Market Insights - 9/8/26
Observations & Insights – September 8, 2026
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Summer Doldrums
The major U.S. stock indexes traded in a narrow range for the fourth week in a row, with the NASDAQ up 0.4% for the week, the Dow down -0.2%, and the S&P 500 essentially flat. The market has not seen any big moves since a four-day rally that began on July 30.
Key Points
- The S&P 500 posted its fourth monthly gain out of the past five, adding about 2.6% in August.
- A strong August jobs report increased expectations for a possible Federal Reserve rate hike in September.
- Long-term Treasury yields remain near multi-decade highs as investors weigh persistent inflation, stronger economic growth and heavy government borrowing.
- The federal debt has surpassed $40 trillion, but CBO's baseline projects a gradual fiscal deterioration rather than an imminent debt crisis.
- If a U.S. debt crisis were to develop, I believe it would more likely appear through a weaker dollar, higher inflation and rising long-term interest rates than through a conventional default.
- AI-driven productivity growth could materially improve the debt equation by increasing real economic output without creating the same degree of inflationary pressure.
Observations: Strong Jobs Report Puts Pressure on Fed
The U.S. labor market’s summer slowdown reversed course in August. Friday’s monthly labor market report showed a monthly gain of 162,000 jobs, marking a sharp turnaround from July’s upwardly adjusted figure of 21,000 jobs added. The August gain was roughly triple the number of jobs most economists had forecast, and the largest in five months. The unemployment rate held steady at 4.1%.
Following Friday’s better-than-expected jobs report, bond trading reflected rising expectations for a potential interest rate hike at the U.S. Federal Reserve meeting that concludes on September 16. Trading in rate futures markets implied a roughly 58% probability that the Fed would raise its benchmark rate by a quarter point, versus a 42% probability that the rate would stay unchanged, according to CME FedWatch. The day before the jobs report, prospects for a September rate increase were roughly 50%-50%.
Yields of U.S. 2- and 10-year Treasuries climbed to year-to-date highs of 4.39% and 4.80%, respectively, on Tuesday before pulling back slightly later in the week. At the longer end of the yield curve, the 30-year note closed at 5.24% on Friday, just below a recent peak of 5.31% and near the highest level in two decades.
Oil prices rose to the highest level in about six weeks, driven largely by developments in the Middle East and the Strait of Hormuz. On Friday afternoon, U.S. crude was trading above $91 per barrel, up from $83 a week earlier. Even with the latest rise, oil prices remained well below their year-to-date peak levels in early April, when crude briefly traded above $112.
The most widely traded cryptocurrency extended a rally that began in mid-August. Bitcoin briefly traded above $81,000 on Thursday, reaching its highest level since mid-May. It retreated modestly on Friday afternoon to roughly $80,000, up about 3% for the week.
The S&P 500 posted its fourth monthly gain out of the past five months, adding about 2.6% in August. The NASDAQ outperformed, rising 3.9%, while the Dow gained 1.3%.
A Consumer Price Index report scheduled for release on Friday will provide one of the last major data points for the U.S. Federal Reserve ahead of its two-day policy meeting ending on September 16. The most recent CPI report released in August showed inflation at a 3.4% annual rate in July, slightly below June’s 3.5% figure.
Insights: Living With $40 Trillion of Debt
Last week, we discussed the federal government's $40 trillion debt burden and made an important distinction: the United States does not need to pay off the national debt, but it does eventually need to slow the rate at which that debt is growing relative to the economy.
I want to continue that discussion because I think the national debt will increasingly influence the investment environment. Not because I expect an imminent debt crisis, I do not, but because living with this much debt may have consequences that look different from the economic environment investors became accustomed to over the past several decades.
The most likely outcome, in my view, is a long period of adjustment rather than a dramatic financial crisis. That could mean somewhat higher for longer long-term interest rates, inflation that proves more persistent than the Federal Reserve would like and periods of weakness in the dollar. None of those outcomes, by itself, would constitute a debt crisis. They could simply be part of the adjustment to a government that needs to borrow enormous amounts of money year after year.
