Macro Report Interpretation

Overview

The report examines whether US public debt surpassing $40 trillion must inevitably cause insufficient demand for Treasuries and higher long-term yields. Morgan Stanley believes that the debt total is a potentially misleading round-number threshold; more explanatory factors include the pace of deficit formation, the currency and risk structure of the debt, the transaction prices investors are willing to accept, as well as inflation, the macro environment, and Federal Reserve policy. Based on historical relationships, the report concludes that the CBO's long-term yield assumption is clearly too high.

Core views

The report first uses a similar debate from 2022 to test the intuition that more debt means higher yields. US public debt reached $31 trillion in October 2022 and has now risen by $9 trillion to $40 trillion; however, the recent peak in the 10-year Treasury yield was 4.75%, only 40bp above the 4.35% level in October 2022. The report therefore argues that the $40 trillion round-number threshold cannot by itself explain bond prices. Similar concerns repeatedly arose when debt reached $1 trillion in the early 1980s and $10 trillion in 2008, while marketable Treasury debt outstanding has grown at an approximately 6.6% CAGR since 1946, or 6.4% excluding the Federal Reserve's SOMA holdings. Apart from the period of fiscal consolidation from the late 1990s to the early 2000s, the growth trajectory did not change materially at round-number thresholds. The definition of debt itself can also materially change the conclusion. The approximately $40 trillion total of public debt includes nonmarketable securities, most of which are held by government trust funds; marketable Treasury debt outstanding is closer to $31.5 trillion and approximately $26.8 trillion excluding SOMA. The gap among the three measures exceeds $13 trillion, even larger than the recent $9 trillion increase that attracted public attention. The distinction between face value and market value is equally important, particularly during periods of unusual volatility; most of the Treasury holdings data cited in the report are measured at market value, while primary dealer transaction data are measured at face value. The report therefore shifts its analytical focus from the absolute scale of debt to the size and timing of deficits, the risk characteristics of the debt, the prices investors will accept, and the principal drivers of market yields. The CBO projects that federal debt held by the public will rise from approximately $31 trillion currently to $47 trillion in 2033 and $56 trillion in 2036, exceed the 1946 record of 106% of GDP in 2030, and reach 175% of GDP over the long term. Correspondingly, net interest outlays are projected to rise from 3.3% of GDP in fiscal 2026 to 4.6% in 2036 and reach 6.9% in 2056; their share of total federal outlays is projected to increase from approximately 14% to approximately 19% over the next decade. Morgan Stanley emphasizes, however, that these interest-cost projections depend heavily on yield assumptions. The CBO's February 2026 baseline assumes that the 10-year Treasury yield rises from 4.1% in 2026 to 4.4% in 2031 and remains broadly unchanged thereafter. Combined with its policy-rate path, this implies that the Federal Reserve cuts rates by 50bp from the current level while the 10-year yield falls by only approximately 25bp, bringing the 2-year/10-year term spread close to 100bp. The report argues that this long-term yield path lacks historical precedent. Over the past 75 years, the 10-year Treasury yield has not remained more than 50bp above nominal GDP growth for an extended period; since the 1960s, the 10-year yield has averaged 60bp below the trailing 10-year average nominal GDP growth rate. Based on this relationship, a more reasonable long-term 10-year yield would be approximately 3.2%, rather than 4.4%. If the CBO's forecast that core PCE inflation returns to 2% in 2030 is also adopted, and the spread of yields relative to nominal GDP growth is conditioned on the inflation level, the 10-year yield could be 110 to 135bp below the CBO's projected nominal GDP growth of 3.8%, or approximately 2.45% to 2.70%. Morgan Stanley therefore concludes that the CBO's 4.4% long-term yield forecast is overstated by at least 100bp. Cross-country comparisons also do not support a stable relationship in which higher debt-to-GDP ratios produce higher long-term government bond yields. Among the four G10 countries with the highest general government debt-to-GDP ratios—Japan, Greece, Italy, and the United States—30-year government bond yields instead decline as the debt ratio rises. Japan's gross general government debt has long exceeded 200% of GDP, yet it has consistently served as a counterexample to such concerns; as of 2025, average global government debt was approximately 76% of GDP, and several countries with similar monetary systems were above that level. The report therefore argues that fiscal variables such as debt-to-GDP cannot be mapped reliably to long-term interest rates. The currency in which debt is issued changes its risk structure. The United States and Japan can control their domestic currencies, so their domestic-currency government debt differs from the sovereign debt of Greece and Italy, which cannot independently create the currency they use, and from emerging-market hard-currency debt. Drawing on the logic of Modern Monetary