New CBO report shows national debt spiraling into uncharted territory by 2035—and Trump’s tariff defeat will make the picture even worse

The CBO’s new 2026–2036 outlook projects materially larger primary deficits and borrowing needs, with the deficit reaching $2.96 trillion (6.2% of GDP) by 2035 and debt held by the public rising from $30.2 trillion in 2026 to $53.1 trillion (116% of GDP). The Trump 2025 Reconciliation Act (OBBB) adds an estimated $3.4 trillion (or $4.1 trillion including immigration and extra interest) to deficits over nine years, while previously projected tariff receipts of $2.7 trillion are now undermined by a Supreme Court ruling, worsening the fiscal path. Under a realistic alternative that lets discretionary spending grow with GDP, interest expense balloons (projected to rise toward ~$2.2 trillion), becoming one of the largest budget items and materially increasing borrowing costs, with clear negative implications for sovereign debt dynamics, yields and fiscal sustainability.

Analysis

Market structure: Rising projected primary deficits and a re‑rated tariff outlook create clear winners and losers — beneficiaries include defense contractors (higher discretionary defense budgets) and real assets/commodity hedges (gold) while long‑duration interest‑rate sensitive sectors (homebuilders, mortgage REITs, long‑duration growth stocks) are losers. Competitive dynamics favor firms with pricing power and low leverage; net importers and consumer staples regain margin if tariffs fall but consumer staples see muted growth versus cyclical defense/energy names.

Risk assessment: Tail risks include a debt‑ceiling standoff or sovereign downgrade (S&P/Fitch), which could spike 10y yields >100bps in weeks and force a liquidity shock; monetization by the Fed is a lower‑probability, high‑impact scenario that would reprice inflation expectations. Immediate (days) risk: Treasury auction volatility and knee‑jerk yield moves; short term (weeks/months): 10y repricing and curve steepening; long term (years): sustained higher debt service that crowds out capex and raises term premium.

Trade implications: Expect term premium expansion — favor steepener trades (long 10y vs short 2y), long TIPS vs short nominal duration, overweight defense equities (LMT/RTX/NOC) and underweight homebuilders/REITs (PHM/DHI/NLY). FX: higher real yields support USD; commodities/gold should be held as 0.5–1% portfolio tail hedge if real yields decline.

Contrarian angles: Markets may underprice the probability of fiscal consolidation post‑midterms — a credible bipartisan cut could compress term premium and propel long duration bonds (TLT) higher; conversely, consensus may be underestimating persistent supply pressure from Treasury issuance (favors long real yields). Historically (1980s/90s) deficits raised yields but equities later outperformed if growth recovered — watch fiscal policy inflection points as reversal catalysts.

Key Decisions for Investors

• Establish a 3% portfolio short in long‑duration Treasuries: buy 3‑month TLT 20‑delta puts (or short 10y futures) sized for a 3% notional exposure; add if 10y yield breaches +50bps from current levels or if TLT falls 12–15%; target horizon 3–12 months.
• Implement a relative‑value steepener: go long IEF (7–10y) and short SHY (1–3y) equal notional for a 2% portfolio exposure to capture 2s10+ steepening; trim if 2s10 flattens by 30bps or within 6 months.
• Buy TIPS vs sell nominal duration: establish 3% long TIP (I share) and 3% short TLT pair to capture rising real yields/term premium; close if breakeven inflation rises >50bps or real 10y yield moves >75bps within 6–18 months.
• Overweight defense and underweight housing: allocate 2–3% overweight to a basket (equal‑weight LMT, RTX, NOC) for 6–18 months; initiate 2% short (or buy puts) in homebuilders PHM and DHI and 1% short in mortgage REIT NLY, stop‑loss at 12% adverse move or if 30‑day mortgage rates fall >75bps.
• Hedge tail risk with 0.5–1% allocation to gold (GLD) and 6–12 month GLD calls sized to pay off if real yields drop or yields spike >75bps; increase hedge allocation if a major rating agency warns or if the next 10y Treasury auction fails (stop bid).