US public debt, Treasury supply, and long-term Treasury yields Report Interpretation

Overview

This US rates strategy report challenges the view that the $40 trillion public-debt headline by itself signals a Treasury-market funding problem or persistently higher yields. Morgan Stanley argues that investors should focus instead on inflation, Federal Reserve reaction functions, debt structure, supply expectations, and the marginal price-setting buyer.

Core views

Morgan Stanley frames the move in US public debt from $31 trillion in October 2022 to $40 trillion as a headline-grabbing but analytically incomplete measure. Ten-year Treasury yields reached 4.35% in October 2022 and recently peaked at 4.75%, only 40bp higher despite the additional $9 trillion of debt. The report notes that marketable Treasury debt has compounded at 6.6% annually since 1946, or 6.4% excluding securities held in the Federal Reserve's SOMA portfolio, and argues that concern has repeatedly resurfaced at round-number debt milestones without a visible structural acceleration in debt growth. The report stresses that debt definitions matter. Roughly $40 trillion of total public debt includes nonmarketable securities largely held in government trust funds; marketable Treasury debt is closer to $31.5 trillion, and marketable debt excluding SOMA is about $26.8 trillion. These measures differ by more than $13 trillion. It also distinguishes par from market value, particularly during volatile periods. In Morgan Stanley's view, the relevant questions are the pace and timing of deficits, the risk characteristics of the debt investors must hold, the price and value offered to buyers, and the macro drivers of yields—not the headline stock alone. Morgan Stanley challenges the CBO's interest-cost and rate assumptions. The CBO projects debt held by the public to rise from about $31 trillion to $47 trillion in 2033 and $56 trillion in 2036, with debt reaching 175% of GDP by the time current college graduates retire and surpassing the prior 106% of GDP record in 2030. It projects net interest outlays to rise from 3.3% of GDP in fiscal 2026 to 4.6% in 2036 and 6.9% by 2056, and from about 14% to roughly 19% of federal spending over the next decade. However, these projections embed a 10-year yield of 4.1% in 2026, rising to 4.4% by 2031. Morgan Stanley says this is inconsistent with the CBO's projected return of core PCE inflation to 2% by 2030. Since the 1960s, the 10-year yield has averaged 60bp below trailing 10-year nominal GDP growth, implying 3.2% rather than 4.4%; conditioning that relationship on core PCE inflation suggests yields of 2.45% to 2.70%, or 110-135bp below the CBO's 3.8% nominal-GDP projection. Cross-country comparisons also lead the report to reject a stable debt-to-yield relationship. Among Japan, Greece, Italy, and the US—the four G10 countries with the highest general-government gross debt-to-GDP ratios—30-year government-bond yields descend as debt-to-GDP ratios ascend. Morgan Stanley emphasizes that debt issued in a currency controlled by the sovereign, such as the US dollar or Japanese yen, has a different risk profile from hard-currency debt or euro-area debt where the sovereign cannot create the currency by fiat. It also argues that the post-pandemic growth of emerging-market local-currency bonds should reduce macro-level concern about debt-sustainability-driven risk-off episodes relative to hard-currency issuance. The report places government bonds within a broader universe of liabilities and investments. US federal debt should not be assessed in isolation from non-federal USD debt, which increased from 200% to 300% of GDP between 1997 and 2007 and remains more than twice