Rising U.S. Debt and the Race to Position Portfolios for Higher Borrowing Costs

The U.S. national debt has crossed a historic threshold, surpassing $36.2 trillion as of July 2025, according to the Treasury's “Debt to the Penny” dataset. This staggering figure—equivalent to roughly 120% of the country's GDP—has profound implications for interest rates and investor strategy. As borrowing costs rise to manage this debt burden, portfolios must adapt to avoid pitfalls and capitalize on new opportunities.

The Debt-Interest Rate Nexus

The math is stark: servicing this debt requires significant interest payments. In 2024, the U.S. spent $1.1 trillion on interest alone—surpassing military spending for the first time. Projections for 2025 put interest costs at $776 billion, though this figure may climb further as the Federal Reserve's rate hikes bite. With the Congressional Budget Office estimating that the “Big Beautiful Bill” legislation could add another $3 trillion to the debt over a decade, fiscal pressures are set to intensify.

The Treasury's reliance on borrowing to fund deficits means higher interest rates are inevitable. The Fed's dual mandate to control inflation and stabilize the economy will require a delicate balance. If rates rise too quickly, the cost of debt servicing could spiral out of control. But if they rise too slowly, inflation may resurge. Either way, investors must prepare for a prolonged era of higher borrowing costs.

Portfolio Strategies for a High-Rate Environment

1. Shorten Duration in Bond Holdings
   Long-term bonds are highly sensitive to rising rates. Consider shifting to short-term Treasury bills or ultra-short ETFs (e.g., SHY or BIL) to minimize duration risk.

2. Embrace Floating-Rate Instruments
   Floating-rate notes (FRNs) and bank loans adjust as rates climb. ETFs like FLOT or FLRN offer exposure to this sector, which typically outperforms in rising-rate environments.

3. Prioritize Inflation-Protected Securities
   TIPS (Treasury Inflation-Protected Securities) and ETFs like TIP hedge against inflation, a secondary risk tied to high debt and accommodative monetary policies.

4. Financials: Winners in a Steeper Yield Curve
   Banks and insurers benefit from wider interest rate spreads. Look to sector ETFs like XLF or individual names with strong capital positions, such as JPM or WFC.

5. Avoid Long-Duration Assets
   Steer clear of 30-year Treasuries (TLT) and real estate investment trusts (REITs), which are highly rate-sensitive. Utilities (XLU) may also underperform as their fixed-income-like dividends lose appeal.

6. Consider Inflation-Linked Currencies
   Currencies tied to commodities, such as the Canadian dollar (FXC) or Australian dollar (FXA), could outperform as central banks globally hike rates to combat inflation.

Risks and Considerations

• Foreign Debt Holders' Influence: China and Japan, holding nearly $2.2 trillion combined, could reduce Treasury purchases if geopolitical tensions escalate. This could force the Fed to hike rates more aggressively to attract buyers.
• Automatic Spending Growth: Entitlement programs like Social Security and Medicare are driving fiscal deficits upward. Without reforms, debt will continue to balloon, reinforcing the case for higher rates.

Conclusion: Position for Resilience

The U.S. debt crisis isn't a distant threat—it's already reshaping markets. Investors who prioritize liquidity, short-term bonds, and rate-sensitive sectors will weather the storm. Those clinging to long-duration assets or inflation-agnostic holdings may face steep losses.

The path forward is clear: brace for higher rates, diversify defensively, and avoid complacency. The next chapter of the debt saga is being written, and portfolios must be ready to turn its challenges into opportunities.