Fiscal Deficits Are Exploding, and That’s a Problem

US fiscal deficits are pushing borrowing costs higher because they are expanding during an economic expansion while inflation remains elevated and AI investment is competing for capital.

• The fiscal deficit reached $1.78 trillion in fiscal 2025, while the first 10 months of fiscal 2026 already produced a larger $1.8 trillion deficit.
• July’s $432 billion deficit was the largest monthly shortfall since March 2021, while corporate tax receipts fell 24% year over year and net interest spending reached $931 billion, above the $804 billion spent on defense.
• The deficit is about 6% of GDP and the primary deficit about 2% of GDP, unusually high more than five years after the 2020 recession rather than during a downturn.
• Markets reduced expected 2026 policy rates from 4.11% on July 28 to 3.94% on August 17, but longer-term expectations remained elevated and rates beyond 2028 moved higher.
• The 10-year Treasury yield reached 4.71%, while the 30-year yield rose to 5.30%, near the post-2007 high; a recent $25 billion 30-year auction cleared at 5.22%.
• The author argues that fiscal borrowing, persistent inflation and AI financing demand are raising the cost of capital, with housing particularly exposed.

Takeaway: Investors should not assume that near-term expectations of easier Federal Reserve policy will bring down long-term yields, because persistent deficits and capital demand may force tighter policy and keep borrowing costs high.