Theory, the report argues that the solvency of a government able to repay debt in a currency it controls should not be equated with a corporate or household balance sheet. Following the 2012 Greek debt crisis, emerging-market hard-currency bond issuance temporarily grew faster than local-currency issuance, increasing exposure to sustainability shocks. Since the pandemic, emerging-market local-currency bond issuance has expanded, which the report believes should reduce, at the macro level, the risk of flight-to-safety moves triggered by debt-sustainability concerns, although issuer-specific risks remain. Government bonds must also be compared with other investment alternatives. From 1997 to 2007, US dollar debt outside the federal government rose from 200% to 300% of GDP, yet it did not generate sustained concern of comparable intensity at the time; nonfederal debt relative to GDP currently remains more than twice the level of federal debt. The report argues that tax revenue is more likely to materialize than corporate revenue, so the probability of repayment on federal debt is higher than on nonfederal debt. Government bonds' share of debt in global indices has risen since the pandemic but remains below its post-global-financial-crisis peak; if global equities are included in the set of alternative investments, government bonds' relative share has instead declined. The more immediate source of competing supply recently has been corporate bonds. Through July, total corporate bond issuance reached $1.6 trillion, up more than 25% year over year, with artificial intelligence infrastructure financing contributing a large portion of the increase. One market interpretation is that corporate bond supply crowded out demand for long-dated Treasuries; the narrower explanation cited by the report is that trading was light in August, corporate issuance affected prices when primary dealer trading volumes were low, investors sold bonds in preparation for the September issuance calendar, and dealers also sold duration into a thin market. Although primary dealers were net short long-dated investment-grade bonds, their balance sheets simultaneously absorbed a large amount of corporate bond duration that the market was unwilling to hold. The report rejects the claim that artificial intelligence-related borrowers are completely indifferent to yields. Even if projects target a 25% return on invested capital and margins of 15% to 20%, issuance should begin to slow as financing costs rise, before corporate bond yields reach the upper end of the 5% to 10% range. This view should be tested by observing whether total investment-grade bond issuance by artificial intelligence-related borrowers slows as yields rise, rather than merely examining whether the overall issuance calendar continues to expand. Regarding the question of who will buy Treasuries after the Federal Reserve exits, holder data indicate less change than the prevailing narrative suggests. As of March 2026, foreign investors held 32% of the Treasury market, down only 2 percentage points from the third quarter of 2022; over the same period, the Federal Reserve's share declined by 10 percentage points. The combined 12-percentage-point reduction by the Federal Reserve and foreign investors was absorbed almost entirely by money market funds and the household sector, the latter of which includes hedge funds. Since the third quarter of 2022, the 10-year Treasury yield has risen by approximately 50 to 75bp, broadly comparable to the 50bp increase in the federal funds target rate from 3.25% to 3.75%. Hedge funds not only increased their Treasury holdings but expanded their holdings of corporate and foreign bonds even more rapidly, showing that the same investor group can simultaneously increase allocations to Treasuries and corporate bonds; it cannot simply be assumed that corporate bonds inevitably crowd out Treasury demand. The DV01 of nominal coupon-bearing Treasuries borne by the private sector excluding SOMA accounts for approximately 80% of the total, but its trajectory has remained broadly stable since 2022 and it is still below pre-global-financial-crisis levels. Morgan Stanley ultimately argues that predicting buyer identity does not effectively predict yields; it is also necessary to know when buyers enter the market and what prices they are willing to accept. Sovereign debt supply has the greatest impact on prices when market expectations of supply are formed or when supply changes relative to existing expectations, while the timing and prices of investors' purchases and sales are ultimately driven largely by the macro environment and its influence on central-bank decisions. Fiscal deficits create public or private demand through government spending or tax cuts, and the associated funds ultimately flow into financial assets, including Treasuries; the real question is the price at which Treasuries clear. The report recommends using the difference between maturity-matched cash Treasury yields and SOFR swap rates to assess relative value because supply effects should be reflected more directly in swap spreads than in absolute yields. Debt is not entirely risk-free: excessively large deficits over a short period may cause excessive inflation, but the report argues that Treasury yield levels remain driven primarily by inflation, the macro environment, and the Federal Reserve, rather than being mechanically determined by the $40 trillion figure.

