Rising U.S. government debt is a concern. But is it a crisis? Coming up, we have answers.

From Thrivent Asset Management, welcome to Advisor’s Market360^™, a podcast for you, the driven financial advisor.

On May 16^th, Moody’s Ratings downgraded the U.S. government from AAA to Aa1 in long-term issuer and senior unsecured ratings. And while this is only one step down, it is a signal that debt levels in the U.S. have started to raise concerns. With U.S. debt being in the news and also a political hot potato, we thought the topic deserves a deeper analysis. And who better to be our guide than Steve Lowe, Chief Investment Strategist at Thrivent Asset Management. Let’s get to it.

The downgrade from Moody’s made news, but what was the actual effect for investors? Here’s Lowe:

Lowe: What was the impact of Moody’s downgrading the last Triple-A rating for the U.S.? Very little. It wasn’t a surprise. And two other agencies went first. And if you look at markets there is very minimal movement. In fact, it didn’t really drive markets the day of the downgrade. You know, stocks were up moderately in a small move in rates.

You heard Lowe mention two other ratings agencies. They are S&P Global Ratings and Fitch Ratings. Here’s Lowe on what happened when they lowered their U.S. ratings…

Lowe: The first downgrade, which was 2011 by S&P, rates fell sharply down with the S&P’s downgrade. It was totally risk off and equities struggled. The issue though really was the economy was also weakening rapidly then. And that helped drive markets. And Europe was in the throes of a debt crisis. If you look at Fitch, which was in 2023, that also wasn’t much of a shock. The economy was much stronger then. And that was pushing up rates and markets rose through Fitch’s downgrade.

Another impact of the first downgrade by S&P was that there were a lot of contracts that required companies to have triple A collateral. So, there was disruption from that. You know the market had to work through and change all these contracts and that caused a little bit of volatility in the market.

Of course, the issue of sovereign debt is the risk of default. What are the odds that the U.S. will default? Here are Lowe’s thoughts:

Lowe: The probability of default rose. But to be clear it’s still relatively low. So, looking at credit default swaps, the U.S. has roughly the same odds of default as Greece, which was the poster child of the European debt crisis and default odds are also similar to credit default swaps on Italy, another country that has struggled with debt. And if you look at the UK, France and Spain, all those traded much lower levels and U.S. yields, 10-year yield, which also factors in some risk for default is now more correlated with Greece and Mexico than Germany. So that means the U.S. is more correlated to triple B-rated countries, which is the lowest level of investment grade ratings.

Overall, Lowe’s comments do not sound too bullish on U.S. debt levels. We asked him for a little reassurance:

Lowe: We don't think the U.S. will default. It is the world’s largest economy. And it’s hard to default when the debt you issue is in your own currency and you run the printing presses.

U.S. debt is just one part of a larger equation—namely, its relationship to gross domestic product, or GDP. And currently, there is an increasing focus on the unsustainability and the trajectory of the U.S. debt-to-GDP ratio. We will let Lowe explain it further:

Lowe: If you think about debt to GDP, GDP is a measure of the size of the economy, sort of like your income to your debt levels if you’re a consumer. And we are running deficits right now in the range of 6 to 7% of GDP, and this mountain of debt is rising and it’s approaching not there, but it’s approaching $40 trillion in total public debt. And if you look at what’s called marginal debt—that’s more like Treasuries—that’s around $30 billion. And then debt to GDP, which is like debt to income levels is around 100% and projected to head toward 120% in 10 years. And depending on how the budget plays out in this year, it could even head higher than that on some estimates. And if you look at it historically, debt levels to GDP were relatively stable for a number of years and then started heading up around the financial crisis and then absolutely shot up during Covid with large rounds of stimulus.

So, what is driving this is actually pretty simple. We’re spending more than we have in revenue, which is taxes, Social Security and Medicare. That’s the core of it. But then interest expense is a rising amount of that. Right now, what we pay in interest is about $1.1 trillion a year, which is a massive amount of money. So that’s about 3% of GDP. And projections are that it’s heading toward 5% in 15 years or more.

Obviously, the U.S. has a deficit problem. But what is the root of that problem? Lowe has a few ideas about the tax bill currently being discussed by Congress…

Lowe: Right now, it’s in the range of adding about $2.5 or so trillion to the deficit over the next 10 years. And what they are doing is extending the tax cuts that will expire. And these are the 2017 tax cuts under the first Trump administration. But it adds other elements such as no tax on tips if you work in a restaurant, no tax on overtime pay and no tax on auto loan interest. And it also includes what are called SALT deductions. It increases those. And that’s a deduction you can take on your federal income tax return for the state and local taxes that you pay. So, the impact could be higher than $2.5 trillion. It could be closer to $4 trillion over 10 years.

