By Vivien Lou Chen
'The trajectory definitely looks dire,' researcher says of the U.S. fiscal outlook
The Congressional Budget Office's latest forecasts are out on the U.S. government's deficit situation - and they don't look very good.
An ever-widening U.S. budget deficit over the next 10 years will be accompanied by ever-rising interest costs that eat up a greater share of government spending, according to the Congressional Budget Office's latest forecasts.
This is producing an environment in which interest rates for consumers and bond-market participants are already higher than they ought to be - and it could keep looking worse from here.
By 2036, the deficit is expected to soar to $3.1 trillion, from $1.9 trillion in the 2026 fiscal year that ends on Sept. 30, according to a CBO report released on Wednesday. Whenever expenditures on services exceed tax revenue to produce a wider deficit, the government must borrow from the public via the U.S. Treasury Department's sales of bonds, bills and notes. The greater the supply of Treasurys, the higher that their yields might need to be to attract investors, depending on the composition of those maturities.
&#34;The bond market has been showing us that it is consistently concerned&#34; about the fiscal outlook, said Brian Mulberry, a senior client portfolio manager for Chicago-based Zacks Investment Management. &#34;One of the biggest concerns seems to be around a growing deficit that seems to be moving at an exponential pace.&#34;
Already, concerns about the U.S. fiscal outlook have translated into higher interest rates and yields than would otherwise be the case, even before the CBO's forecasts came out, according to Mulberry. In a phone interview on Thursday, he estimated that the Federal Reserve's main interest-rate target, now between 3.5% to 3.75%, would probably be lower by about 100 basis points on greater confidence about the U.S.'s ability to make progress on government spending and its deficit, as well as inflation. Yields across the spectrum of Treasurys also would be lower, he said.
The 10-year yield BX:TMUBMUSD10Y - which influences borrowing costs for everything from mortgages and auto loans to corporate bonds and capital investments - finished Thursday's session at 4.1%, and has remained largely contained because of efforts by the Trump administration and Treasury Department to rely more on the issuance of short-term T-bills to manage government financing costs. In Mulberry's mind, though, the 10-year yield ought to be closer to 3.5% to 3.75%.
A chart from the CBO that reflects the federal budget deficit's path toward $3.1 trillion, or 6.7% of gross domestic product, by 2036 versus $1.9 trillion, or 5.8% of GDP, in fiscal 2026 reveals just how much of this shortfall is made up of rising interest costs. Lightly shaded purple areas of this chart, shown below, reflect net interest outlays, which will eventually make up more of the deficit as time goes on.
This chart reflects total deficits as a percentage of GDP, as well as the amount being taken up by interest costs.
&#34;In the grand scheme of things, the trajectory definitely looks dire,&#34; said Subadra Rajappa, head of research at Société Générale in New York. &#34;But the bond market seems to be focused on the ability to finance this debt over the near and medium term,&#34; and the market has been &#34;much more forgiving of the U.S. and its trajectory of debt and deficits&#34; than it would be with another country.
Rising government deficits and interest costs threaten to overshadow President Donald Trump's efforts to focus on the issue of affordability in housing and daily living for most Americans. That's because a worsening deficit situation impacts many Americans as well as participants in the bond market.
For one thing, rising borrowing costs means there's less to spend on things such as government services, roads and bridges, defense, research and Medicare. Meanwhile, the Treasury Department will need to keep increasing the supply of U.S. government debt in circulation. If potential buyers balk at future sales, this would raise the risk of an unwieldy spike in yields that might spook the broader financial market.
Given the Treasury Department's reliance on issuing more short-term T-bills, market participants have been expecting the agency to eventually shift more in the direction of interest-bearing coupon sales. Earlier this month, however, those expectations were dashed after the Treasury left in place its guidance indicating that future auction sizes on notes and bonds would be unchanged &#34;for at least the next several quarters.&#34;
On Thursday, a day after the release of the CBO's forecasts, the bond market rallied on a worsening mood in stocks. U.S. stocks DJIA SPX COMP closed sharply lower on uncertainty created by disruptions from artificial intelligence. Most Treasury yields also fell, led by declines in rates on 5-year notes through the 30-year bond BX:TMUBMUSD30Y .
-Vivien Lou Chen
This content was created by MarketWatch, which is operated by Dow Jones &amp; Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.
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02-12-26 1613ET

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The Congressional Budget Office forecasts a U.S. budget deficit soaring to $3.1 trillion by 2036, raising concerns about rising interest costs and their impact on government spending. This situation is expected to lead to higher yields on Treasurys as the government borrows more. Analysts warn that the bond market is already reacting to these fiscal challenges, with current yields higher than they should be. The trajectory of the deficit could hinder government services and economic stability, affecting both consumers and investors.

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