Following the COVID-19 pandemic, the surge in fiscal deficits has emerged as one of the most concerning economic issues. Although inflation peaked in 2022, the fiscal deficit situation continued to deteriorate, influenced by the "fiscal doom loop" created by the combination of massive government spending and high interest rates.
Last year, the U.S. fiscal outlook remained bleak: the rolling 12-month fiscal deficit hovered around $2.1 trillion, accounting for 7.3% of GDP, a record high for a non-emergency period. Concurrently, the 10-year U.S. Treasury yield persistently remained above 4.7%, further exacerbating the fiscal challenges. However, the U.S. fiscal deficit situation has now shown significant improvement.
Data released yesterday afternoon vividly illustrates this dramatic shift: during the first three months of fiscal year 2026 (October to December), the U.S. fiscal deficit decreased by $109 billion compared to the same period last year, a decline of 15%. A substantial increase in tariff revenue was the core driving factor—tariff income reached $90 billion in the first three months of this fiscal year, compared to just $20 billion during the same period last year.
In fact, the market anticipated an improvement in the deficit situation as early as last summer. Last fall, the 10-year Treasury yield even briefly fell below 4%. The core question now, however, is how long this trend of deficit improvement can last. Current trends indicate that monthly tariff revenue is showing signs of peaking and stabilizing, generally remaining around $30 billion. Furthermore, the proposed "One Big Beautiful Bill" is expected to expand the fiscal deficit in the coming months.
Dan Clifton, an analyst at Strategas, a Baird Financial Group institution, pointed out, "The scale of fiscal spending remains persistently high." He emphasized that current fiscal spending still accounts for about 23% of GDP, whereas the historical average is only 20%. This round of fiscal deficit narrowing is essentially the result of stronger-than-expected growth in both individual income tax and tariff revenues. Clifton stated, "If the scale of fiscal spending cannot be reduced, it will be very difficult for the U.S. fiscal deficit-to-GDP ratio to fall from the current 6% to the target level of 3%."
Perhaps it is precisely this factor that has prevented market interest rates from declining further recently. It is important to note that the President's initiatives to promote housing affordability are highly dependent on a significant drop in the 10-year Treasury yield—after all, mortgage rates are priced based on this benchmark. Market experience over the past year has also shown that even if the Federal Reserve begins a rate-cutting cycle, it does not directly lead to a decline in the 10-year Treasury yield.
The White House has consistently blamed the Federal Reserve for high interest rates, urging it to cut rates; however, many analysts point the finger at the White House itself, arguing that it is the government's fiscal policies that are keeping rates elevated.
What is the basis for this argument? Michael Darda, an analyst at Roth MKM, wrote in a report this week: "The only path to achieving a sustained decline in market interest rates lies in maintaining price stability, establishing central bank credibility, and ensuring fiscal sustainability. Undermining central bank independence and squandering tariff revenue on various fiscal gimmick policies will only produce the opposite effect."
In summary, the U.S. fiscal deficit situation has indeed improved significantly recently, which is undoubtedly a positive signal. However, it must be acknowledged that, after a series of policy controversies, the crucial measure of reducing fiscal spending remains a goal that the current administration has yet to achieve.
Comments