The CBO Baseline: Serious, but Not a Crisis
The Congressional Budget Office provides a useful place to start because its projections are concerning without being catastrophic. CBO estimates that the federal deficit will equal 5.8% of GDP in 2026 and rise to 6.7% by 2036. Debt held by the public is projected to increase from approximately 101% of GDP to 120% over the same period, while net interest expense rises to 4.6% of GDP. These are unusually large deficits for an economy that CBO expects to remain near full employment.
There is an equally important point in those projections: CBO is not forecasting a debt crisis. Its baseline has inflation gradually returning to roughly 2% by 2030, while longer-term interest rates rise modestly and then stabilize. In other words, the government's own budget forecaster sees a serious and deteriorating fiscal problem, but not an impending financial collapse.
As we discussed last week, higher rates also do not immediately apply to the entire national debt. Higher borrowing costs work their way into the federal budget as existing debt matures and new debt is issued. That gives the country time to improve the trajectory, but the longer debt grows faster than the economy, the more difficult that adjustment becomes.
The Math Still Needs to Improve
Faster economic growth would certainly help, but I do not believe we can simply grow our way out of the problem. CBO projects federal spending to rise from 23.3% of GDP this year to 24.4% in 2036, while revenues rise only modestly from 17.5% to 17.8%. That persistent gap is what ultimately drives the debt higher.
This does not mean eliminating the national debt or even balancing the federal budget every year. A growing economy can support a growing amount of debt, and Treasury securities are deeply embedded in the global financial system. The objective should be a healthier relationship between the growth of the debt and the growth of the economy supporting it.
Getting there will eventually require some combination of stronger economic growth, slower spending growth and greater revenues. Exactly how that balance is achieved is a political question that I will leave to others. From an economic perspective, what matters is that the gap eventually narrows.
What Would a U.S. Debt Crisis Look Like?
If the United States eventually did experience a genuine debt crisis, I do not think it would look like the sovereign debt crises we have seen in countries that borrow heavily in currencies they do not control. The United States issues its debt in dollars and controls the currency in which that debt is repaid. A conventional default caused by an inability to produce dollars is therefore not the risk that concerns me most. The greater risk would be to the value of those dollars.
Imagine a point at which investors begin to seriously question the government's ability to stabilize its fiscal trajectory. They might demand higher yields to own long-term Treasury securities. A weakening dollar could increase the cost of imported goods and add to inflation, while rising inflation expectations could push bond yields still higher as investors demanded greater compensation for the loss of purchasing power.
The CBO itself identifies this general mechanism as one of the risks associated with rising federal debt: deteriorating confidence could push Treasury yields higher, while concerns about the fiscal outlook could contribute to higher inflation expectations and a decline in the dollar.
That is the kind of debt event that concerns me more: a weaker dollar, higher inflation and rising long-term interest rates reinforcing one another as confidence deteriorates. The government would not necessarily have to miss a payment. The adjustment could occur through the purchasing power of the dollars being repaid.
Importantly, we are not there today. A 5% Treasury yield is not a debt crisis. A period of dollar weakness is not a debt crisis, nor is inflation running somewhat above the Federal Reserve's target. A genuine fiscal event would involve a much broader and more persistent deterioration in confidence.
Inflation Is Not an Easy Way Out
Inflation does have one seemingly attractive characteristic for a heavily indebted borrower: it reduces the real value of existing fixed-rate debt. If wages, prices, tax revenues and nominal GDP rise while yesterday's debt remains fixed in dollars, that debt becomes easier to repay in real terms.
In effect, unexpected inflation changes the relationship between creditors and debtors. The lender owns a promise to receive a fixed number of future dollars, while the borrower has promised to repay those dollars. If their purchasing power declines, the obligation becomes less burdensome to the borrower and less valuable to the lender. As the world's largest dollar borrower, the federal government would benefit from that dynamic on its existing fixed-rate debt.
The problem is that markets adjust. Once investors expect higher inflation, they demand higher interest rates on newly issued debt. Inflation may reduce the real burden of yesterday's borrowing while increasing the cost of tomorrows. It also reduces household purchasing power and can be particularly damaging to savers and those dependent upon relatively fixed streams of income.
