Podcast Series: Notes on the Week Ahead, a JP Morgan Asset Management podcast providing market and economic insights.
Host/Speaker: David Kelly, Chief Strategist at JP Morgan Asset Management.
Date of Recording: May 25, 2026.
Current Financial Snapshot (Household vs. Federal Debt)
Household Debt (End of 2025): Total household liabilities—including mortgages, credit card debt, student loans, auto loans, and personal debt—stood at almost exactly $20 trillion, averaging $58,300 per person.
Household Assets: Total household assets exceeded $195 trillion, far surpassing total liabilities, though neither assets nor debt are evenly distributed. Many Americans experience sleeplessness over personal indebtedness.
Indirect Federal Debt: By virtue of citizenship, Americans indirectly owe $30.9 trillion, or , in federal government debt. This induces no similar insomnia because individuals cannot easily estimate their ultimate personal responsibility.
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Historical Debt Trajectory: The federal debt in the hands of the public has surged from a low of 31% of GDP in Q2 2001 to 101% of GDP by Q1 2026.
The Fiscal 2026 Budget and Deficit Outlook
Timeline Context: The Congressional Budget Office (CBO) released its budget projections on February 11, 2026. Nine days later, on February 20, 2026, the Supreme Court ruled the administration's IIPA tariffs illegal, threatening to increase future deficits. Recent April tax filing data clarified the budget impacts of the OBBA (tax breaks), while the war with Iran is projected to increase defense spending.
Fiscal 2026 Deficit: With just over four months left in the fiscal year (ending September 30), the fiscal 2026 deficit is projected at roughly $1.890 trillion (5.9% of GDP), up from $1.775 trillion (5.8% of GDP) in fiscal 2025.
Public Federal Debt: Expected to rise to $32.2 trillion (100.4% of GDP) by the end of fiscal 2026, up from $30.3 trillion (99.7% of GDP) at the close of fiscal 2025.
Spending Breakdown ($7.385 Trillion Total): Total spending is projected to reach $7.385 trillion. (Note: The transcript contains an internal contradiction stating total spending is both $7.385 trillion and $1.951 trillion). This budget includes $1.037 trillion in interest payments, $1.666 trillion in Social Security payments, $1.908 trillion in major medical spending programs, and $885 billion in defense spending.
Revenue Breakdown ($5.495 Trillion Total): Total revenue is estimated at $5.495 trillion. This comprises $4.650 trillion in personal income and payroll taxes, $390 billion in corporate income taxes, $255 billion in net tariff revenue, and $200 billion in other taxes.
Five Scenarios for the Path of Federal Debt
1. Steadily Rising Debt to GDP with Increasing Borrowing Costs (Baseline)
The Projection: The CBO’s baseline forecast assumed tariff revenue would average $403 billion per year and that OBBA tax breaks would expire at the end of 2028, leading to a debt-to-GDP ratio of 100.6% at the end of fiscal 2026 and 120.4% by the end of fiscal 2036.
Adjusted Projections: If tariff revenues fall $150 billion short annually and the OBBA tax breaks become permanent, the ratio rises to 127.7% of GDP by 2036.
Economic Variables: The CBO baseline assumes a 1.8% real GDP growth rate, 4.3% average unemployment, and a 4.3% average 10-year Treasury yield, but makes no provision for recessions, inflation surges, or extra defense spending. Factoring in inevitable economic cycles, the debt-to-GDP ratio could easily hit 130% by 2036.
Market Impact: A Dallas Fed paper established that a 1 percentage point increase in the debt-to-GDP ratio raises the five-year-ahead five-year Treasury rate by 3 basis points. Moving from 100% to 130% debt-to-GDP could boost this yield by 90 basis points. Under certain assumptions, this would increase the 10-year Treasury yield from 4.56% (as of May 22, 2026) to 5.46% a decade from now. This implies a 70 basis point annual haircut to bond returns, suppressing total returns and hampering the ability of bonds to hedge equity sell-offs.
2. Slower Debt Growth with Little Financial Market Reaction (Optimistic)
The Projection: AI productivity gains or relaxed immigration restrictions could accelerate workforce and economic growth beyond the baseline, limiting the debt-to-GDP ratio to 115% by 2036. A prolonged period of divided government could further restrain pre-election fiscal stimulus.
