Interest costs are eating into fiscal space. Analysts say US bond yields are being "artificially pushed up".

The latest forecast from the Congressional Budget Office (CBO) shows that the U.S. fiscal deficit will continue to expand over the next decade, with interest payments rising rapidly and accounting for an increasing share of total government spending. This trend not only increases the financial burden but also raises interest rates in the market environment, which should be lower. According to the report released by the CBO on Wednesday, the U.S. annual fiscal deficit is expected to rise to $3.1 trillion by 2036, accounting for 6.7% of Gross Domestic Product (GDP); while for the fiscal year ending on September 30, 2026, the deficit is estimated to be around $1.9 trillion, accounting for 5.8% of GDP. When government spending continues to exceed tax revenues, the Treasury Department must finance it by issuing government debt, Treasury bills, and notes to the public. Increasing debt supply often requires higher yields to attract investors, depending on the maturity structure. Brian Mulberry, Senior Client Portfolio Manager at Zacks Investment Management, points out that the bond market has been consistently expressing concerns about fiscal prospects, with the core issue being the exponentially growing size of the deficit. He believes that it is these concerns that are keeping current interest rates higher than where they should be in a more manageable fiscal situation. Mulberry further estimates that if the market is more confident in the U.S. controlling government spending, reducing the deficit, and suppressing inflation, the Federal Reserve's current policy rate target range of 3.5% to 3.75% could be lowered by about 100 basis points, and the entire U.S. Treasury yield curve would shift down. For example, the yield on the 10-year U.S. Treasury, which affects mortgage loans, car loans, corporate bonds, and capital investment costs, closed at around 4.1% on Thursday. He believes that if not for the fiscal deficit constraints, the reasonable range for the 10-year yield should be 3.5% to 3.75%. Currently, the relatively controlled 10-year yield is partly due to the U.S. Treasury Department increasingly relying on short-term Treasury bills in recent years to manage financing costs. However, the CBO points out that over time, net interest payments will continue to account for an increasing share of the deficit structure, becoming a significant driver of the expanding fiscal gap. Subadra Rajappa, Head of Research at French Industrial Bank in New York, emphasizes that while the long-term U.S. fiscal path is "indeed worrisome," the bond market is currently more focused on the short and medium-term financing abilities. She notes that the market's tolerance for U.S. debt and deficits is significantly higher than for other countries. The continuously expanding fiscal deficit and rising interest costs may also weaken the Trump administration's emphasis on the affordability of housing and living costs. On one hand, higher borrowing costs mean that the fiscal space available for public services, transportation infrastructure, defense, research, and healthcare coverage is reduced; on the other hand, the Treasury Department needs to continually increase bond supply, and if investor demand weakens in the future auctions, yields may rise uncontrollably, subsequently impacting wider financial markets. It was previously widely expected that the Treasury Department would increase the issuance of interest-bearing notes and long-term bonds as short-term Treasury bill sales account for a larger proportion. However, earlier this month, the Treasury Department maintained guidance that "the size of bill and bond auctions will remain unchanged for at least several quarters in the future," which disappointed related expectations. The day after the release of the CBO report, the bond market rebounded as a result of deteriorating stock market sentiment. The major U.S. stock indices experienced significant declines, with most U.S. bond yields falling, led by the 5-year to 30-year Treasury bonds. This indicates that, amidst a cooling of risk appetite, investors still view U.S. bonds as an important safe-haven asset.