t know for sure. But with midterm elections marking the end of two years of divided government, it is unclear what will bring the country off its current alarming trajectory.
Massive federal debt issuance is pushing interest rates higher, starting to hurt parts of the economy and threatening to worsen the government’s debt problems. And since the two parties are highly unlikely to agree on a fiscal solution after the Nov. 3 midterm elections, any fixes will be years away.
The housing market is showing signs of slowing, with average interest rates on 30-year fixed-rate mortgages hovering around 7.5%. Redfin said Monday that pending home sales fell 4% in September, the largest monthly decline in three years.
home loan interest rate is 10 year government bond yield. The 10-year bond rose 123 basis points (one-hundredth of a point) from the end of February to Wednesday’s close, when the 10-year bond was trading at 5.19%.
Multiple factors are pushing up 10-year rates, including the Iran war that broke out on February 28 and prompted long-term yields to rise. Oil and diesel prices are soaring, and bond traders are pushing yields higher on the possibility that the Federal Reserve and other central banks will raise interest rates.
Additionally, investors want more compensation for holding long-term bonds, in part because they believe the U.S. government will continue to flood the market with long-term bonds. Corporate and government debt markets are interconnected, and competition for capital between them is intensifying as companies issue hundreds of billions of dollars in new debt to build artificial intelligence infrastructure. Global investors looking to buy long-term, low-risk bonds have an attractive alternative to the U.S. Treasury market.
If the U.S. government can reliably commit to reducing its budget deficit, yields on long-term government bonds are likely to fall. Admittedly, the exact scale of such a move is not clear and will depend on how much the budget deficit is reduced, but other factors such as a slowing economy and falling oil prices would also push yields lower.
But the potential for a virtuous cycle of lower deficits and lower yields has led Treasury Secretary Scott Bessent to argue that the U.S. should aim to bring the deficit below 4% of gross domestic product by the end of President Donald Trump’s term.
The United States has little chance of achieving that goal. The Treasury is expected to release official results for the 2026 fiscal year, which ended in September, in the coming days. But the results are already clear. The deficit will be close to $2 trillion, if not more.
Based on the Congressional Budget Office’s $1.993 trillion deficit estimate and third-quarter gross domestic product forecasts, the deficit will likely be in the range of 6.0% to 6.2% of gross domestic product this year.
Higher interest rates make it harder to reduce debt. If interest rates were 0.5 percentage point higher than CBO’s forecast, the agency estimates that the cumulative deficit over 10 years would increase by $1.9 trillion. A 1.5 percentage point overshoot in interest rates would add $6 trillion to the budget deficit.
CBO expects the average interest rate on 10-year Treasuries over the same period to be 4.3%, up from the current 5.3%. An alarming scenario would require economy-wide interest rates to continue rising for years.
“My view is that we have this mountain of debt and we have to grow our way out of it,” Bessent said in Dallas last month. They cite artificial intelligence as a key source of future growth.
AI may help, but it cannot completely solve the problem. According to the Committee for a Responsible Federal Budget, a research group that advocates for balanced budgets, it would take 10 years of 7.2% growth to balance the budget through growth alone.
The second quarter GDP growth rate was recently revised upward from 1.5% to 2.2% annually. Rapid acceleration to reach a growth rate of 7.2% would mean an almost unimaginable transformation of the economy.
President Trump will soon enter the final two years of his presidency, a period in which presidents often undertake large-scale projects that define their legacy. However, he has shown little indication that he wants to make reducing the budget deficit part of his efforts. He promised to give every adult American a $5,000 check if Republicans win the election.
In fact, Republicans are widely expected to lose at least the House and possibly the Senate. Moments of government division like this can sometimes produce surprising compromises, but the starting points are very different. Rep. Hakeem Jeffries, likely to become the next Democratic House speaker, wants to undo the $1 trillion in health care cuts Congress enacted last year as part of President Trump’s flagship bill.
And that puts aside the deep animosity between the parties.
Total U.S. debt reached $40 trillion this year, but no one knows what levels are unsustainable. It is likely that a full-scale debt crisis will occur even further into the future. It would feel similar to what Americans are currently experiencing with steroids. Bond yields will soar as global investors sell dollar assets, and there will be little the Treasury or the Fed can do about it.
For now, rising yields are also drawing investors into U.S. Treasuries, but they serve as a reminder that high borrowing and crisis are not the same thing. But the bottom line is that economics alone cannot solve the problem. If Americans want to forestall a full-blown debt crisis, they must also find some way to fix politics.
