US debt burden raises longer-term risks as borrowing costs rise

US government debt continues to be viewed by investors as one of the world's safest assets, but rising borrowing costs, persistent fiscal deficits, and growing competition for global savings are raising concerns about the longer-term sustainability of the country's debt burden, according to Reuters analysis.

The United States has not faced another sovereign credit downgrade, inflation expectations implied by Treasury inflation-protected securities remain relatively contained, and the cost of insuring against a federal default has not surged. These indicators suggest that investors still largely regard US Treasuries as a haven, even as they demand higher yields to hold longer-dated government debt.

According to Reuters, however, recent market developments are putting the US fiscal position into a broader environment of structurally higher global interest rates, increased competition for capital, and demographic and geopolitical pressures. While those factors do not point to an imminent debt crisis, they have made the possibility of a future fiscal stress point more visible.

Economic Growth Is Struggling to Keep Pace With Borrowing

For decades following World War Two, the US benefited from an economic dynamic in which growth generally outpaced the expansion of federal debt. That helped keep government borrowing manageable relative to the size of the economy.

The relationship began changing after the 2007-2009 financial crisis, when government spending increased substantially to support the economy. The COVID-19 pandemic triggered another enormous fiscal response, further expanding federal borrowing.

According to Reuters, tax cuts implemented during President Donald Trump's first and second terms have also contributed to larger fiscal deficits and a rising debt burden.

The key concern is that debt is continuing to accumulate at a pace that may be difficult to offset through economic growth alone.

Deficits Remain Elevated Even Without a Recession

Government deficits typically widen during recessions as tax revenues decline and spending on unemployment benefits and other automatic stabilizers increases. Such borrowing is generally intended to cushion economic downturns and support demand.

The unusual feature of the current situation is that the U.S. deficit remains close to levels normally associated with economic crises despite continued economic expansion.

Reuters reported that the annual federal deficit is now close to 6% of gross domestic product, significantly above the roughly 3% level economists often view as more manageable over the long term.

Several factors are contributing to the persistent deficit. Tax reductions have played a role, while spending associated with an aging population has become increasingly embedded in the federal budget. Policy changes involving tariffs have also created additional fiscal complications.

The United States recently crossed the $40 trillion mark in total federal debt, but the size of the annual deficit may ultimately be more important for assessing debt sustainability.

Is $40 Trillion of Debt Sustainable?

Not all U.S. government debt represents borrowing from outside investors. Roughly $8 trillion is held by government accounts, including trust funds associated with programs such as Social Security.

The remaining roughly $32 trillion is owed to public creditors, including households, investors, foreign governments and the Federal Reserve. Publicly held federal debt is now approximately equal to the country's annual economic output.

The U.S. retains an important advantage because the dollar is the world's primary reserve currency. That status gives Washington access to a deep pool of global investors and helps maintain demand for Treasury securities.

But there is no precise debt-to-GDP level at which markets suddenly determine that a country has borrowed too much. The sustainability of government debt depends on borrowing costs, economic growth, fiscal policy and investor confidence.

Reuters noted that corporate credit spreads and other market-based risk premiums have suggested that some of the U.S. advantage over other major borrowers has narrowed.

Higher Interest Rates Are Changing the Equation

One influential framework for evaluating debt sustainability is based on the relationship between a government's borrowing cost and the economy's growth rate. If interest rates remain below economic growth, it becomes easier for a government to stabilize its debt burden over time.

That relationship was particularly favorable during the years when global interest rates remained exceptionally low. It also helped support the enormous borrowing undertaken during the pandemic.

The environment has since changed.

Interest rates appear to be structurally higher, meaning the U.S. government can no longer rely as comfortably on borrowing costs remaining below the pace of economic growth.

The impact is increasingly visible in federal interest payments. According to Reuters, interest costs as a share of GDP have roughly doubled to around 3%.

That creates a feedback problem: higher debt leads to larger interest payments, while higher interest rates make refinancing existing debt more expensive.

Growth Alone May Not Solve the Problem

President Trump and Treasury Secretary Scott Bessent have emphasised faster economic growth as an important way to improve the US fiscal outlook. Stronger growth can increase government revenues and reduce debt relative to the size of the economy.

But relying solely on faster growth carries significant uncertainty.

Current estimates for the economy's sustainable, non-inflationary growth rate are generally around or below 2%, according to the analysis cited by Reuters. That may not be sufficient to substantially reduce the debt burden if large deficits persist.

A recession could worsen the situation by reducing tax revenues while increasing government spending, forcing Washington to borrow more to support the economy.

AI Could Boost Growth While Increasing Borrowing Pressure

Artificial intelligence offers a potential source of productivity growth that could strengthen the U.S. economy over time. Higher productivity could raise output and tax revenues, potentially improving the government's ability to manage its debt.

But the timing and scale of any such economic boost remain uncertain.

AI could also create fiscal challenges if automation reduces employment in some sectors and weakens income-tax receipts, even as corporate profits and equity valuations rise.

At the same time, the AI investment boom is creating enormous demand for capital. Technology companies and hyperscalers are raising and spending heavily on data centres, chips and other infrastructure, increasing competition with governments for the world's available savings.

According to Reuters, that competition could help keep interest rates elevated, making it more expensive for the US government to finance its growing debt.

A Risk That Is Building Gradually

The U.S. debt market does not currently show the characteristics of an immediate sovereign crisis. Treasury securities remain a cornerstone of global financial markets, and the dollar's reserve-currency status provides the United States with significant financing advantages.

The bigger concern is that the underlying conditions supporting those advantages are becoming less favourable.

Persistent deficits, rising interest costs, an ageing population, higher global interest rates and intense private-sector demand for capital could gradually increase the pressure on US finances.

As Reuters' analysis suggests, the issue may therefore be less about a sudden debt crisis and more about how much room policymakers will have to respond when the next recession, geopolitical shock or financial disruption arrives.

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