The U.S. federal debt-to-GDP ratio has been on the rise, reaching 124% in December 2024. Historically, a debt-to-GDP ratio exceeding 90-100% has been associated with economic challenges. The U.S. has surpassed this threshold, raising concerns about its ability to service the debt, especially if interest costs outpace economic growth.
This escalation is primarily driven by increasing net interest payments which have become the fastest-growing component of the federal budget, surpassing even defense spending.
What does this mean for investors?
Importantly, the composition of debt holders is shifting. The Federal Reserve has reduced its purchases of government securities, banks are managing devalued assets, and foreign investors like China and Japan are decreasing their holdings. As a result, domestic households have increased their participation in purchasing federal debt.
It’s important to note that federal debt comprises about 30% of the total credit market. For a significant impact on bond markets and to observe a wider term premium – a higher return demanded by investors for holding long-term bonds – there must be an increase in private sector credit demand.
In light of these dynamics, NDR recommends an overweight position in stocks, a market-weight in cash, and an underweight in bonds, reflecting concerns about rising debt levels and interest rates.
