Payden & Rygel: Is the US going broke?
Thirty-year US Treasury bond yields hover at multi-decade highs as investors focus on the U.S. fiscal situation, specifically the “budget bill” that was passed through Congress and signed by the President on July 4. We address common misconceptions about the U.S. federal government budget and its economic implications.
Fiscal concerns are brewing again due to the One Big Beautiful Budget Act (OBBBA), which was passed by both chambers of Congress by a slim margin and signed into law by the President on July 4. Specifically, the bill includes the extension of the sunsetting provisions in the Tax Cuts and Jobs Act of 2017, additional tax cuts (tips, overtime pay, and car loan interest), reductions in Medicaid and nutrition programs, and increased funding for defense.
Treasury yields reflect market angst over a widening budget deficit expected to result. Treasury term premiums rose to their highest level in decades, while the 30-year Treasury yield topped 4.9% when markets opened after the 4th of July weekend.
But U.S. fiscal worries are not new. In fact, the quote at the start of this note is from the cover of Time magazine, dated March 13, 1972. Back then, the U.S. deficit was 1.9% of GDP, or approximately $14 billion. Since then, the U.S. economy has continued to expand, but even larger deficits have accompanied the growth.
Don’t get us wrong: while America is not on the verge of 'going broke', the big, beautiful bill means big budget deficits are here to stay.
Beyond that, we debunk a few misconceptions about the federal budget below.
The federal budget is the key to the US economic outlook
Federal spending and revenue decisions are important, but the signing of the OBBBA bill will not alter the U.S. growth trajectory as policymakers and investors might believe.
First, most of the tax cuts in the bill are extensions of existing tax rates rather than the introduction of new ones. The average consumer won’t see their tax rate change materially from the bill.
Second, timing matters. The OBBBA won’t start impacting government budgets or growth until the fiscal year 2026 (which begins on October 1, 2025) and beyond. Furthermore, some of the provisions for spending cuts don’t even take effect until 2028!
Third, consumer expenditures and private investments account for 89% of U.S. real GDP, while federal government spending and investment account for just 6.5%. As a result, the real GDP growth trend remains essentially unchanged, even after excluding the impact of government spending and the indirect benefits of government spending on households and businesses.
The new budget bill adds$3.4 trillion to the deficit. How can you say it doesn’t matter much?
The CBO released a report estimating that the budget reconciliation process will add $3.4 trillion to the federal deficit over the next 10 years. Sounds like a lot, but on average, the budget bill is estimated to add $340 billion to annual deficits, equivalent to one percentage point of GDP, not $3.4 trillion in one year.
Phew. So The Deficit Is Not A Problem?
No, investor concerns are not unfounded. Since the deficit is a flow measure, running a deficit of 6-7% of GDP is equivalent to adding nearly $2 trillion annually to the total federal debt outstanding, which already stands at $29 trillion, or ~104% of US GDP. Therefore, although the current debt burden is not at an unsustainable level, it is projected to grow faster than the nominal economy, meaning it's on an unsustainable path.
But global examples suggest the critical threshold for debt-to-GDP is much higher. By comparison, while US general government debt-to-GDP is higher than the UK’s 87.3%, it is lower than Italy’s 135.6% and Japan's 205.6%. Both Italy and Japan boast borrowing costs below the US Further, unlike Italy and Japan, US Treasuries remain the world's safest and most liquid assets, garnering a bid beyond mere financing of the public debt. As a result, the US likely has more capacity to support a higher debt burden compared to other major developed economies.
But DOGE found billions in fraud and waste! Shouldn’t there be more spending cuts?
While the DOGE official website claims that it has saved $190 billion in spending, President Trump’s recent rescission request, which represents the actual cancellation of Congress-appropriated funds, was only $9.4 billion, which is merely 0.14% of total federal spending in FY 2024.
So why is it so hard to cut spending?
The big picture is that most of the increase in deficits is inherently structural as the U.S. population ages. Social Security, Medicaid, and Medicare account for more than 50% of total federal outlays, up from 13% in 1960, as the number of people eligible for these benefits increases. For example, from 2019 to 2024, federal outlays increased by 52%, or $2.3 trillion, of which 61% of the increase is attributed to Social Security, healthcare (including Medicaid and Medicare), and net interest costs.
