The Debt Ceiling and the Liz Truss Moment: Navigating Fiscal Risks in U.S. Markets

The U.S. federal debt-to-GDP ratio is projected to hit 124.4% by Q2 2025, a level not seen since World War II, and it's on track to exceed 156% by 2055 under current policies. This unsustainable trajectory, compounded by geopolitical shifts in global financing and inflation risks from trade wars, has sparked warnings reminiscent of the UK's 2022 “Liz Truss moment”—a fiscal crisis that sent markets into turmoil. Larry Summers, former U.S. Treasury Secretary, has likened today's fiscal recklessness to that episode, urging investors to brace for volatility. Here's how to navigate these risks.

The Debt Trajectory: A Ticking Time Bomb

The Congressional Budget Office (CBO) warns that rising interest costs and entitlement spending will push the federal deficit to 6.1% of GDP by 2035, even without new spending programs.

By 2055, interest payments alone could consume 18% of federal revenue, crowding out investments in infrastructure and defense. The CBO also highlights a chilling truth: primary deficits (excluding interest) are projected to average 0.3% of GDP above historical norms, meaning even modest economic shocks could trigger a fiscal crisis.

China's Retreat: A Financing Lifeline Unspooling

China, once the largest foreign holder of U.S. Treasuries, has slashed its holdings from a peak of $1.3 trillion in 2013 to $765 billion by March 2025.

This retreat reflects strategic diversification—into gold and short-term Treasuries—and geopolitical friction. With Beijing now prioritizing liquidity, the U.S. must increasingly rely on private investors to finance its debt. This reduces the buffer against market panics, as seen in the 2023 debt ceiling standoff, when yields spiked amid fears of default.

Tariff-Driven Inflation: The Stagflation Threat

The Trump administration's tariffs—145% on Chinese goods and 25% on autos—have injected $2 trillion of fiscal stimulus into an already overheated economy. The CBO now forecasts headline CPI inflation at 3.1% in Q2 2025, up from earlier estimates, with core inflation hitting 3.4%.

This creates a dangerous loop: higher inflation → rising interest rates → higher debt servicing costs → more inflation. The risk? A stagflationary spiral where growth slows but prices keep rising. The EY-QUEST model predicts that current policies could slash GDP by $1.8 trillion by 2075, worsening unemployment and wage stagnation.

Investment Strategies: Shorting Bonds, Hedging Inflation

1. Short Long-Duration Treasuries

With yields rising and fiscal credibility eroding, long-duration Treasuries (e.g., 30-year bonds) face a double whammy of rate hikes and inflation. The TLT ETF, which tracks 20+ year Treasuries, has underperformed equities for years. Shorting TLT or using inverse ETFs like TBF could capitalize on this.

2. Allocate to Inflation-Hedged Equities

Energy stocks (e.g., XLE), materials (e.g., IYM), and real estate (e.g., IYR) offer natural inflation protection. For example, oil majors like Exxon (XOM) benefit from higher energy prices, while REITs like Simon Property (SPG) gain from rising rents.

3. Stay Defensive in Bonds

Focus on short-term Treasuries (e.g., SHY) or high-quality corporate bonds (e.g., LQD), which are less sensitive to rate hikes than long-dated issues.

Conclusion: Prepare for the Fiscal reckoning

The U.S. fiscal path is unsustainable, and Summers' “Liz Truss moment” warning is no exaggeration. Investors ignoring debt dynamics and inflation risks face severe losses. By shorting long-duration bonds and allocating to inflation-hedged equities, portfolios can weather the storm.

The writing is on the wall: fiscal discipline is a mirage, and markets will demand a reckoning sooner than later.