The US deficit is nearing $2 trillion, and interest bills have exceeded $1 trillion for the first time, with long-term US Treasury bonds setting the stage for a debt spiral pricing strategy.

The US fiscal deficit is expanding at a rate approaching $2 trillion, with net interest payments exceeding $1 trillion for the first time and the average interest rate on tradable Treasury bonds rising to 3.48%. This means that even without further deficit increases, the rolling refinancing of existing debt is continuously pushing up the interest burden, and the market is beginning to price in a self-reinforcing debt spiral.

Data released by the U.S. Treasury Department on Friday showed that the federal budget deficit reached $1.97 trillion in the first 11 months of fiscal year 2026, one of the highest levels on record, with a deficit of $166.8 billion in August alone.

In the 11 months ending in August, net interest expenses totaled $1 trillion, exceeding all other major spending categories except for those of the Department of Social Security and Health and Human Services.

U.S. Treasury yields rose to multi-year highs this week, driven by inflation concerns and expectations that the Federal Reserve will raise interest rates to curb inflation: the 2-year yield touched 4.66% on Friday, and the 10-year yield touched 4.98%. The average yield on tradable Treasury bonds rose to 3.48%, more than 2 percentage points higher than five years ago.

As a large amount of Treasury bonds issued during periods of low interest rates mature and need to be refinanced at higher costs, the Treasury's average financing costs will continue to rise. For a government with outstanding debt exceeding $40 trillion, the expansion of interest payments is squeezing fiscal space and making the "risk-free anchor" status of long-term US Treasury bonds less secure.

Deficit size: Could rank third highest in history for the year

According to data from the U.S. Treasury Department, the federal budget deficit for the first 11 months of fiscal year 2026 (ending in August) was $1.97 trillion, a decrease of about 5% compared to the same period in 2025 after adjusting for calendar differences.

The deficit in August was $166.8 billion, a significant narrowing from $432 billion in July. However, the latter was mainly affected by calendar factors such as tariff refunds and is not comparable.

In terms of revenue and expenditure structure, total federal spending in the first 11 months reached $6.81 trillion, a year-on-year increase of 3%; total revenue reached $4.85 trillion, also a year-on-year increase of 3% after adjustments. While revenue and expenditure grew in tandem, the absolute value of expenditure significantly exceeded revenue, resulting in a still substantial deficit.

According to data compiled by Bloomberg, the deficit for fiscal year 2026 is expected to increase by approximately $200 billion compared to 2025, making it the third-highest deficit year in U.S. history, second only to the pandemic crisis years of 2020 and 2021.

September, the last month of the fiscal year, usually sees a surplus due to the corporate income tax filing deadline, but this is unlikely to fundamentally change the overall trend for the year.

Interest expenses have already exceeded defense spending and may surpass social security payments by 2028.

Interest burden is the core issue causing current federal fiscal pressure. Net interest payments totaled $1 trillion in the first 11 months, exceeding defense and all other major spending categories, second only to the Department of Social Security and Health and Human Services (which oversees Medicare).

If calculated on a rolling 12-month basis, U.S. interest expenses have now reached a historical peak of $1.4 trillion, representing a year-on-year increase of 12%.

In comparison, Social Security rolling 12-month spending totaled $1.66 trillion, but its growth rate was significantly slower. At this rate, interest payments are expected to surpass Social Security by the end of 2028, becoming the largest single expenditure item for the U.S. federal government.

The core factor driving up interest burdens is the continued rise in borrowing costs. Data from the Ministry of Finance shows that as of the end of August, the average interest rate on marketable treasury bonds had risen to 3.48%, more than 2 percentage points higher than five years ago.

This figure will continue to rise as low-yield bonds mature and the Treasury is forced to refinance at higher costs. Currently, 23% of marketable U.S. Treasury securities are short-term Treasury bills (T-Bills), and once the Federal Reserve resumes raising interest rates, interest payments will face a more direct and rapid impact.

The widening gap between income and expenditure makes structural pressures difficult to resolve.

Federal spending continues to grow faster than fiscal revenue, and the deficit is likely to widen further.

In August, the U.S. government spent $527 billion and received $360 billion. Looking at the trend lines over the past six months, the spending and revenue curves are diverging rapidly, with spending growth approaching its peak during the COVID-19 pandemic, while revenue growth is constrained by a narrower range.

The continued expansion of spending on Social Security and Medicare is a significant driver. With a steady increase in the retired population, spending on these "statutory benefits" programs has been under long-term pressure, while Congress lacks the political incentive to cut benefits or increase contributions.

Tariff refunds have recently had a temporary impact on the deficit. In February, the U.S. Supreme Court ruled that most of the Trump administration's previous tariff increases were illegal, leading to a continuous decline in net tariff revenue for several months afterward. However, net tariff inflows rebounded to $12.8 billion in August.

Long-term interest rates are rising, shifting from risk-free benchmarks to fiscal risk pricing.

The 2-year yield touched 4.66% on Friday, and the 10-year yield touched 4.98%, both at multi-year highs.

The rise in long-term yields largely reflects the market's compensation for risks related to expanding fiscal deficits, increased supply, and deteriorating debt sustainability.

In February, the Congressional Budget Office warned that by 2030, the U.S. debt-to-GDP ratio could exceed the record of 106% set in 1946, just after the end of World War II.

U.S. Treasury Secretary Bessant has pledged to release a fiscal consolidation plan in the coming weeks or months, saying he is working with White House budget director Russ Vought to develop it; he also expects that most of the previous tariff revenue will be recovered as the government introduces new import tariffs based on other legislation.

The signs that debt levels, interest costs, and fiscal deficits are reinforcing each other are causing the pricing of long-term US Treasury bonds to shift from a "risk-free benchmark" to a "fiscal risk asset".

The market's focus now shifts to the adjustments the Treasury Department will make to the issuance structure and long-term bond repurchase plan in its next quarterly refinancing statement, and whether Bessenter's promised fiscal consolidation plan can be implemented within weeks.

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