as large relative to GDP. It argues that federal tax revenues are more probable than corporate revenues. Globally, government bonds have risen as a share of indexed debt since the pandemic but remain below their post-global-financial-crisis peak; when equities are included, their share of alternative investments has declined. Morgan Stanley addresses the concern that heavy AI-related corporate issuance crowds out Treasury demand. Total corporate debt issuance reached $1.6 trillion through July, more than 25% above the same period a year earlier, with AI-infrastructure financing contributing a large share of the increase. The report attributes an August price effect more narrowly to thin trading and lower primary-dealer transaction volumes, alongside dealer absorption of unwanted corporate duration. It disputes the claim that AI borrowers are yield-agnostic: a borrower targeting a 25% return on invested capital with a 15%-20% profit margin should slow issuance before corporate yields reach the upper end of a 5%-10% range. The report specifically identifies gross investment-grade issuance by AI-related borrowers as the relevant gauge as yields rise. On Treasury absorption, Morgan Stanley argues that asking who will buy supply is less useful than determining when investors will buy and at what price. Foreign investors held 32% of the Treasury market in March 2026, only 2 percentage points below 3Q22, while the Fed's share fell 10 percentage points. Money-market funds and the household sector, including hedge funds, absorbed nearly all of the combined 12-point reduction in Fed and foreign ownership. Hedge funds increased their holdings of both Treasuries and corporate and foreign bonds, undermining a simple diversion narrative. About 3.5% of outstanding Treasuries changes hands daily, so marginal buyers and sellers—not the largest holders—set prices. The report uses Treasury-SOFR swap spreads to isolate relative-value effects of supply. More Treasury issuance should, all else equal, cheapen cash Treasuries versus swaps and tighten swap spreads, but Morgan Stanley finds the relationship non-mechanical. A near-record amount of nominal Treasury DV01 is held privately, yet 10-year swap spreads widened more than 15bp since QT2 ended in December 2025. Since debt passed $31 trillion in October 2022, the next $9 trillion coincided with just 13bp of 10-year spread tightening and 4bp of 30-year spread widening. Federal Reserve balance-sheet policy, regulation, investor demand, financing conditions, and dealer intermediation capacity all affect Treasury clearing levels. Finally, Morgan Stanley argues that fiscal variables do not have a stable empirical mapping to long rates. It cites IMF work by Furceri et al. (2025), using the approach of Laubach, as finding that the relationship between fiscal variables and long-term rates changes over time. The report says the missing variable is investor expectations for supply, rather than semiannual CBO deficit projections, and that fiscal stimulus has different market implications depending on whether it is countercyclical or procyclical and how central banks respond. It sees the speed of deficit accumulation as the clearest fiscal-market risk because an excessive deficit over a short period can generate inflation, as in the post-pandemic period. Treasury risk characteristics also matter: the index currently offers a below-average coupon at an above-average duration. Over time, Morgan Stanley concludes, Fed rate policy and forward guidance are the main drivers of rate expectations and therefore 10-year yields; since late 2008, Fed balance-sheet policy and other central banks' policies have also materially influenced term premiums.

