US budget deficit nears $2 trillion as debt interest, entitlements surge

The US federal budget deficit is on track to breach $2 trillion in fiscal 2026, driven by surging national debt interest payments and mandatory entitlement spending.

The Congressional Budget Office's latest projection shows the FY2026 deficit approaching $2 trillion, a $35 billion increase from the prior year, as interest on the national debt and outlays for Social Security, Medicare and Medicaid consume an ever-larger share of federal revenue. The widening gap comes despite the economy operating near full employment, highlighting the structural nature of the fiscal imbalance.

"The US is running trillion-dollar deficits in peacetime at full employment — that's historically unprecedented outside of war or recession," said Maya MacGuineas, president of the Committee for a Responsible Federal Budget. "Interest costs alone are now the fastest-growing line item in the budget."

Net interest on the national debt has surpassed $1.1 trillion annually, exceeding total federal spending on both Medicare and defense. Social Security and Medicare together account for roughly 45 percent of all federal outlays, and their share is expanding as the population ages. The $35 billion year-over-year increase in the deficit reflects higher borrowing costs on the $35 trillion-plus national debt, compounded by the Federal Reserve's elevated interest rate posture. Revenue growth, while positive, has not kept pace with the compounding growth of mandatory spending and debt service.

The trajectory raises questions about fiscal sustainability at a time when the Fed is weighing whether to resume rate increases. A near $2 trillion deficit requires the Treasury to issue roughly $5 billion in new debt every trading day, absorbing liquidity that might otherwise flow into private investment. The Congressional Budget Office projects that by 2030, interest costs will consume more than 20 percent of all federal revenue, up from about 8 percent a decade earlier. That dynamic creates a fiscal feedback loop: higher deficits drive more debt issuance, which pushes up yields, which raises interest costs, which widens the deficit further.

Debt Dynamics Worsen as Rates Stay Elevated

The federal government's borrowing costs have climbed sharply since the Fed began its tightening cycle in 2022. The average interest rate on marketable Treasury debt has risen to roughly 3.3 percent, up from 1.6 percent in fiscal 2021, according to Treasury Department data. Each percentage point increase in rates adds approximately $350 billion to annual interest costs over a decade.

The last time the US ran a deficit of this magnitude relative to GDP outside a crisis was in 2012, when the shortfall hit 6.8 percent of GDP as the economy recovered from the financial crisis. The FY2026 deficit is projected at roughly 6.5 percent of GDP — a level historically associated with recessions or major wars. During the 2008 financial crisis, the deficit peaked at 9.8 percent of GDP in 2009, while the Covid-era shortfall hit 14.9 percent in 2020.

What's at Stake for Markets

The persistent deficit expansion could push Treasury yields higher as investors demand a larger risk premium to absorb the growing supply of government debt. The 10-year Treasury yield has already risen to around 4.5 percent, and some strategists warn that without fiscal consolidation, term premiums could widen further. Higher yields would in turn raise borrowing costs for corporations and households, potentially slowing economic growth and squeezing the housing market, where 30-year mortgage rates have already climbed above 7 percent.

The next official budget update from the Congressional Budget Office is expected in August, which will provide updated baseline projections incorporating the latest economic data and spending legislation. Lawmakers face a September deadline to fund the government, setting up a potential fiscal showdown that could determine whether additional spending restraint is imposed.

This article is for informational purposes only and does not constitute investment advice.