The 10-year Treasury yield climbed to 5.1% on Friday, a level that, combined with a $2 trillion deficit, is beginning to stress the U.S. economy without yet constituting a full-blown debt crisis. This trajectory raises a difficult question for policymakers: how can a government reduce borrowing costs when political division makes fiscal correction nearly impossible?
Higher interest rates, driven by a surge in federal debt issuance, are already biting in specific sectors. The housing market is slowing as the average 30-year fixed-rate mortgage hovers around 7.5%. Redfin reported on Monday that pending home sales fell 4% in September, marking the largest monthly drop in three years. These mortgage rates track the 10-year Treasury yield, which has risen 114 basis points since the end of February.
Several factors are pushing long-term yields higher. The war with Iran, which began on Feb. 28, has spiked oil and diesel prices, leading bond traders to demand more yield to account for the possibility that central banks like the Federal Reserve will raise interest rates. Additionally, investors seek greater compensation for holding longer-term bonds because they expect the U.S. government to continue flooding the market with debt. This competition for capital is intensifying as companies issue hundreds of billions in new debt to build artificial intelligence infrastructure, providing global investors with attractive alternatives to the Treasury market.
Treasury Secretary Scott Bessent has argued that the U.S. should target a deficit lower than 4% of gross domestic product by the end of President Donald Trump's term. However, data released Friday by the U.S. Treasury shows the 2026 fiscal year deficit reached $1.992 trillion, up 12% from the previous year. Based on an estimate of third-quarter GDP, this deficit amounts to approximately 6.2% of GDP.
The Congressional Budget Office (CBO) expects the 10-year Treasury to average 4.3% over the next decade, compared with today's 5.1%. The agency estimates that if interest rates stay a half-point above CBO expectations, the cumulative deficit over 10 years will be $1.9 trillion higher. If rates overshoot by 1.5 points, that adds $6 trillion in deficits. While a credible commitment to cutting the deficit could ease long-term bond yields, the exact magnitude of such a move remains unclear and would depend on the size of the cut and other factors like slowing economic growth or lower oil prices.
Bessent stated in Dallas last month that the country must "grow our way out" of its mountain of debt, with he and others singling out artificial intelligence as a key source of future growth. However, the Committee for a Responsible Federal Budget notes that it would take a decade of 7.2% growth to balance the budget with growth alone. GDP growth was recently revised up for the second quarter from 1.5% to 2.2% at an annualized rate, but reaching 7.2% would imply an almost unimaginable transformation of the economy.
Political obstacles further complicate the outlook. With Republicans widely forecast to lose at least the House and possibly the Senate in the Nov. 3 midterms, divided government is likely for two years. Rep. Hakeem Jeffries, Democrats' likely next House speaker, aims to reverse $1 trillion in healthcare cuts enacted last year as part of Trump's signature legislative package. Meanwhile, Trump has shown little sign of prioritizing deficit reduction, having pledged $5,000 checks to every adult American citizen if Republicans swept the election.
The overall U.S. debt hit $40 trillion this year, yet no one really knows what level is unsustainable. A full-on debt crisis likely remains further out in the future and would involve spiking yields and global investors selling dollar assets, leaving little for the Treasury or Fed to do. For now, higher yields are attracting investors to U.S. government bonds, a reminder that expensive borrowing is not yet a crisis. But economics alone cannot solve the problem; if Americans want to forestall a full-on debt crisis, they must find a way to fix the politics as well.