Analysis framework

The report first tests the debt-total narrative using yield performance after debt surpassed $31 trillion in 2022, and then distinguishes among public debt, marketable debt, and debt excluding SOMA. It subsequently dissects the CBO's assumptions regarding debt, interest outlays, and interest rates, and compares the 10-year yield with its historical relationships to nominal GDP growth and core PCE inflation. The report further analyzes supply and demand using cross-country debt ratios, the structure of local-currency versus hard-currency debt, global alternative assets, corporate bond issuance, primary dealer positions, holder shares, and DV01 data. It concludes with the Treasury-SOFR swap spread to illustrate why attention should focus on the marginal clearing price rather than buyer identity.

Methodology notes

• Fixed Income and Credit AnalysisSpread analysis

  Cash Treasury-SOFR swap spread relative-value analysis

  The report compares cash Treasury yields with SOFR swap rates at the same maturity, using the spread to identify the relative value of Treasuries and supply pressure. Compared with absolute yields, this metric can more directly isolate the effects of Treasury supply and holding prices.

• Fixed Income and Credit AnalysisDuration/Convexity Analysis

  DV01 analysis of nominal coupon-bearing Treasuries inside and outside SOMA

  DV01 measures the change in a bond's value when yields move by 1bp. The report uses it to compare the interest-rate risk borne by the Federal Reserve and private investors, noting that the private-sector share excluding SOMA is approximately 80% but has not undergone a new abrupt shift since 2022.

• Industry/Sector Analysis FrameworkSupply and Demand Framework

  Analysis of Treasury supply, marginal buyers, and alternative-asset supply

  The report examines fiscal supply, foreign investors, the Federal Reserve, money market funds, the household sector, hedge funds, and corporate bond issuance, but emphasizes that supply and demand have directional explanatory power only when combined with changes in expectations, transaction timing, and clearing prices.

• (Out-of-Vocabulary Method)

  Historical conditional analysis of yields relative to nominal GDP growth and core PCE inflation

  The report first estimates the historical spread of the 10-year Treasury yield relative to the trailing 10-year average nominal GDP growth rate and then conditions it on the level of core PCE inflation to assess whether the CBO's long-term yield forecast is too high.

• (Out-of-Vocabulary Method)

  Monetary-sovereignty comparison between local-currency and hard-currency sovereign debt

  The report differentiates risk according to whether the issuer controls the currency used for repayment, arguing that sovereigns able to issue and control their domestic currency face different debt-sustainability risks from sovereigns dependent on hard currency or unable to create the currency they use.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• US Treasuries

  The report's core analytical asset; an increase in the debt total is not viewed as a sufficient condition for a mechanical rise in long-term yields.

  Strengths

  The United States controls the issuance of the dollar and has taxing authority; the buyer base includes foreign investors, money market funds, the household sector, and hedge funds.

  Weaknesses

  Following the Federal Reserve's exit, private investors bear more duration risk, while excessively rapid fiscal-deficit expansion could also affect prices through inflation.

  Comparison

  Comparisons among Japan, Greece, Italy, and the United States show no stable positive relationship between debt-to-GDP and long-term government bond yields; the relative value of Treasuries can also be assessed through SOFR swap spreads.

  Risks

  Higher-than-expected inflation, sudden changes in supply expectations, or concentrated issuance amid thin liquidity could push yields higher.

• Emerging-Market Local-Currency Sovereign Bonds

  Issuance has expanded since the pandemic, which the report argues helps reduce, at the macro level, flight-to-safety shocks triggered by debt-sustainability concerns.

  Strengths

  Denominated in a currency controlled by the issuer, generally resulting in lower currency-mismatch risk than hard-currency debt.

  Weaknesses

  Emerging-market issuers still face idiosyncratic risks.

  Comparison

  Compared with hard-currency sovereign bonds, local-currency bonds are less constrained by the inability to create the currency used for repayment.

  Risks

  Issuer-specific problems may still trigger debt-sustainability pressures.

• Long-Dated Investment-Grade Corporate Bonds

  As an alternative investment to Treasuries and a source of duration supply, they may affect long-term interest-rate pricing when trading is light.

  Strengths

  Most of the $1.6 trillion issued through July was investment grade, while artificial intelligence infrastructure financing provided an important demand backdrop.

  Weaknesses

  Primary dealer balance sheets are absorbing substantial corporate bond duration that the market is unwilling to hold, and issuers are not entirely insensitive to yields.

  Comparison

  Hedge funds simultaneously increased their holdings of Treasuries, corporate bonds, and foreign bonds, so corporate bond demand does not translate into one-for-one crowding out of Treasuries.

  Risks

  If yields continue to rise, investment-grade bond issuance by artificial intelligence-related borrowers may slow before corporate bond yields reach the upper end of the 5% to 10% range.

