The Debt Warning Light: Pay Attention, But Don’t Overreact

Many of you know this, but earlier this year I was involved in a car accident on I-485. Thankfully I walked away mostly unscathed and my two sons were not in the back seat. I was rear-ended, and my reliable, trusty red Honda Accord was totaled and officially laid to rest. So this became the year of getting a new car.

Thankfully, knock on wood, I shouldn’t have to worry too much about warning lights coming on in the new car anytime soon. But it did get me thinking about how we respond when one does. If a warning light comes on in your car, there are two bad responses. The first is to ignore it completely and keep driving as if nothing happened. The second is to panic, slam on the brakes, pull over, and assume the engine is about to fall out.

The better response is somewhere in between. Pay attention. Understand what the warning light is telling you. Then decide whether anything actually needs to change. I think that’s a useful way to think about the conversation surrounding U.S. government debt today.

Howard Marks recently addressed this topic in an excellent memo titled Shall We Repeal the Laws of Economics – Part III. For anyone who wants to dig deeper into the mechanics behind rising interest rates, federal deficits, Treasury issuance, inflation and the dollar, I’d encourage you to read it. Marks does an excellent job explaining why these issues matter without suggesting investors should head for the exits. And that distinction is important.

The United States is spending more than it takes in, and the amount of debt outstanding continues to grow. The Congressional Budget Office projects the federal deficit for fiscal year 2026 at $1.9 trillion, or 5.8% of GDP. Howard Marks similarly describes the deficit as being in the vicinity of 6% of GDP and notes that net interest outlays are projected to exceed $1 trillion. These figures are projections and may change as economic conditions and policy evolve. At the same time, Treasury must continually refinance existing debt while raising additional money to fund new deficits. Those are real issues. We shouldn’t pretend otherwise.

Treasury supply is competing for investor capital at the same time businesses are demanding enormous amounts of capital for things like data centers, artificial intelligence and other investments. All else equal, heavier demand for capital can put upward pressure on borrowing costs, although interest rates also reflect inflation expectations, monetary policy, economic growth, risk appetite and other factors. But acknowledging a problem and overreacting to it are two very different things.

One of the easiest mistakes investors can make is to take a legitimate concern and carry the conclusion too far.

Federal debt is high, therefore sell U.S. stocks.

Long-term rates are rising, therefore avoid bonds altogether.

The dollar faces challenges, therefore move everything overseas.

That’s where a reasonable concern can turn into an unreasonable portfolio decision.

Marks makes a point in his memo that I largely agree with: this starts as a fiscal and political problem. The underlying issue isn’t that American companies suddenly stopped innovating or that the U.S. capital markets stopped functioning. It’s that the country has been running persistent deficits and accumulating debt faster than the economy has grown. Unfortunately, fiscal problems don’t stay neatly contained in Washington.

Eventually, investors feel them through interest rates, inflation, currency movements and asset prices. So while this may begin as a political problem, it becomes something we have to account for in portfolio construction. The key word is account for, not overcompensate for.

For portfolio construction, the takeaway is not to make a dramatic allocation change based on one macroeconomic concern. We continue to view equities as an important source of long-term growth, while evaluating exposures in light of each client’s objectives, time horizon, liquidity needs and risk tolerance. We also remain thoughtful about fixed income, particularly the amount of interest-rate risk being taken. Depending on market conditions and client needs, intermediate maturities may offer meaningful income with less duration exposure than very long-dated bonds. They still carry interest-rate and other fixed-income risks, and the appropriate maturity profile varies by investor and market environment. International exposure can also broaden diversification where appropriate, while introducing currency, geopolitical, regulatory and market-specific risks.

But diversification doesn’t mean abandoning the United States. Moving away from U.S. assets introduces an entirely new set of risks, and many of the characteristics that have historically made the United States attractive to investors remain in place.

That brings us back to the warning light.