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[UNITED STATES] The temporary reprieve following the de-escalation of the trade war may soon be overshadowed by growing tensions over the U.S. government’s fiscal trajectory.
Alarm bells are ringing as the United States crosses a historic debt threshold, even as the administration pushes to extend sweeping tax cuts. This week, House Republicans, operating with a slim majority, launched public deliberations on legislation to prolong the tax cuts enacted during former President Donald Trump’s first term. The proposal is central to the administration’s broader budget agenda.
According to Congress’ Joint Committee on Taxation, extending those cuts could cost the U.S. government an estimated $3.72 trillion over the next decade—a sum that would add to the existing record-high federal debt of $36.2 trillion.
The proposal has reignited partisan clashes. Democrats argue the tax breaks overwhelmingly benefit corporations and high earners. Republicans counter that preserving lower tax rates is essential for driving economic growth and maintaining America’s global competitiveness—especially as nations like China continue using fiscal incentives to lure investors.
At the same time, increased spending plans on border security and defense are compounding fiscal pressures. Hopes that the so-called Department of Government Efficiency (DOGE) initiative would deliver significant cost savings have so far fallen short.
Uncertainty also looms over tariff revenue, as bilateral trade talks remain unresolved. Meanwhile, reports have surfaced suggesting the administration is eyeing sweeping budget cuts—including reductions to housing, education, medical research, and the State Department—to meet a proposed $163 billion spending reduction target for next year.
Some reports suggest Trump has signaled openness to raising the top tax rate to nearly 40%. Others indicate DOGE may be reviewing potential cuts to military expenditures.
On the proposed “millionaire’s tax,” Trump offered a typically ambiguous stance on his social media platform: “Republicans should probably not do it, but I’m OK if they do!!!”
Economists caution that the administration’s mixed signals on tax and spending could rattle financial markets. “The lack of a cohesive fiscal strategy risks exacerbating uncertainty at a time when investors are already grappling with elevated Treasury yields and inflation concerns,” said Diane Swonk, chief economist at KPMG. “The longer this continues, the more it could dampen business confidence and investment.”
The fiscal package also seeks to raise the debt ceiling by $4 trillion, with Treasury Secretary Scott Bessent urging lawmakers to act by mid-July to avoid another brush with default—a scenario that could destabilize both bond and equity markets. Without a deal, the so-called "X date"—when the government runs out of money to pay its bills—is expected to fall in August.
Treasuries on Edge Amid Fiscal Uncertainty
After a volatile start to the year, Treasury markets remain unsettled. A synchronized sell-off in bonds and equities last month—triggered by tariff tensions—has kept investors nervous, especially as recent optimism about recession-driven rate cuts faded following the trade truce.
The Federal Reserve has held off on easing policy again, opting to wait for more clarity on inflationary impacts from tariffs. In the meantime, markets are left combing through every economic indicator for signs of when the Fed might shift course.
Strong job growth data coupled with slowing wage gains has offered limited guidance. “The Fed is in a holding pattern, and that’s keeping volatility elevated,” said Rick Rieder, BlackRock’s global fixed income chief investment officer.
Ten-year Treasury yields are now hovering near a three-month high at 4.47%, with the so-called “term premium”—a gauge of perceived long-term risk—sitting at a decade high around 70 basis points.
The Congressional Budget Office (CBO) had projected a 2025 yield of 4.1%, but yields have averaged 4.4% so far this year—heading in the wrong direction. Even under the CBO’s relatively optimistic scenario, U.S. federal debt is expected to top 100% of GDP this year for the first time since World War II, rising to 120% by 2035, and 156% by 2055.
Despite earlier hopes of post-election fiscal reform, the mood has darkened. Currency strategist Stephen Jen and Joana Freire at Eurizon SLJ voiced their dismay at both the spending math and political gridlock in Washington. “Long-term U.S. Treasury yields being stubbornly elevated suggests that investors no longer believe in the U.S. ability to bend the fiscal deficit curve. We share this concern.”
They estimate a gaping shortfall between projected $7 trillion in spending and roughly $5 trillion in revenues. Even accounting for around $500 billion in DOGE-related cost cuts and $300 billion from tariffs, the deficit remains close to $1.2 trillion.
Morgan Stanley projects the fiscal deficit will widen further, rising to 7.1% of GDP in 2026, up from 6.7% this year—an increase of roughly $310 billion.
Historical Warnings Resonate
This mounting fiscal strain brings to mind a sobering historical benchmark often cited by conservative historian Niall Ferguson. Drawing from 18th-century economist Adam Ferguson, he warns that once a nation’s interest payments exceed military spending, decline may follow. By that metric, the U.S. crossed a critical threshold last year.
However, some experts caution against applying such historical analogies too rigidly.
“The U.S. isn’t just another empire—it has unparalleled borrowing capacity because of the dollar’s dominance,” said Mark Sobel, former Treasury official and U.S. chair at the Official Monetary and Financial Institutions Forum. “But that doesn’t mean fiscal recklessness comes without consequences.”
Notably, China has reportedly hit the same debt-service-to-defense ratio. And the U.S. briefly flirted with the threshold in the late 1990s. Still, for an administration focused on “making America great again,” that symbolic fiscal milestone may carry weight.
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