The explosion of the budget deficit was one of the most worrisome things that happened post-Covid. While inflation peaked in 2022, the deficit kept getting worse because of the "fiscal doom loop" caused by bloated spending and higher interest rates.
At this time last year things were still looking extremely grim. The deficit was stuck around $2.1 trillion on a rolling 12-month basis, or 7.3% of GDP--the largest non-emergency deficit we've ever had. And the10-year Treasury yield was stuck above 4.7%, worsening the situation daily. Now, though, we are experiencing a dramatic improvement.
The latest numbers which we got yesterday afternoon illustrate the sharp change we've seen. For the first three months of the fiscal year (October through December), the deficit is down $109 billion, or 15% from a year earlier. Tariff revenues, known as "customs receipts," are a big part of that, hitting $90 billion from $20 billion the prior year.
The market had been anticipating some improvement, as we wrote last summer. The 10-year Treasury yield even dipped below 4% briefly in the fall. The question now is how long this improvement can last. Tariff revenues already appear to be plateauing at around $30 billion a month. And the "One Big Beautiful Bill" is expected to increase the deficit in the months ahead.
"Spending is not budging," writes Dan Clifton of Strategas, a Baird company. It's still around 23% of GDP, versus 20% historically, he notes. It's because income tax receipts (along with tariffs) have been stronger than expected this year that the deficit has been improving. "Without spending coming down, it's hard to get the deficit from 6% to 3% of GDP," he says.
And perhaps that's why interest rates haven't been able to fall much further lately. Remember--everything the president wants to achieve with his housing affordability push would be much easier if the 10-year Treasury yield, which mortgage rates are priced off of, fell considerably. Even Fed rate cuts don't lower this rate, as we've seen over the past year.
And as much as the White House has been pointing the finger at the Federal Reserve to bring down rates, many analysts are pointing the finger right back at the White House for keeping rates elevated.
Why? "The only path to sustained lower market interest rates is through price stability, central bank credibility, and fiscal integrity," wrote Roth MKM's Michael Darda this week. "Undermining central bank independence, and squandering tariff revenue on fiscal gimmicks is likely to do just the opposite."
So yes, the deficit looks much better lately, and thank goodness. But for all of the DOGE drama, lowering spending is the one true change this administration hasn't been able to deliver on yet.