That is why I do not see deliberately "inflating away the debt" as an easy solution. Doing so risks undermining the confidence that allows the United States to borrow so efficiently in the first place.
The AI Wild Card
There is a much more constructive way to improve the debt equation: produce more.
CBO already assumes that wider adoption of generative AI will contribute to faster productivity growth over the coming decade. Faster productivity increases economic growth and, all else equal, improves the federal budget through higher incomes and tax revenues. CBO's sensitivity analysis illustrates just how important productivity can become over time.
The potential upside is that AI could ultimately deliver greater productivity gains than current forecasts assume. If businesses can increase output per worker, reduce costs and allocate resources more efficiently, the economy could grow faster without generating the same amount of inflationary pressure. Faster real growth would mean greater incomes, corporate profits and tax revenues while increasing the size of the economy supporting the debt.
There is an interesting tension in the meantime. The enormous amount of capital being invested in AI infrastructure is competing for money at the same time the federal government has enormous borrowing needs. That competition could contribute to somewhat higher interest rates today, even if the resulting productivity gains ultimately improve economic growth and reduce inflationary pressure.
AI will not make $40 trillion of debt disappear, and technology cannot substitute entirely for fiscal discipline. But sustained productivity growth could materially improve the equation. The best way to reduce the burden of a large debt is not simply to create more dollars. It is to create more economic output.
What Would Change My View?
The size of the national debt alone does not tell us when, or even whether, a crisis will occur. There is no obvious number at which investors suddenly decide the United States can no longer manage its finances. In fact, the CBO's baseline demonstrates this point: debt rises to historically unprecedented levels without the agency forecasting a fiscal crisis.
What would concern me is a combination of market signals pointing in the same direction. Treasury yields rising substantially without stronger economic growth to explain the move, inflation expectations becoming unanchored and a meaningful decline in the dollar would suggest that investors were demanding greater compensation not simply for interest-rate risk, but for the future purchasing power of the dollars they were being promised.
That is a very different environment from the one we have today. Recognizing a legitimate long-term fiscal problem does not require us to behave as though the worst possible outcome is inevitable.
What Would It Mean for Investors?
An inflationary debt event would change the relative value of assets and liabilities. A promise to receive a fixed number of dollars many years in the future behaves differently when the purchasing power of those dollars is declining. Likewise, fixed-rate liabilities become less burdensome in real terms when inflation rises. Assets capable of generating growing income may behave differently still.
Those relationships are worth understanding, but they are not a reason to restructure a portfolio today around a crisis that may never occur. Timing would matter enormously, as would the policy response, and markets would begin adjusting prices long before the ultimate outcome became obvious.
A severe fiscal event would also likely create substantial market dislocations. Fear and the need for liquidity can cause investors to sell fundamentally sound assets alongside those that are genuinely impaired. Sharply higher interest rates can eventually create opportunities that did not exist when yields were lower, just as falling asset prices can create more attractive valuations.
For me, that is the more useful investment lesson. Diversification, appropriate liquidity, discipline and flexibility provide the ability to adapt as circumstances change. The objective is not to build a portfolio around one economic forecast, but to avoid being placed in a position where fear or financial necessity dictates decisions during a period of market stress.
Final Thoughts
The national debt is a serious long-term problem, and CBO's projections make that clear. Debt held by the public is expected to rise substantially relative to the economy, deficits remain historically large and interest expense consumes an increasing share of federal resources. But it is equally important to understand what CBO is not forecasting: an imminent debt crisis, runaway inflation or a collapse in the dollar.
My base case is also considerably less dramatic. We may have to live with somewhat higher long-term interest rates, more persistent inflation and occasional dollar weakness as the economy adjusts to greater government borrowing. AI-driven productivity could improve that equation considerably, but ultimately the fiscal math will also have to improve.
If it does not, and confidence eventually begins to erode, I believe a U.S. debt event is more likely to manifest itself through a weaker dollar, higher inflation and higher long-term interest rates than through a conventional default. That is a risk worth understanding, but not one investors should assume is inevitable.
Successful investing does not require predicting every crisis. It requires recognizing risks without becoming consumed by them, remaining flexible, and being prepared to take advantage of the opportunities that market dislocations inevitably create.
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Jeff
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