U.S. government debt may become so onerous that it may also affect spending in the private sector. Lowe explains:

Lowe: So, another impact of having a lot of debt, and particularly government debt, is that it can crowd out private spending. So, the more government spending you have, you tend to have less private spending, which private companies tend to be much more productive than the government and much more innovative. So that can dampen potential growth over time.

How does high debt affect the government? What constraints come with it? Here’s Lowe:

Lowe: Well, it limits a lot of flexibility for one thing, because the interest on the debt crowds out other spending. So, you spend less on other programs maybe defense or maybe social spending.

You heard Lowe mention interest on the debt. That leads to the question, how much interest is the government paying now and how much is it expected to increase?

Lowe: Interest payments on the federal debt are expected to increase pretty significantly from around 18 to 20% now to up to about 30% of revenue. So, one third of revenue isn’t going to something productive. It’s not building things. It’s simply paying interest on our debt.

Clearly, having a large and growing deficit is not good for the U.S. You may recall that last year we discussed the presidential election candidates and highlighted that neither candidate had a position for addressing the U.S. debt. So, what can be done to rein in the debt? Lowe offers three options. Here’s the first:

Lowe: How do you get out of this overwhelming debt burden for the U.S.? The preferred way is you grow your way out of it. This is what the U.S. Treasury Secretary, Scott Bessent, focuses on and believes will happen over time. So, you have to increase your growth rate. How do you do that? Deregulation is a key focus of theirs, and they expect to get more activity out of that, more growth by removing barriers to growth, investment incentives such as on-shoring or building manufacturing here, and also other areas such as tax code levels, like the immediate expensing of capital expenditures could spur more activity here and grow what you would call your tax base or the revenue part of the equation.

Here’s the second way Lowe says we can reduce the debt:

Lowe: The more classic way is you cut spending. Spending right now is about 20% more than we collect in taxes.

Of course, cutting spending and the programs it supports is easier said than done. Again, here’s Lowe:

Lowe: Cutting programs is really hard to do. That doesn’t get a lot of votes in Congress, and Congress ultimately has to pass the budget that would include cutting programs. And mandatory spending is about half of the overall budget right now. That’s interest expense, Social Security and Medicare.

And the final way to ease the debt problem is to suppress interest rates. Lowe explains:

Lowe: The other way you can get your way out of this is suppress interest rates. In other words, have intervention that pushes down interest rates. And we saw this with what was called quantitative easing after the wake of the financial crisis. In other words, the Federal Reserve bought U.S. debt, which helped keep rates lower and costs down for the federal government. We also did that during COVID in a pretty significant way.

Growing debt is certainly a cause for concern. But has it reached the level of a crisis? Let’s see if Lowe can talk us off the ledge…

Lowe: So, a crisis is not our expectation, but it is a rising risk over time. You know, the U.S. economy is very dynamic, and Treasuries remain a safe haven asset. But there is growing concern internationally and within the U.S. about these debt levels. And we are heading toward a crisis unless something changes. And sometimes, you know, it takes a crisis to actually do the right thing. And that can be the trigger that solves the problem. That's what you saw in Europe with their debt crisis. It precipitated action toward getting, you know, more balanced budgets or at least less debt levels.

So how should investors be positioned to deal with the growing debt of the U.S. government? Here’s Lowe:

Lowe: I still think Treasuries have a role in a balanced portfolio, and I still think they will play a diversifying effect. But that impact could be diminished if there are growing concerns over debt levels because they are less likely to rally on negative economic news, which is typically what happens. So that impacts the diversifying element of Treasuries. And as a fixed income investor, and this is how we are currently positioned—we are underweight on longer-term Treasuries because we are concerned about this dynamic of higher risk premiums on treasuries and concerned over the debt—keeping long-term rates higher than they would be. So, where we do like to invest within bonds on the Treasury curve is the shorter end, because we think ultimately, if there is a problem, the Fed is likely to cut rates, whether it’s because of a weakening economy or more concerns over U.S. debt levels.

We hope this episode helped you gain some insights around the issue of government debt. Once again, we would like to thank Steve Lowe for his analysis. What did you think of this episode? Email us at podcast@thriventfunds.com with your feedback or questions for our experts. Want more episodes of Advisors Market360^™ and other market and investing insights? Visit us at thriventfunds.com, where you can learn how we can partner with you, the driven financial advisor. Bye for now.

(Disclosures)

All information and representations herein are as of 6/6/2025 unless otherwise noted.

Past performance is not necessarily indicative of future results.

Investing involves risks, including the possible loss of principal.

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Thrivent Asset Management, LLC associates. Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

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