Key data

• US public debt$40 trillion$31 trillion in October 2022, an increase of $9 trillion
• Recent peak in the 10-year Treasury yield4.75%40bp above the 4.35% level in October 2022
• Long-term growth rate of marketable Treasury debt6.6% CAGRSince 1946; 6.4% excluding SOMA
• Different debt measures$40 trillion, $31.5 trillion, $26.8 trillionTotal public debt, marketable Treasury debt, and marketable Treasury debt excluding SOMA, respectively, with a difference of more than $13 trillion among the measures
• CBO forecast for federal debt held by the public$47 trillion in 2033; $56 trillion in 2036Based on a current starting point of approximately $31 trillion
• CBO long-term debt-to-GDP forecast175%Projected to surpass the 1946 record of 106% in 2030
• Net interest outlays as a share of GDP3.3% in 2026; 4.6% in 2036; 6.9% in 2056CBO baseline and extended baseline projections
• Net interest as a share of federal outlaysRising from approximately 14% to approximately 19%The CBO's projected change over the next decade
• CBO's 10-year Treasury yield path4.1% in 2026; 4.4% in 2031Projected to remain near 4.4% thereafter
• CBO-implied policy and curve changesFederal Reserve cuts rates by 50bp; 10-year yield declines by approximately 25bp; 2s10s approximately 100bpDerived from the CBO's policy-rate and long-term-yield paths
• Yield implied by the historical nominal GDP relationship3.2%Since the 1960s, the 10-year yield has averaged 60bp below the trailing 10-year average nominal GDP growth rate
• Yield implied by the core PCE conditional analysis2.45% to 2.70%Assumes core PCE returns to 2% in 2030 and is 110 to 135bp below the CBO's 3.8% nominal GDP growth rate
• Japan's gross general government debt as a share of GDPMore than 200%Used by the report as a long-standing counterexample showing that high debt does not necessarily correspond to high yields
• Global average government debt as a share of GDP76%As of 2025
• US nonfederal dollar debtRising from 200% to 300% of GDPChange from 1997 to 2007; it currently remains more than twice federal debt relative to GDP
• Corporate bond issuance$1.6 trillion through JulyUp more than 25% year over year, with artificial intelligence infrastructure financing making a substantial contribution
• Economic assumptions for artificial intelligence-related borrowers25% return on invested capital; 15% to 20% marginsThe report argues that issuance should begin to slow before corporate bond yields reach the upper end of the 5% to 10% range
• Foreign investors' share of Treasury holdings32%As of March 2026, down 2 percentage points from the third quarter of 2022; the Federal Reserve's share declined by 10 percentage points over the same period
• Substitution among holder shares12 percentage pointsThe reduction in the shares of the Federal Reserve and foreign investors was absorbed almost entirely by money market funds and the household sector
• Interest-rate changes since the third quarter of 202210-year Treasury yield up 50 to 75bp; federal funds target rate rising from 3.25% to 3.75%The magnitudes of the two changes are broadly comparable
• Share of Treasury DV01 excluding SOMAApproximately 80%The trajectory has remained broadly stable since 2022 and is below pre-global-financial-crisis levels

Impact & implications

The report argues that investors should not infer directly from the $40 trillion debt total that long-term Treasury yields must rise. If core PCE falls back to 2% as assumed by the CBO, historical relationships support a 10-year yield well below the CBO's 4.4%. When assessing the direction of Treasuries, investors should focus on inflation, the macro environment, Federal Reserve decisions, changes in supply expectations, and the marginal clearing price. Corporate bond supply may disrupt long-term rates when liquidity is thin, but holder data do not indicate an abrupt collapse in foreign demand, and the private sector has already absorbed most of the share released by the Federal Reserve's balance-sheet reduction.

Risks

• The CBO warns that high and steadily rising debt could weaken investor confidence in the US government's ability to repay and increase the probability of a fiscal crisis, although the report argues that historical evidence has not validated this concern.
• High debt could raise inflation expectations, weaken confidence in the dollar as a reserve currency, and constrain the government's ability to use deficits for countercyclical stabilization.
• Excessively large fiscal deficits over a short period could create too much demand and cause excessive inflation.
• Hard-currency sovereign debt, or debt issued by sovereigns unable to create the currency used for repayment, is more vulnerable to debt-sustainability shocks than local-currency sovereign debt.
• When concentrated corporate bond issuance coincides with low market trading volumes, it may temporarily disrupt long-term Treasury prices and yields.

What to watch

• Monitor whether core PCE inflation returns to 2% in 2030 as projected by the CBO, a key condition underlying the report's view that long-term yields will be materially below 4.4%.
• Observe whether total investment-grade bond issuance by artificial intelligence-related borrowers slows as yields rise, rather than looking only at the overall issuance calendar.
• Watch when Treasury supply expectations are formed or change relative to existing expectations, because the report argues that such expectation gaps have the greatest impact on prices.
• Track the macro environment and the Federal Reserve's policy path, which determine when and at what prices investors buy, hold, or sell.
• Monitor the spread between cash Treasury yields and SOFR swap rates at the same maturity to assess supply pressure and the relative value of Treasuries.
• Continue monitoring changes in the holdings shares of foreign investors, money market funds, the household sector, and hedge funds, rather than relying solely on the narrative that foreign buyers are exiting.