Last week, President Trump called on the Federal Reserve to cut short-term interest rates by 100 basis points. While such a move might seem positive for capital markets if it led to a drop in the 10-year Treasury yield, market reactions can be more complex. In 2024, initial expectations of Fed rate cuts shifted as inflation remained elevated. In January, the Fed signaled rates would stay higher for longer, causing the 10-year yield to rise by about 100 basis points. This movement occurred alongside growing concerns over federal deficits and increased attention to the interaction between fiscal and monetary policy.

The bond markets are increasingly reacting not only to monetary policy but also to fiscal dynamics. Recently, the U.S. House passed the One Big Beautiful Bill Act, a broad fiscal package that includes include front-loaded tax cuts, new exemptions for retirees, and elimination of taxes on tips and overtime all while promising future savings through cuts to Medicaid, food assistance, and green energy programs. Even with added tariff revenues, the bill is expected to keep the federal deficit above 6% of GDP for the foreseeable future.  According to Capital Economics, if that pace continues, the federal debt will climb to 120% of GDP within the next decade.

Deficit spending has long been part of U.S. fiscal policy, with annual budget deficits occurring in most years since 1970. Historically, these deficits were largely driven by recessions, wars, or temporary economic challenges, often fluctuating with economic cycles. In recent years, deficits have become more persistent, with trillion-dollar shortfalls occurring even amid low unemployment and steady economic growth. Long-term fiscal pressures are also expected to increase as Social Security and Medicare obligations rise with an aging population.

Low interest rates have made it easier to control the cost of servicing the national debt over the past few decades. However, the dynamic is changing. In light of growing fiscal risks, investors are now requesting higher yields. Government borrowing is becoming more costly due to the increase in the term premium and Moody’s recent downgrade of the U.S. credit rating outlook.

While no immediate policy shifts have been triggered, ongoing fiscal pressures are drawing increased attention from policymakers, investors, and market participants. The discussion around long-term fiscal sustainability is becoming more prominent as economic and demographic factors evolve.

Looking ahead, market dynamics may continue to influence fiscal policy decisions. Historically, significant fiscal reforms have often followed periods of heightened market scrutiny. In certain scenarios, higher yields could create a feedback loop, with rising borrowing costs contributing to further increases in deficits and yields.

For commercial real estate, the 10-year Treasury remains a key benchmark influencing construction financing, cap rates, and overall capital costs. Sustained increases in Treasury yields may lead to slower transaction activity, higher borrowing costs, and potential impacts on asset valuations. Ongoing concerns regarding the long-term fiscal outlook could add further pressure if meaningful fiscal adjustments are not made.

These trends could ripple through commercial real estate markets. Rising borrowing costs may slow investment activity, contribute to adjustments in cap rates, and prompt lenders to adopt more selective underwriting standards.

Market confidence could stabilize if fiscal policymakers introduce measures to address long-term deficits, such as targeted tax reforms, adjustments to entitlement programs, or revised spending priorities. Such steps may help maintain a more stable 10-year Treasury yield, support predictable capital costs, and promote pricing stability across commercial real estate asset classes.

While bond markets have not yet signaled acute concerns, recent developments have drawn greater attention to fiscal trends. For CRE professionals, continued monitoring of deficit spending and fiscal policy will be important as these factors may influence capital markets in the years ahead.