Key takeaways

  • The growing U.S. national debt is drawing increased attention.

  • The estimated national debt in early 2024 stands at $34 trillion, a record amount that has doubled over the past 15 years.

  • A major concern is not just about the growing level of debt, but how today’s higher interest rate environment affects debt repayment.

What is the national debt?

News reports about the U.S. national government debt are becoming more frequent, and often are major discussion items for government policymakers. Yet the debt continues to rise. In mid-February 2024, the national debt stood at $34.27 trillion.1 The level of debt has approximately doubled in just 15 years.

How is government debt financed? By the issuance of U.S. Treasury bills, notes and bonds. With debt growing, issuance of new Treasury bonds is on the rise. A growing concern is that the recent upturn in interest rates means the cost of financing government debt has become more expensive. According to the U.S. Treasury, the average interest rate for all federal government issued interest bearing debt has jumped dramatically in recent years, to 3.15% as of January 31, 2024.2

Chart depicts average interest rates on U.S> Treasuries 204 - January 31, 2024.
Source: U.S. Treasury, Average Interest Rate on U.S. Treasury Securities, as of Jan. 31, 2024.

“The U.S. government is now paying more interest, requiring further debt issuance,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “The proportion of the federal budget required to maintain the national debt has grown significantly.” The combination of rising debt and the increased interest expense associated with financing the national debt raises questions not just about the impact on the federal government’s budget, but on the economic impact, potential tax ramifications and the implications for investors.

 

Living in a period of higher interest rates

Three of the primary drivers of interest rates are the Federal Reserve’s (Fed’s) policy rate, economic growth and inflation. Beginning in 2021, inflation began to rise significantly, and interest rates followed soon after. The Fed also responded to the resurgence of inflation by raising its target federal funds rate by over 5% from near zero over the course of between March 2022 and July 2023. As shown here, in early 2024, the yield on the benchmark 10-year Treasury note traded at its highest levels since 2007.

Chart depicts 10-year U.S. Treasury yields from January 1999 though January 31, 2024.
Source: U.S. Bank Asset Management Group analysis; Factset; Jan. 31, 1999 through Jan. 31, 2024.

“Initially, higher bond yields reflected rising inflation,” says Bill Merz, head of capital market research at U.S. Bank Wealth Management. “Now, even as inflation decelerated, the U.S. economy demonstrated surprising strength, which also likely had an impact on investors’ expectations for interest rates.” Both faster growth as well uncertainty over the timing of a Fed shift in monetary policy, including interest rate cuts, contribute to elevated bond yields, according to Merz.

Other considerations come into play as well. “One key factor is the supply of bonds relative to the demand by bond buyers.” If the Treasury needs to issue more bonds, that results in greater supply. “In that event,” says Merz, “more supply might result in buyers demanding higher interest rates to absorb the expanded issuance.”

Treasury bond issuance has increased to cover rising debt levels. The U.S. Treasury borrowed $776 billion in the fourth quarter of 2023 with plans to borrow another $750 billion in the first quarter of 2024.3 Just as Treasury debt supply expands, the pool of Treasury securities buyers has been reduced. “The most important buyer to leave the market is the Fed,” says Haworth. As part of its effort to slow economic growth and temper inflation, the Fed ended its bond-buying program in 2022 and began allowing their existing Treasury holdings to slowly mature. “The Fed’s absence from the current market puts more of an onus on private investors,” says Haworth.

In addition, interest in U.S. Treasuries has subsided among foreign buyers, most notably the Chinese government. “One advantage of this trend is that debt becomes more sustainable if we are financing it domestically, rather than relying on foreign buyers,” says Haworth.

Chart depicts the percentage of categories of holders of U.S. Treasury debt in 2013 versus 2023.
Source: U.S. Bank Asst Management Group analysis. Data as of 9/30/2013 and 9/30/2023.

Can rising government debt result in higher interest rates?

Merz notes that long-term fiscal viability and credit issues can, in certain circumstances, become factors that influence bond yields. “If investors become concerned with the U.S. Treasury’s ability to make good on its debt and avoid default, that could have an impact on interest rates,” says Merz. Credit agencies such as Fitch, Standard & Poor’s and Moody’s have either downgraded credit quality of U.S. Treasury issues or issued warnings about potential future downgrades.