Analysis framework

Morgan Stanley compares debt measures and historical growth rates, tests CBO interest-rate assumptions against nominal GDP growth and core PCE inflation, uses international debt-and-yield comparisons, examines ownership and dealer-positioning data, and evaluates Treasury supply through SOFR swap spreads. It then decomposes Treasury yields into policy-driven rate expectations and term premiums to argue that monetary-policy reaction functions dominate the level of yields.

Methodology notes

• OtherYield curve analysis

  Decomposition of 10-year Treasury yields into rate expectations and term premiums.

  The report uses this decomposition to show that Fed policy and forward guidance have historically driven the larger rate-expectations component, while balance-sheet policy and global central-bank actions also affect term premiums.

• OtherSpread analysis

  Comparison of cash Treasury yields with matched-maturity SOFR swap rates through swap spreads.

  Morgan Stanley treats swap spreads as a more direct measure of Treasury relative value and possible supply effects than outright Treasury yields, while emphasizing that other market forces also affect spreads.

• Macroeconomics

  Historical comparison of Treasury yields with trailing 10-year nominal GDP growth, conditioned on core PCE inflation.

  The report uses this empirical relationship to argue that the CBO's long-run 10-year yield assumption appears too high if its projected 2% core PCE outcome is achieved.

Asset mapping & comparison

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

• US Treasury securities

  Primary market subject; yield levels are argued to be driven mainly by Fed policy, inflation, and marginal market pricing rather than debt stock alone.

  Strengths

  Issued in the sovereign's own currency; broad and liquid investor base; federal tax revenues are presented as more probable than corporate revenues.

  Weaknesses

  Below-average coupon and above-average duration in the current Treasury index.

  Comparison

  Supply effects are more visible in Treasury-SOFR swap spreads than in outright yields, but are not mechanical.

  Risks

  A large deficit accumulated over a short period can create inflation; clearing prices are also affected by balance-sheet policy, regulation, demand, financing, and dealer capacity.

• AI-related investment-grade corporate debt

  Alternative source of long-duration supply that may affect Treasury pricing in thin markets.

  Strengths

  AI infrastructure financing has contributed materially to elevated corporate issuance.

  Weaknesses

  Morgan Stanley doubts issuance is truly yield-agnostic.

  Comparison

  Corporate issuance may temporarily influence Treasury prices through dealer balance sheets and market liquidity rather than permanently displace Treasury demand.

  Risks

  Issuance could slow as corporate yields rise, particularly for borrowers targeting 25% ROIC and 15%-20% profit margins.

Key data

• US public debt$40 trillionUp from $31 trillion in October 2022.
• 10-year Treasury yield comparison4.35% to 4.75%The recent peak was 40bp above the October 2022 level despite an additional $9 trillion of public debt.
• Marketable Treasury debt growth6.6% CAGR since 1946; 6.4% excluding SOMAMorgan Stanley says the accumulation rate has barely changed over the past decade.
• CBO debt-held-by-public projectionAbout $31 trillion today, $47 trillion in 2033, and $56 trillion in 2036CBO also projects debt at 175% of GDP over the longer run.
• CBO net interest projection3.3% of GDP in fiscal 2026; 4.6% in 2036; 6.9% by 2056Projected to rise from about 14% to roughly 19% of federal spending over the next decade.
• Morgan Stanley 10-year yield estimate3.2%; 2.45%-2.70% under an inflation-conditioned comparisonVersus the CBO's 4.4% long-run assumption and 3.8% nominal-GDP projection.
• Corporate debt issuance$1.6 trillion through JulyMore than 25% above the same period last year; AI infrastructure financing supplied a large share of the increase.
• Foreign Treasury ownership32% in March 2026Only 2 percentage points below 3Q22, while the Fed's share was down 10 percentage points.
• Treasury market turnoverAt least 3.5% of outstanding USTs dailyUsed to support the view that marginal rather than largest holders set prices.
• Swap-spread response since October 202210-year spreads tightened 13bp; 30-year spreads widened 4bpOccurred alongside a $9 trillion increase in public debt.

Impact & implications

Morgan Stanley's implication for macro investors is to prioritize incoming economic data and central-bank reaction functions over headline debt totals or forecasts of which investor category will absorb Treasury supply. It views debt growth as consequential chiefly when deficits are large and rapid enough to alter inflation and monetary-policy expectations, or when debt risk characteristics and market-clearing conditions change.

Risks

• The report identifies excessive deficit accumulation over a short period as a risk because it can generate runaway consumer-price inflation.
• Treasury investors face risk from the current combination of below-average coupons and above-average duration.
• Thin trading, financing conditions, dealer intermediation capacity, regulation, and changes in central-bank balance-sheet policy can affect Treasury clearing prices and relative value.

What to watch

• Whether core PCE inflation returns to the CBO's projected 2% level by 2030.
• Federal Reserve policy, forward guidance, balance-sheet policy, and the economic data shaping the Fed's reaction function.
• Whether gross investment-grade issuance by AI-related borrowers slows as corporate yields rise.
• Treasury-SOFR swap spreads, dealer positioning, and liquidity conditions rather than headline Treasury supply alone.
• The speed and timing of fiscal deficits, rather than the debt stock in isolation.