In a recent note, Chris Brightman, who is a partner, senior advisor, and board member at the firm, and Alex Pickard, senior vice president for research, traced the historical trend between the deficit and how earnings are recycled to inflate asset prices.

“In the financialized U.S. economy, each dollar of deficit spending may flow into a dollar of corporate profit,” they wrote.

Annual budget deficits have reached $2 trillion, with debt-servicing costs alone hitting $1 trillion. As federal spending exceeds revenue by wider margins, the Treasury Department must issue greater volumes of bonds.

Much of the money the government raises by selling debt goes into consumers’ pockets, primarily via entitlement payments, which eventually boost profits, according to Research Affiliates.

But for decades, companies largely didn’t invest those profits to expand their capacity. Due to intense global competition, especially from China, returns from U.S domestic production were kept low. And even the money that is invested wound up replacing depreciated capacity rather than expanding it.

As a result, companies returned much of their capital to shareholders in the form of buybacks and dividends, which were plowed back into financial markets, often in price-insensitive passive funds that inflate valuations, the report argued.

“Mandated to remain fully invested, these funds then recycle the inflows to purchase stocks in proportion to their market capitalization indifferent to valuation, thus bidding up prices without any change in fundamentals,” Brightman and Pickard wrote.

They pointed to a real-world experiment that reinforces their thesis. During the late 1990s, the federal government briefly erased its budget deficit and actually boasted a surplus.

That came as the booming economy helped lift revenue while cuts to federal welfare programs limited spending. During this period, corporate profits fell too, they added.

This dependence on federal deficits has left financial markets increasingly fragile, the report warned, as corporate earnings have shifted away from relying on returns from private investment.

“Reversion to a healthier macroeconomic environment of declining deficit spending and greater net investment may cause sharp declines in both corporate profits and valuation multiples and likely trigger a financial crisis with politically toxic consequences,” Brightman and Pickard concluded.

“Ironically, the more palatable option may be to remain on the current path until a financial crisis imposes on us the discipline that we are unwilling to impose on ourselves.”

Changing U.S. debt market

Despite surging revenue from President Donald Trump’s tariffs, debt continues to pile up, drawing alarm bells from Wall Street heavyweights like JPMorgan CEO Jamie Dimon and Bridgewater Associates founder Ray Dalio.

Meanwhile, Trump plans to grow defense spending by 50%, pushing it to $1.5 trillion a year and blowing up the debt even more.

At the same time, the holders of U.S. debt have shifted drastically over the past decade, tilting more toward profit-driven private investors and away from foreign governments that are less sensitive to prices.

That threatens to turn the U.S. financial system more fragile in times of market stress, according to Geng Ngarmboonanant, a managing director at JPMorgan and former deputy chief of staff to Treasury Secretary Janet Yellen.

Foreign governments accounted for more than 40% of Treasury holdings in the early 2010s, up from just over 10% in the mid-1990s, he wrote in a New York Times op-ed last month. This reliable bloc of investors allowed the U.S. to borrow vast sums at artificially low rates. Now, they make up less than 15% of the overall Treasury market.

To be sure, the federal budget deficit isn’t the only driver of growth. The AI boom has set off a massive investment wave, spurring demand for chips, data centers, and construction materials.

But so-called AI hyperscalers are also turning to the bond market to raise capital for annual expenditures of hundreds of billions of dollars. And their debt issuance represents more competition to the Treasury Department, which is looking to ensure investors continue absorbing the fresh supply of debt it must sell.

In a note last week, Apollo Chief Economist Torsten Slok pointed out that Wall Street estimates for the volume of investment grade debt that’s on the way this year reach as high as $2.25 trillion.

“The significant increase in hyperscaler issuance raises questions about who will be the marginal buyer of IG paper,” he said. “Will it come from Treasury purchases and hence put upward pressure on the level of rates? Or might it come from mortgage purchases, putting upward pressure on mortgage spreads?”

Hong Kong’s capital market is likely to experience significant fluctuations this year owing to intensifying geopolitical risks, the city’s finance chief has warned, stressing the need for caution in financial management.

During a briefing for lawmakers on Friday, Chan reported that the economic growth for last year is forecast at 3.2 per cent despite geopolitical pressures. While export performance remained strong, consumer spending had weakened, he said.

For the coming year, Chan expressed “cautious optimism” about the economic outlook, citing risks that could affect financial security but also highlighted the improving economy in mainland China.

“Caution is needed because we anticipate that geopolitical risks will only intensify. Under such circumstances, the capital market is inevitably subject to significant fluctuations,” he said at a special meeting of the Legislative Council’s finance committee. “Geopolitical factors influence capital flows. We must exercise caution.

“While we must vigorously pursue development, we also need to coordinate efforts on security, particularly in financial safety, to prevent unexpected disruptions and ensure financial stability.”

Start The Year Off Learning & Earning

The beginning of the year is a great time to think about how to make smarter financial decisions in 2026. But with volatile interest rates, shifting markets, budgeting realities and rapid advances in AI technology, it can be hard to know how to best navigate your spending, saving, and investing—from major decisions such as buying a home or saving for retirement to everyday shopping. Join us January 28th at 12pm ET for a members-only panel moderated by Associate Editor Emma Waldman with clear, actionable guidance and a 101 of many of the new AI tools. This forward-looking discussion will help you navigate the year with confidence and clarity.

We’ll Discuss:

• Actionable money moves for the year ahead, from investing in an uncertain environment to managing debt and strengthening long‑term plans
• What’s really driving the 2026 financial landscape, including inflation trends, rate expectations and the signals that matter more than the headlines
• Clear, practical guidance to stay financially resilient, with expert insights on habits, strategies and trends to build your confidence
• How new technology (especially AI‑driven tools) is reshaping personal finance, and what consumers should embrace or approach with caution.

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Speakers