The impact of the U.S. national debt on interest rates and investors

The impact of federal debt on interest rates

The U.S. national debt is increasingly becoming a costly problem. Rising costs related to the federal government’s large, accumulated debt further complicate the issue. Interest payments on federal debt constitute a significant portion of government spending. In January, the average interest rate for all federally issued interest-bearing debt rose to 3.37%, and interest payments neared $1 trillion.

In anticipation of the Fed’s interest rate cuts from recent high levels, yields across the bond market declined in early 2024. However, after the Fed implemented its initial rate cut, 10-year Treasury bond yields began to trend higher. Ten-year Treasury yields rose from 3.63% to 4.79% from mid-September to mid-December. Since that peak, rates have retreated back to 4.22%.Part of the recent net increase in long-term bond yields is linked to concerns about the deficit. There’s considerable uncertainty regarding how government policy will affect Treasury prices and yields going forward.

What’s the outlook for debt and interest rates moving forward?

Uncertain economic times have investors, homeowners, and businesspeople seeking guidance from trusted sources. “Today’s government debt is manageable,” says Toerpe. However, the ability to sustain rising debt levels over time is causing concern for many. The sooner the long-term debt problem is addressed, the easier it will be to resolve.”

An increased supply of bonds and reduced market participation by foreign buyers  puts upward pressure on interest rates. At the same time, efforts to scale back Federal spending, along with the impact of tariffs will put a brake on the economy, which typically leads to lower rates. As a result, rates have been volatile as investors struggle to navigate these offsetting impacts. In addition, the potential “staginflationary” effects of tariffs put the Federal Reserve in a bind. As inflation fell and the economic growth moderated in late 2024, the central bank began cutting short term rates. That trend is expected to resume later this year, but at a slower pace, as the uncertainty over fiscal, trade and monetary policy clears. Until then, longer term rates are likely to remain in a band between the highs and lows of the past year.

Impact on investors and borrowers

“A key investor concern is the extent to which Treasury debt issuance may influence fixed income and equity markets. Higher bond yields could prompt investors to allocate more capital to fixed income instruments instead of stocks,” says Senior Vice President Capital Markets Thomas Toerpe. “This shift could have detrimental effects on the stock market. However, government debt isn’t a concern for now unless the bond market views it as such.”

Given the uncertainty, Associated Bank Private Wealth Chief Investment Officer Mike Hochholzer suggests that “Investors might consider remaining close to their target allocations for both bonds and stocks in the face of current uncertainty, watching for opportunities created through either price changes or more clarity in the environment.”

To avoid the risk of higher potential payments, long term borrowers such as homebuyers may want to take advantage of today’s rates. And for commercial borrowers, locking in a rate and using interest rate swaps over a longer period may make sense. Toerpe adds, “10-year swap rates aren’t significantly different from five-year swap rates, so if you want to avoid uncertainty in the marketplace right now, it may be wise to lock in for an extended period. On the other hand, if your primary exposure is to short-term interest rates, the Fed is expected to cut rates modestly over the next year or two, so you may want to capitalize on that with any floating-rate debt.”

Associated Bank closely monitors the government’s growing debt burden and policies that impact long-term sustainability for signs of change in the broader investment landscape. Our, capital markets specialists, private wealth advisors and commercial banking relationship managers can help you identify which part of the interest rate puzzle affects you and what actions you can take in response.

Focus on your particular financial goals

Adopting a risk management approach is essential instead of merely guessing where the market will head. There are many moving parts right now since we’re in a highly dynamic economic and political environment filled with uncertainty. There is no one-size-fits-all solution for investors, so it’s vital to focus on your financial goals, adhere to your wealth planning and business strategy, and collaborate with experts to ensure you have a plan that will help you withstand the impacts of interest rate fluctuations. Call us today to schedule an appointment to ensure you are comfortable with your current plan and investment position.