US Debt Is Tightening Its Grip: Three Ways Out of the Trap

💡The three primary ways to reduce the US national debt ratio, according to the fundamental formula Change in Debt Ratio = Fiscal Deficit Ratio + (r - g) × Current Debt Ratio, are to reduce the fiscal deficit, lower interest rates (financing cost 'r'), and increase economic growth (nominal economic growth 'g'). These factors directly influence the debt ratio expressed as a percentage of GDP.

💡Short-term US Treasury rates have remained stable, with the 3-month Treasury bill yield at 3.9%, primarily due to a lack of need for aggressive Federal Reserve rate hikes as core inflation remains controlled and wage growth slows. Additionally, demand for short-term Treasury bills remains stable, supported by large money market funds approaching $8 trillion, and the Federal Reserve's strategy of reinvesting maturing MBS into short-term Treasury bills.

💡Stablecoin market capitalization could significantly impact demand for short-term US Treasuries by 2028, with estimates suggesting an eightfold growth to $2 trillion. This expansion would imply their short-term Treasury reserves could increase from approximately $120 billion to $1 trillion, nearing the holdings of Japan, the largest foreign holder of US Treasuries at about $1.1 trillion, thereby increasing overall demand for short-term government debt.

💡The US Treasury Department is adjusting its issuance strategy by potentially issuing more short-term debt and reducing long-term issuance, evident in a shift in language in its August quarterly refunding announcement. This change from assessing the possibility of 'increases' to 'changes' for future coupon-bearing Treasury auctions suggests an intention to modify the maturity structure of Treasury issuance to ease the term premium demanded by investors for holding long-dated bonds.

💡The SEC's central clearing rule for US Treasury transactions mandates that eligible transactions gradually transition to central clearing, with compliance deadlines by the end of 2026 for cash transactions and June 30, 2027, for repo transactions. This rule is important because central clearing improves netting efficiency, reducing the balance sheet space and capital required for financial institutions, thereby increasing their capacity to absorb US Treasuries.

💡Increased labor productivity through AI can improve the US fiscal deficit and debt ratio by expanding the denominator (GDP) in the debt-to-GDP ratio without requiring fiscal austerity and by directly expanding the tax base. The Congressional Budget Office estimates that every 1 percentage point increase in annual labor productivity growth could reduce the cumulative deficit by approximately $3.17 trillion over 10 years, fostering a positive fiscal cycle.

💡The internet boom of the 1990s significantly impacted US productivity growth, which at one point approached 4% on an annualized basis, while nominal growth reached 7%. This surge directly contributed to four consecutive years of fiscal surpluses from 1998 to 2001, resulting in a significant decline in the debt-to-GDP ratio, despite 10-year Treasury yields remaining in the 5% to 6% range, illustrating the importance of nominal growth exceeding financing costs.

💡Signs indicating that AI-driven productivity gains are starting to affect the US economy include a historically elevated direct contribution of technology investment to GDP, with information technology investment contributing 0.61 percentage points to GDP growth in Q2 2026. Additionally, JOLTS job openings have risen from 6.5 million to around 7.5 million, signaling expanding labor demand that outpaces automation, supporting resilient employment and consumption growth, which was revised up to 3.4% in Q2 2026.

💡MacroMicro recommends short-term Treasuries over long-dated ones for bond exposure because long-dated Treasuries are likely to remain more volatile due to the US debt's maturity structure being overly concentrated at the long end. For investors needing bond exposure to reduce portfolio volatility, short-term Treasuries are considered a better choice, especially as demand for them increases and the Treasury Department shifts its issuance strategy towards shorter maturities.

💡The overarching investment principle when economic growth continues in an expansionary phase is that equities over bonds remains the preferred allocation. This strategy is based on the expectation that sustained economic growth will drive corporate earnings and expand the tax base, supporting steady growth in tax revenue and providing fundamental support for the bond market, creating a positive fiscal cycle.