Analysis: Why a $2 trillion deficit and 5% Treasury yields are becoming America's biggest economic challenge
Treasury yields above 5% are raising borrowing costs for households and the federal government, highlighting the challenge of financing $2 trillion deficits.
Key points
- Long-term Treasury yields above 5% and a $2 trillion deficit are exposing the U.S. to debt-crisis-like conditions.
- The housing market is slowing as mortgage rates near 7% and pending home sales fell 4% in September.
- Divided government after the midterms makes fiscal fixes unlikely for years.
Long-term bond yields above 5% and a $2 trillion federal deficit are giving Americans a preview of what a U.S. debt crisis could feel like, according to an analysis. A true emergency would be far worse and is not currently expected.
With the midterms likely to lock in divided government for two years, it remains unclear what could change the country's current fiscal path. Higher interest rates, worsened by heavy federal borrowing, are already affecting parts of the economy and threaten to deepen the government's debt problem.
Housing market feels the strain
The housing market is slowing as the average 30-year fixed mortgage rate hovers around 7.5%. Pending home sales fell 4% in September, the largest monthly drop in three years, according to Redfin.
Mortgage rates track the 10-year Treasury yield, which has climbed 123 basis points since the end of February through Wednesday's close, when it traded at 5.19%. Factors pushing yields up include the war with Iran, which began on Feb. 28 and set off the rise in long-term yields, as well as higher oil and diesel prices that have bond traders demanding more yield in case the Federal Reserve raises rates.
My view is that we've got this mountain of debt, and we have to grow our way out of it
— Scott Bessent
Deficit targets look out of reach
Investors also want more compensation to hold longer-term bonds because they expect the U.S. to keep flooding the market with them. Competition for capital is intensifying as companies issue hundreds of billions in new debt to build artificial intelligence infrastructure, and global investors seeking low-risk, long-term debt have attractive alternatives to Treasurys.
Treasury Secretary Scott Bessent has argued the U.S. should target a deficit below 4% of gross domestic product by the end of President Donald Trump's term. But the deficit for the 2026 fiscal year, which ended in September, will come in near $2 trillion, or about 6.0-6.2% of GDP, based on Congressional Budget Office estimates. The CBO also estimates that if rates stay a half-point above its expectations, the 10-year cumulative deficit will be $1.9 trillion higher; a 1.5-point overshoot would add $6 trillion.
