America is running a crisis-size deficit without a crisis

On 8 October the Congressional Budget Office (CBO), Congress's nonpartisan budget scorekeeper, put the US federal deficit for fiscal 2026 at $2.0 trillion. That is $218bn more than the year before, a rise of 12%. The fiscal year ran from 1 October 2025 to 30 September 2026.

"Running $2 trillion deficits in a growing economy with low unemployment and no major emergency situation going on is an unsustainable trend." Shai Akabas, Bipartisan Policy Center, to the Wall Street Journal

Deficits this size usually signal an emergency. Before 2026, the US had topped $2 trillion only in the pandemic years of 2020 and 2021. This time there was no war, no recession and no pandemic. CBO projects unemployment to stay below 5%.

So why is the gap so wide, and why is it so hard to close? The short answer is interest. The biggest single driver of higher spending was the cost of the debt itself. Bond markets are also now charging more than the government's own forecasts assume.

A peacetime record

Measured against the size of the economy, the deficit rose to an estimated 6.2% of GDP, from 5.8% in fiscal 2025. CBO says deficits over the past 50 years averaged 3.8%. The Committee for a Responsible Federal Budget (CRFB) calls this year's figure "the highest ever outside of a war or recession". It proposes a target of 3% of GDP, about half today's level.

The deficit also beat the forecast. CBO's February baseline expected $1.9 trillion. The American Action Forum puts the overshoot at about $140bn. These are still CBO estimates. Treasury's final statement for September has not yet been published.

Interest led the way

Total spending rose about $386bn (6%) to $7.4 trillion. The largest single increase was net interest, the cost of servicing the debt after interest the government earns. It rose $115bn, or 11%, in one year.

The three big benefit programmes came next. Social Security rose $86bn, Medicare $77bn and Medicaid $55bn, a combined $217bn (7%). This reflects an ageing population and rising health costs. The American Enterprise Institute says that is 80% of the rise in non-interest spending, which we derive at $271bn. Defence rose $48bn, or 5%.

Revenue could not keep up

Revenue grew too, just much more slowly. It rose $169bn (3%) to $5.4 trillion. Income and payroll taxes added $255bn. Corporate taxes fell $70bn (16%), mainly because the 2025 tax law lets businesses write off more investment straight away. Customs duties also fell. CBO says that was because of a Supreme Court ruling on tariffs that came after its February forecast.

That matters for the next decade. Since January 2025, CBO added $4.7tn to its ten-year deficit total for the tax law and $0.5tn for immigration actions. Tariffs were supposed to offset much of that, with a $3.0tn saving. In August, CBO said trade-policy changes add $0.9tn back to deficits over 2027-2036. The offset is shrinking.

Interest now outranks the military

Net interest reached about $1.14 trillion in fiscal 2026, a record. Defence spending was roughly $1.0 trillion. That defence level is our rough derivation from the reported $48bn (5%) rise. Either way, the US now spends more servicing its debt than on its armed forces.

Net interest "set a record at $1.1 trillion, consuming over 20% of federal tax dollars." Carolyn Bourdeaux, Concord Coalition

Interest took about 21% of all federal revenue, again our derivation ($1.14tn divided by $5.4tn). Every dollar of interest is a dollar unavailable for roads, research or tax cuts, and it buys nothing new.

Past $40 trillion

Total federal debt passed $40 trillion on 18 August 2026, as reported. Treasury data show $40.17tn on 30 September, up from $37.64tn a year earlier, a rise of about $2.5tn (derived). By 7 October it was $40.28tn.

The total includes $7.75tn the government owes its own trust funds. The figure that matters most for markets is debt held by the public, owed to outside investors. It stood at $32.4tn at the end of the fiscal year, above CBO's February projection of $32.1tn, or 101% of GDP. In the Concord Coalition's words, it is now "as large as our entire economy".

The next decade, on CBO's own numbers

CBO's February baseline assumes current law and no recession. Even so, the deficit widens from 5.8% of GDP in 2026 to 6.7% in 2036, or from $1.9tn to $3.1tn. Look inside and the story is clear. The primary deficit, the gap before interest costs, actually narrows from 2.6% to 2.1%. Net interest rises from 3.3% to 4.6% of GDP.

