As we turn the page on the summer of 2026 and look to the fall, debt and bond yields dominate the financial headlines. Bonds are often referred to as boring, but bond markets can yield market insights in areas where stocks fall short. This past week in the United States we had the dubious distinction of seeing our national debt cross the $40 trillion threshold for the first time. In parallel, we’ve seen long-term interest rates hit their highest level in nearly 20 years. For this month’s Insights, I’d like to do a deep dive into the bond market—where it currently stands, why it’s important, and potential impacts going forward.
What’s Happening
The United States along with most developed countries has seen its debt burden balloon over the past 25 years. This has happened due to persistent budget deficits (more spending than tax receipts). The growth of debt during and post 2008 was substantial, and since 2020, the rate of debt expansion has been even more pronounced. The below chart shows our outstanding national debt as a percentage of our annual economic output (GDP) over the past 50 years. Note the dramatic shift since the year 2000 (ignore the big drop post pandemic; this is a function of depressed pandemic economic output, not falling debt):
The reason we’ve seen such an explosion in debt is that we’ve had persistent budget deficits for two decades. Year in and year out, we’ve had far higher spending than tax receipts. At present, for example, we’re spending approximately $7 trillion annually while we’re taking in about $5 trillion annually. The $2 trillion annual shortfall is financed by issuing debt. This concept is intuitive to most people—If a household is making $50,000 per year but spending $70,000 per year, the $20,000 shortfall needs to be financed (likely with credit cards). If this behavior persists for a decade, the household will have $200,000 in debt in addition to any accrued interest.
While this concept is intuitive, the second concept is not quite as straightforward. While the recipe to solve this problem is simple (spend less or earn more), implementation is very nuanced and politically unpalatable. If we take a granular look at our nation’s finances, we find that a large proportion of our annual spending is not discretionary. For example:
Source: usdebtclock.org
The first chart shows the national debt and annual budget deficit as described above. The second chart shows where the lion’s share of our annual spending is going. Between Medicare/Medicaid, Social Security, defense, and Interest, about $5.7 trillion of our annual spending is spoken for before any discretionary spending occurs. Medicare/Medicaid and Social Security modifications are the third rail in American politics that neither party wants to touch. Defense spending is expected to increase for rearmament in a world with increasing threats, and interest on debt if anything stands to rise as interest rates will likely drift higher.
Some would advocate to increase taxation to eliminate the deficit and start to pay down the debt, but taxation does not happen in a vacuum. Higher taxation has its own unintended consequences.
The best fiscal path forward as I’ve mentioned in previous months is to have very robust growth which shrinks the size of the debt relative to the economy. Absent strong growth or reduced deficits, the US debt problem will continue to worsen over time.
In addition to ballooning debt in the US and sovereign actors more broadly, we’re also seeing massive debt issuance by large tech companies to finance the AI boom. Their debt competes with US government debt for buyers. Goldman Sachs estimates that we’ve seen over $500 billion in AI related debt issuance so far in 2026 (see https://www.goldmansachs.com/insights/goldman-sachs-exchanges/how-ai-debt-is-reshaping-the-credit-market). Debt markets work no differently than other markets in that they are driven by supply and demand. When supply is low and demand is high, the price of bonds is pushed up, and the interest rate is pushed down. Conversely, when supply exceeds demand, the price of bonds is discounted down, and the interest rate is pushed up. With so much debt available, interest rates are drifting upward. Observe what the rate on a 30-year government bond has done over the past 5 years:
These rising rates exacerbate the US government debt issue as rising rates push interest expense higher and over time, lead to an even greater share of our annual budget being spent exclusively on interest. Moreover, in addition to supply and demand dynamics, the rate of interest paid is also driven by inflation expectations and expectations around creditworthiness. These factors can push funding costs even higher.
Why Does this Matter?
Stock markets and bond markets are inextricably linked. Interest rates and credit contraction or expansion play a key role in economic output and economic output drives corporate earnings, which over time, drives stock prices. Moreover, bonds are a central piece of the financial system’s “plumbing” and distress or disfunction in bond markets can lead to financial crises (like 2008). A well-functioning bond market that prices risk correctly and rewards the right behaviors and punishes the wrong ones serves the public interest.
For the US in particular, maintaining the status as the world’s preeminent issuer of bonds (both in terms of quantity and quality) is central to maintaining our role as the world’s reserve currency.
While rates have risen significantly in the last 5 years, they still remain low by historical standards. Consider the same chart for 30-year government bonds stretched out over the past 50 years:
The 1990s are particularly illustrative here. This was a time of tremendous innovation and economic growth and fiscal responsibility. Rates were higher than they are today, yet economic growth thrived.
Policy makers today face immense political pressure to keep rates artificially low. The artificially low rates of the past 20 years have created a dependency, and the economy is starting to show the withdrawal symptoms of being addicted to artificially low rates. Rather than let the withdrawal run its painful, but ultimately healthy course, however, policy makers have consistently intervened since 2008. The latest example of this was this past week when the Treasury Secretary announced buybacks of longer dated debt to push long term rates down. This resulted in a temporary impact that was quickly reversed. Absent fiscal reform, we’ll likely see more and more intervention in the future with mixed results.
Perhaps the most important questions here are what these movements in the bond market and interest rates portend for us as investors. For bond investors, this means that one needs to closely monitor credit quality and the duration of bonds in one’s portfolio. Higher credit quality fares better during times of crisis and right now markets aren’t providing much additional compensation for additional risk being taken. High yield bonds, (junk bonds), for example, are near record lows in terms of the spreads over high-quality debt:
Duration risk also warrants close monitoring in one’s bond holdings. The longer the duration of a bond, the more sensitive its price is to interest rate movements. Short-term bonds (<3 years until maturity) have very little price sensitivity to interest rates movements. Conversely, long-term bonds have tremendous sensitivity to interest rates. Over the past 5 years as 30-year rates have risen, long-term bonds have fallen by more than 50%:
It’s strange to think that boring government bonds could incur such heavy losses, but that’s what a bond bear market will do. While long bonds can have a hedging role in a portfolio (they did extremely well during the financial crisis and COVID), one should be cautious and aware of the risks of these in one’s portfolio. Bonds are still a key part of an investment portfolio, but owning the right types of bonds is more important than ever.
For stock investors, there is a mixed bag to unpack. On the one hand, we have the cautionary tale of Japan whose debt expansion and excess during the 1980s led to decades of stagnation. Disturbingly, it took their stock market nearly 35 years to get back to the highs of 1990 (see chart below). This is not a fair comparison as the demographics of Japan (aging population, low birth rates) are dissimilar to the United States as is the deeply innovative nature of our economy and our economic primacy. Japan faced deflationary pressures throughout their malaise; for the United States, we’ll likely see more inflationary pressure. We believe having some assets in one’s portfolio that hedge against inflation risk will be beneficial in the future.
We wish you the best as we enter this fall season and look forward to connecting with you. As always, should have any questions, please reach out.
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