“The question long-term investors ask is whether the country’s debts can ultimately be paid,” says Haworth. “Despite the lack of a policy consensus in Washington, there remains an expectation for now that Congress will find ways to cut spending and raise taxes to help resolve debt issues.”

“If investors become concerned with the U.S. Treasury’s ability to make good on its debt and avoid default, that could have an impact on interest rates,” says Bill Merz, head of capital markets research at U.S. Bank Wealth Management.

The issues created by the national debt don’t appear to be immediate. “The government’s debt is manageable today,” says Merz, “but its ability to sustain rising debt levels over time is the issue that concerns some investors.” A key question, according to Merz, is how quickly the government addresses the challenge. He says the sooner the long-term debt problem is addressed, the less painful it will be to resolve.

 

Future expansion of the national debt

A combination of growing expenditures and tax revenues that can’t keep pace will result in larger projected yearly deficits for the foreseeable future. As a result, continued growth in the total national debt is projected.

To help put debt totals in perspective, analysts frequently compare the total national debt to the nation’s gross domestic product (GDP), which measures the size of the economy. In 2023, for example, it’s projected that the nation’s total publicly held debt will equal the full value of the economy (100%) as measured by GDP. By 2052, the debt-to-GDP ratio will, according to most recent projections from the Congressional Budget Office, exceed 175% (meaning debt totals nearly double the nation’s economy).4

Chart depicts both the actual and projected federal debt 1980 - 2052.
Source: *CBO: Congressional Budget Office. Federal debt held by the public does not include Treasury obligations held by the Federal Reserve. Data as of September 8, 2023.

What’s not clear in assessing the debt-to-GDP ratio is at what point the debt becomes unsustainable or has a negative impact on economic growth. Such residual effects are possible because increased taxes, lower federal government spending or both, aimed at lowering the debt, could be detrimental to the economy. “Many developed countries, such as Japan, have faced high debt-to-GDP levels, and still found ways to growth their economy,” says Merz.

Haworth points out that much of the nation’s long-term debt problem centers on growing deficits for Social Security and Medicare. “We have an aging population and fewer workers in succeeding generations to pay the costs of these programs,” says Haworth. “These are manageable budget matters, but they are not yet on voters’ radar, so Congress hasn’t yet seriously considered solutions to them.”

 

Potential investment implications of the rising national debt

While growing government debt draws increasing attention, an important question for investors is what the potential impact is on the long-term interest rate environment. What could it mean for fixed income and equity portfolios?

“If the supply of Treasury securities continues to grow to finance increasing government debt, there is a risk that it could put upward pressure on interest rates,” says Merz. “But that might not outweigh the impact of inflation, growth and Fed policy rates.” Merz believes the U.S. position relative to the global economy remains strong, which allows the federal government more time to address the debt situation before it results in significant economic ramifications.

Haworth says for equity investors, one key question is whether high interest rates potentially slow corporate borrowing activity. “Capital intensive projects require a payback that justifies higher borrowing costs,” says Haworth. “That has the potential to slow corporate borrowing activity and may prove detrimental to business activity and economic growth.” However, Haworth notes that many other factors could have a bigger impact on the long-term investment landscape.

For investors, the size of the national debt should not present immediate challenges. U.S. Bank continues to see opportunities in high quality bonds, including U.S. Treasury obligations. Investors benefit from the highest yields in years, which translates to steady, reliable portfolio income. Treasuries, along with other investment grade bonds, also possess important diversification properties that can improve portfolios’ long run returns relative to risk. We continue to monitor the government’s increasing debt burden and policies that influence long-run sustainability for signs of change in the broader investment landscape. Consider talking with your financial professional to make sure you have a comfort level with your current plan and investment position.

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Disclosures
  1. U.S. Department of the Treasury, “What is the National Debt.”

  2. Source: U.S. Treasury, Average Interest Rate on U.S. Treasury Securities, as of Jan. 31, 2024.

  3. U.S. Department of the Treasury, “Treasury Announces Marketable Borrowing Estimates,” Jan. 29, 2024.

  4. Congressional Budget Office., “CBO’s Long-Term Projections of Gross Federal Debt,” September 8, 2023.

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