But the budget bill is required to keep deficits under a certain limit, so you will eventually have to cut spending, meaning the bill ‘front loads’ spending and revenue cuts
Technically, a budget reconciliation bill (the ‘One Big Beautiful Budget Bill Act’) needs to specify an estimated deficit target that the bill will increase or decrease over the next 10 years. If the deficit is ever projected to exceed the limit soon, automatic spending cuts in mandatory programs will be triggered.
In reality, though, if the government is about to reach the deficit target before the 10-year mark, the President and Congress can simply pass another reconciliation bill that sets a new target for a new 10-year time frame, and deficits will restart from year zero—wondering why we’ve had 22 budget reconciliations since 1974? Wonder no longer.
OMB says the budget bill saves trillions; the CBO says it adds trillions—clearly, someone’s right, and someone’s wrong
Investors often place too much emphasis or trust on the forecasts the CBO or OMB provides.
Regardless of who you choose to believe, one needs first to understand that the two agencies serve different missions: the OMB is an executive office established to promote the President’s budget proposals, while the CBO is a Congressional agency designed to provide nonpartisan budget analysis for Congress. So, it’s perfectly normal for the OMB and CBO to have different forecasts. The cumulative difference in deficit projections between the two organizations over ten years can be as large as $10 trillion.
Second, when OMB and CBO say 'add' or 'save' in deficits, it’s relative to different baselines. For example, in the context of the OBBBA, the OMB’s baseline forecast assumed the TCJA would be extended, resulting in a higher baseline. On the other hand, the CBO used a lower baseline since it did not assume the TCJA would be extended beyond 2025.
Third, neither the CBO nor the OMB forecasts should be treated as the gold standard. Both forecasts rely on making assumptions for the next 10 years. In reality, the economy often evolves differently than expected, leading previous forecasts astray.
The ‘one big beautiful budget act’ is the only thing that matters for fiscal policy right now
Hold on, aside from the OBBBA, there is still another pending matter: the annual federal budget appropriations process for fiscal year 2026.
Budget appropriation is an annual process for allocating funding to all federal agencies through the 12 Congressional subcommittees for discretionary expenditures in the next fiscal year. Unlike the budget reconciliation process used to pass the OBBBA, which requires only a simple majority vote, appropriations require 60 votes in the Senate to conclude debate, potentially making passage more difficult given the slim margin in the Senate.
The implication is that passing the OBBBA doesn’t mean Congress is off to vacation for the (fiscal) year. Annual appropriations bills must be passed or extended (via a continuing resolution) by October 1, 2025, or we may still face a government shutdown.
Either way, the OBBBA raised the debt ceiling by a staggering $5 trillion, so we (financial markets) are ‘good’ for a while!
Again, while we’re not debt alarmists, the future may be closer than it appears. The OBBBA raised the debt ceiling by $5 trillion, increasing the total debt ceiling on U.S. outstanding federal debt from $36.2 trillion to $41.1 trillion.
But, from August 2019 to August 2021, the debt ceiling was raised by $6.4 trillion after a period of suspension, and the new, higher level was quickly breached again within two years.
Also, remember that the Treasury has been using extraordinary measures and cash to fund government spending, which has to be replenished after the debt ceiling is raised. In our view, total federal debt could easily swell by ~$3 trillion by the end of fiscal year 2026, leaving only ~$2 trillion of room before we hit the debt ceiling again.
The fiscal concerns are mainly a U.S. phenomenon
Not to point fingers, but most developed economies face similar fiscal pressures, with fiscal deficits as a share of GDP in 2024 much higher than the historical average deficits outside recessions.
For example, since the end of April, Japanese 30-year and 40-year yields had risen and remained at their highest levels since they were first auctioned, reflecting concerns about Japan’s rising debt burden. Meanwhile, Germany’s new Chancellor’s spending plans to boost defense and infrastructure investment will likely push the country’s deficits to their highest level in decades.