Historical Context: In mid-2001, when the debt-to-GDP ratio was under 33%, the 10-year Treasury yield was 5.42% and the 10-year TIP yield was 3.5%—both higher than the May 2026 values of 4.56% and 2.14% respectively. In the intervening years, widening income inequality and strong foreign demand funneled capital into US bond markets, suppressing yields despite rising debt.
Market Impact: If this trend continues, financial markets may ignore the rising deficits. Bonds would hold their own, while global and particularly US equities would continue to perform strongly.
3. A Fiscal Crisis and Catastrophic Impact
Debt Ceiling Timeline: In July 2025, Congress increased the debt ceiling from $36.1 trillion to $41.1 trillion for "debt subject to limit". As of May 21, 2026, debt subject to limit remains more than $2 trillion below the ceiling, supplemented by $800 billion in the Treasury's checking account at the Fed. Consequently, a debt ceiling hike is not required until the summer of 2027 at the earliest. A future refusal by Congress to raise the limit could trigger a catastrophic default impacting global financial markets.
Federal Reserve Independence: The current administration has aggressively pressured the Fed to lower interest rates. This included a Justice Department investigation into former Chairman Jerome Powell (now dropped, with Powell remaining as a governor) and attempts to fire Governor Lisa Cook. If an upcoming Supreme Court case rules that the President has the authority to fire Fed governors, a subservient Fed could be co-opted into financing federal spending and abandoning inflation control.
Market Impact: A total breakdown of investor confidence due to structural political spending (most federal debt stems from unfunded tax cuts, stimulus checks, and wars rather than economic underperformance) would spike long-term interest rates and depress the US dollar. Paradoxically, a global rout in risk assets could cause international assets to suffer greater setbacks than U.S. Treasuries.
4. Slower Debt Growth via Spending Cuts
Structural Barriers: Forcing the Fed to lower short-term rates to mitigate the $1+ trillion interest expense could backfire by signaling an indifference to inflation, thereby driving long-term rates higher. Social Security cuts remain politically unfeasible. Medicare and Medicaid spending cuts face steep demographic headwinds from an aging population and a proliferation of high-cost specialized pharmaceuticals. Global defense cuts are hindered by a systemic reliance on military force over diplomacy among the US, China, Russia, and Europe.
Personnel Constraints: Over the last 15 months, federal civilian employment was cut by 11.5% to 2.665 million jobs—marking the lowest raw staffing numbers since 1966 and the lowest percentage of total employment since at least 1939, leaving virtually no room for further administrative cost savings.
Market Impact: Aggressive spending cuts would support the bond market but create an ambiguous environment for equities, as the resulting fiscal drag on corporate profits could overshadow the benefit of lower interest rates.
5. Slower Debt Growth via Higher Taxes
Policy Options: The CBO's December 2024 report, Options for Reducing the Deficit, outlines paths like raising payroll taxes or general individual income tax rates, but these are politically highly unlikely to be enacted. Marginal probabilities are assigned to targeted increases in corporate income, upper-income personal, capital gains, or estate taxes.
Market Impact: If implemented without offsetting low-income tax cuts or spending hikes, revenue increases would slow the debt-to-GDP ratio and bolster Treasuries. The effect on equities is mixed: lower interest rates act as a tailwind, but higher taxes on investment income reduce total after-tax returns, dragging down asset prices.
Political Realities and Investment Strategy
Systemic Political Obstacles: The structure of the U.S. political system prevents proactive deficit management. Low-turnout, first-past-the-post primary elections polarize candidates to ideological extremes. Private money and special interests bind representatives to maintaining tax breaks and spending programs. Lengthy election campaigns focus heavily on horse-race media coverage rather than policy, leaving voters uninformed. Consequently, elected officials consistently prioritize protecting or expanding current tax breaks and spending programs over addressing deficits.
The Expected Outcome: No substantive tax increases or spending cuts will occur over the next decade. While a fiscal crisis scenario remains possible, a return to a divided government after the November elections would decrease threats to Fed independence and prevent further unfunded stimulus. Debt will likely continue to drift steadily higher, punctuated by government irresponsibility or national emergencies, but partially offset by AI-driven real GDP growth and workforce expansion.
Strategic Investment Imperatives: Rising federal debt does not justify abandoning long-term investing. To manage these systemic long-term risks, portfolios should adapt by:
Maintaining core high-quality fixed-income assets to stabilize the portfolio.
Diversifying into alternative assets to introduce additional stability.
Increasing exposure to international assets, as long-term debt expansion could ultimately lead to a depreciation of the U.S. dollar.
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