In other words, interest does all the widening. Debt held by the public rises from 100.6% to 120.2% of GDP. CBO's longer-term numbers, as cited by National Review, show $3tn deficits within a decade, $4tn by 2042 and $5tn by 2046. Those assume interest rates below today's levels.

Markets are already off-script

That last assumption is the weak point. CBO assumes the 10-year Treasury yield averages 4.3% over 2026-2036. Actual yields have run above CBO's assumptions in every quarter this year: 4.20% against 4.06% assumed in Q1, and 4.42% against 4.09% in Q2. In early October the 10-year traded between 5.24% and 5.31%. Treasury's curve showed 5.22% on 8 October, against 4.13% a year earlier.

On 8 October CBO also published a higher-rate scenario. It is a stress test, not a forecast. All rates sit 150 basis points (1.5 percentage points) above baseline, so the 10-year averages 5.8%. Net interest rises by $1.6tn over the decade, plus $297bn in extra debt-service costs. Debt reaches 124.4% of GDP in 2036. CBO noted the 10-year was already near that path.

The rise is mostly in real yields, the return after expected inflation. The 10-year real yield is 2.87%, up from 1.78% a year ago, while expected inflation is 2.35%. Investors are not mainly worried about inflation. They are demanding more to lend.

Our call

Our call: the fiscal 2027 deficit, reported in October 2027, will again be at least $2 trillion and at least 6% of GDP, and net interest will again grow faster than defence.

The data lean this way. The 10-year yield is about a full point above CBO's 4.3% assumption. CBO's 2026 forecast was already too low by about $100-140bn, roughly 5-8%. The tariff offset is eroding, and no deficit-reduction deal is in sight. A recession would make the deficit bigger, not smaller.

We put about 70% on this outcome. Our main reason is arithmetic: with $32.4tn of public debt rolling over at higher rates, interest keeps compounding whatever Congress does.

It gets there if yields stay above 5%, tariff revenue stays below forecast, and the spending risks reported by news outlets come through. Analysts say a proposed $5,000 dividend from President Trump could add $1.2tn to deficits. Commentators have also raised the cost of a conflict with Iran.

A deficit back under $2tn, the other 30% or so, would take a real change of course: the 10-year falling back toward CBO's 4.3%, tariff revenue rebounding sharply, or Congress agreeing a deficit-reduction deal. Any one would help. It would probably take two of them to pull the deficit under $2tn within a year.

The currency trade

The dollar sits between two forces. Higher US real yields pay investors more to hold dollar assets, which supports the currency. A widening deficit, if markets start to treat it as a risk, would push the other way. For now, the rise in real yields with steady inflation expectations looks like the first force at work.

The riskier position, in our view, is a large bet on a weaker dollar while US real yields are still climbing.

• Long the dollar. Pro: a 10-year real yield near 2.87% is a strong carry. Con: if yields rise because investors fear the debt, not because growth is strong, the dollar can fall even as yields go up.
• Short the dollar. Pro: a decade of 6-7% deficits and interest above defence is a slow-moving fiscal story that can eventually weigh on any currency. Con: it fights the yield advantage today, and timing a fiscal reckoning is notoriously hard.

What would change the view

Two signals would change our currency view. If the 10-year real yield falls back toward last year's 1.78%, the support for the dollar fades. If the nominal 10-year pushes through CBO's 5.8% stress path while expected inflation stays near 2.35%, the question becomes whether investors are demanding a fiscal risk premium. That would be a warning for the dollar too. This is analysis, not investment advice.

What to watch

Deficits used to be a symptom of bad times. America now runs a crisis-size deficit in good times, and the reason is interest, not new programmes. Once the cost of the debt becomes the fastest-growing bill, the budget depends less on Congress and more on the bond market.

• October 2026: Treasury's final statement. Confirms or revises CBO's $1.993tn estimate for fiscal 2026. The exact date is not yet confirmed.
• November 2026: CBO's detailed fiscal 2026 review. The exact interest and defence figures will show how wide the gap really is.
• Monthly, through fiscal 2027: CBO's budget reviews. If net interest keeps growing faster than defence and revenue stays near 3% growth, the call holds.
• Q4 2026: the 10-year yield. A move back toward 4.3% weakens our call. A move toward 5.8% puts CBO's stress scenario in play.