What do us debt dynamics imply for insurance investors? | Insight Investment

What impact will the growing level of US debt have on financial markets?

Jim: Growing debt levels have spurred debate about “US exceptionalism” and the future of the US dollar as the world reserve’s currency. The debate has recently intensified as the “One Big Beautiful Bill Act” is projected to add $4.1trn to federal debt over the next decade, pushing the debt-to-GDP ratio from 100% to 127%. If left unchecked, rising debt poses risks to our economic stability, fiscal flexibility and global influence.

Rising debt has significant implications for investment markets that include increasing Treasury issuance, lower foreign demand and higher inflation expectations. All of these will drive yields higher and curves steeper.

For now, we believe short-term cycles will continue to dominate asset price behavior, but trends may emerge as we continue on an unsustainable fiscal trajectory and alarm bells grow louder about the looming insolvency of entitlement programs. And these trends may accelerate if foreign demand for US assets shrinks in response to further deterioration in global attitudes toward the US.

However, we see no immediate alternative to the US as the world’s global reserve currency, particularly as other nations are generally also trending toward higher debt. At some point, we believe there will be a limit to how far long-dated Treasuries sell off. Hypothetical levels in the 5% to 6% range would, we suspect, be attractive to many global investors. So, there may be a limit to how much the US curve will steepen.

When the fiscal crisis does finally arrive, asset performance will depend on the ordering of policy responses.

What tools does the Fed and/or the Treasury have, to respond to market dysfunction?

Jim: The Fed and Treasury have several tools they could deploy in the case of severe and sustained market dislocations in long-end Treasuries.

The Fed would be able to consider longer-dated Treasury purchases, similar to its 2011-era “Operation Twist” with the aim of enforcing a “ceiling” on long-term Treasury yields. Other tools, such as standing repo and securities lending facilities, can help prevent forced selling and help ensure smooth market functioning.

The US Treasury has debt management levers it can pull. For example, it can reduce sales of long-term debt in favor of near-term debt (similar to how its operations have worked in recent years) or increase buybacks certain securities and adjust auction sizes and frequencies.

The Treasury and Fed, if required, can also work in concert, through jointly coordinated operations and joint communication efforts to help ensure market functioning.

We believe these tools are highly powerful. We do not anticipate that any of these measures will be required in the medium term. In the event of market disruption, we believe the Fed and Treasury simply communicating that they stand ready may in itself be enough to ensure smooth market functioning. But if needed, we believe they would intervene.

What are the geopolitical consequences of persistent deficits and rising debt?

Jim: Fiscal instability risks undermining the United States’ global credibility and leadership. Heavy reliance on foreign creditors – some of whom are strategic rivals – introduces vulnerabilities, as these nations could leverage their holdings of US debt in diplomatic or economic disputes. Rising interest payments also constrain the federal budget, limiting the country’s ability to fund defense, foreign aid, and global engagement. Over time, this may reduce the US’s capacity to respond to international crises or support allies. Additionally, persistent deficits could increase calls for de-dollarization and alternative reserve currencies. Altogether, these dynamics risk diminishing US influence on the world stage and weakening its strategic position in an increasingly multipolar world.

For insurance companies, what should they be most concerned about when it comes to the US debt and their own portfolio? Where can they find optimism?

Jim: We believe the projected timelines for a fiscal crisis or market disruption remain well beyond insurers’ typical investment horizons, but meaningful trends may emerge if fiscal conditions continue to deteriorate. We’re not recommending immediate changes to strategic asset allocations or duration targets, but insurers should consider the structural implications of a worsening fiscal outlook.

Insurers should be more intentional about liquidity management. Risk management programs should include stressing liquidity, and not just market liquidity but also the potential financial statement impacts of accessing liquidity in higher rate environments. These considerations should be fully integrated into enterprise risk management (ERM) frameworks and evaluated alongside other core risks.

Additionally, insurers should recognize that a steeper yield curve may persist. While the Federal Reserve can anchor short-term rates, longer-term yields are increasingly influenced by factors such as rising inflation expectations, heavier Treasury issuance, declining foreign demand, and a potential reassessment of the risk-free status of Treasuries. In this environment, the intermediate part of the curve (5 to10-year Treasuries) may offer relative insulation from fiscal noise and could benefit from future Fed rate cuts.

Despite these concerns, there are still compelling reasons for optimism. US Treasuries remain the most liquid and widely held government securities globally, supported by the enduring role of the US dollar as the world’s reserve currency. This foundational status continues to attract demand, even amid fiscal uncertainty.

Moreover, higher yields have historically drawn more interest from investors, and volatility often creates tactical opportunities for active managers. For insurers and other long-term investors, these conditions can present attractive opportunities, particularly in segments of the curve that are less exposed to fiscal pressures.

Finally, as the US approaches key fiscal inflection points – such as the projected insolvency of entitlement programs – there may be a growing political willingness to pursue austerity or reform, especially if the electoral consequences become more manageable. This could help stabilize long-term fiscal expectations and reinforce investor confidence.

Jim is Head of US Insurance and a Senior Portfolio Manager at Insight, responsible for overseeing and guiding portfolio management and solutions design for the firm’s US insurance clients. Jim joined Insight in September 2021, following the transition of Mellon Investment’s fixed income strategies to Insight. He started working at Mellon in 1998 as a portfolio manager and analyst for insurance strategies. Jim has held several leadership roles for Insurance, including Co-Head of Tax Sensitive Crossover Strategies, Head of Insurance Portfolio Management and Co-Head of Insurance. Prior to joining Mellon Investments in 1998, Jim was a research analyst at Citizens Bank, assisting with analysis and risk management for balance sheet holdings of mortgage-backed securities. He began his career at the Federal Reserve Bank of Boston in Banking Supervision. Jim has an MBA from Northeastern University and a BA in Finance from Ohio University. Jim is a CFA charterholder and is a member of the CFA Institute and CFA Society Boston.