The United States government just posted a $432.3 billion deficit for July, the largest monthly shortfall since March of 2021. That single burst of red ink pushed the year‑to‑date deficit to $1.8 trillion, with two months still remaining in fiscal 2026. At this pace, Washington will soon wax nostalgic for the “good old days” when annual deficits were only $2 trillion. The fiscal deterioration is no longer episodic—it is structural, relentless, and accelerating.
The reason is simple: the U.S. financed its debt on the short end of the yield curve, choosing convenience over prudence. Instead of locking in long‑term rates when they were historically low, Treasury saturated the market with T‑bills. That means the entire debt stack must be rolled over constantly at today’s rates, whatever they may be. This is why the White House wants yields lower, and why Kevin Warsh—despite his hawkish reputation—is not raising the Fed Funds Rate. It is also why Secretary Bessent is now doing an operation Treasury Twist—where he is buying back 30-year bonds and issuing even more on the short-end of the yield curve. Washington is busy using smoke and mirrors to mask the daunting math.
The nation is now paying $3 billion per day in interest on our debt, approaching $100 billion per month, and $1.2 trillion per year. Ten months into this fiscal year, net interest has already reached $963 billion, up 14% from the same period last year. Interest expense is now the fastest‑growing major component of federal outlays, and it is rising far faster than tax receipts or GDP.
This leaves the Federal Reserve with a conundrum that borders on the absurd:
- Raise the Fed Funds Rate, which sends T-bill yields higher and increases interest payments even further into unaffordable territory.
- Cut rates and unleash even higher inflation that sends the long-end of the yield curve soaring.
Neither path is viable. Therefore, the Fed will almost certainly attempt a third option next year: shrink the balance sheet while keeping the policy rate near current levels. Warsh has already hinted at this strategy. By selling long‑term Treasuries and mortgage‑backed securities, the Fed can attack asset‑price inflation without directly crushing Main Street–at least initially. Wall Street loses while the middle class remains mostly unscathed.
But make no mistake: this path is not at all painless. Every prior attempt to reduce the balance sheet has destabilized credit markets. Liquidity evaporates, spreads widen, and equities buckle. The fissures are already visible. The 30‑year Treasury yield is at its highest level since 2001, and bond yields across the curve are at quarter‑century highs. This is occurring before any meaningful balance‑sheet reduction has begun.
Warsh has already printed $55 billion since taking office in late May—hardly a tightening cycle. But his task force report, expected in early 2027, will provide the political cover he needs to begin selling assets. When that happens, the credit markets will not respond with polite disagreement. They will convulse.
A crucial component of my model is credit spreads, because spreads reveal what insiders are doing long before equity markets notice. When spreads widen, it means the plutocrats—the bond‑market elite—are quietly selling economically sensitive corporate debt and fleeing to the perceived safety of Treasuries. The overall market appears calm for now, but the hyperscalers tell a different story. The spread between hyperscaler bonds and Treasuries is widening, and the cost of insuring against default for these companies is rising. This is the first tremor of the breaking of the credit bubble.
AI‑related debt is only one segment of the gargantuan credit bubble, but it is a critical one. It accounts for roughly half of U.S. earnings and GDP growth. If these companies credit spreads continue to widen, the entire market narrative around AI, productivity, and earnings momentum will reverse violently.
And AI debt is merely the tip of the spear. The broader credit bubble includes:
- $1.6 trillion in Private Credit
- $1.4 trillion in CLO debt
- $1.5 trillion in Junk Bonds
- $1.4 trillion in Margin Debt
- $40 trillion in National Debt
- $18.8 trillion of consumer debt, which is much more difficult to service because households have been ravaged by inflation.
This is not a bubble. It is a superstructure of leverage, built on the assumption that rates would remain near zero forever. That assumption has died, and the consequences have just started to become priced in.
The most dangerous myth in markets today is the belief that the Fed and Treasury can easily bail out the next crisis. They cannot. Their balance sheets are already broken. The Treasury is issuing debt at a pace that rivals world-wartime financing, and the Fed is trapped between inflation and insolvency, with a balance sheet that is near $7 trillion—not the few hundred-billion-dollar level held during prior economic crises. The next crisis will not be immediately met with unlimited liquidity. It will be met with hesitation, political conflict, and delayed intervention.
The bond market is beginning to understand this. Investors should too.
The fracturing of the massive credit bubble is not a distant risk—it is the next phase of this cycle. The data are clear, the math is unforgiving, and the policy options are narrowing. The implosion of asset prices will begin where it always begins: in credit. And once it starts, the unwind will be swift, disorderly, and intractable; with the tools that worked in the past ineffective.
We monitor credit spreads and financial conditions obsessively and our model is positioned accordingly. We are allocated on the correct part of the Treasury curve, we own gold and the miners, domestic and international dividend payers. And, we have begun to put hedges in place (such as managed futures), which will increase and broaden these hedges as the credit market continues to fracture. The next economic and stock market downturn will not be a garden‑variety recession. It will be a repricing of leverage across the entire financial system.
The reckoning is no longer coming. It has already begun.
Important Disclosures
This commentary is published by Pento Portfolio Strategies LLC (“PPS”), an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply any level of skill or training. The views expressed are those of Michael Pento as of August 24, 2026, are subject to change without notice, and do not necessarily reflect the views of any other person or entity.
This material is for informational and educational purposes only. It is not investment, tax, or legal advice, is not individualized to any person’s financial situation, needs, or objectives, and is not an offer or solicitation to buy or sell any security. No reader should act on any statement in this commentary without first determining, with the assistance of a qualified professional, whether it is suitable for their circumstances.
Statements regarding the Firm’s positioning are descriptive, not recommendations. References to how the IDEC™ Model is currently allocated — including any reference to the Treasury curve, gold and gold mining equities, domestic and international dividend-paying equities, or managed futures — describe positioning as of the date of this commentary only. Model positioning is signal-driven and changes without notice; the allocation described may already have changed and may be reversed at any time. No reader should infer that any asset class, security, or exchange-traded product is being recommended, that PPS will maintain any position described, or that any position is appropriate for their account. Client accounts are managed according to individual suitability and may differ materially from the positioning described.
Forward-looking statements are opinions, not facts. This commentary contains predictions and forward-looking statements concerning interest rates, credit spreads, Federal Reserve and Treasury policy, and the future direction of credit, equity, and asset prices. Forward-looking statements are inherently uncertain, rest on assumptions that may prove incorrect, and are subject to risks and events that cannot be anticipated. Actual outcomes will differ, and may differ materially, from those described. No representation is made that any predicted event will occur, or that it will occur within any stated or implied timeframe.
No assurance of model performance. The IDEC™ (Inflation/Deflation and Economic Cycle) Model is PPS’s proprietary allocation framework. References to indicators the Model monitors, including credit spreads and financial conditions, describe the Model’s inputs. No representation or warranty is made that the Model will correctly identify any market development, that its signals will be accurate or timely, or that positioning based on those signals will protect against loss. Past model signals and past performance are not indicative of future results.
Hedging does not eliminate risk. References to hedges, including managed futures strategies, should not be read as an assurance against loss. Hedging strategies may fail to perform as intended, may underperform in the environments they are intended to protect against, may increase costs, and may result in losses that exceed those of an unhedged portfolio.
Risk of loss. All investing involves risk, including the possible loss of principal. Fixed income investments are subject to interest rate, credit, and inflation risk. Precious metals and mining equities are volatile, may be concentrated in a single sector, and can decline sharply. International investments carry currency and geopolitical risk. Managed futures and alternative strategies involve leverage, derivatives, and other risks and are not suitable for all investors. Diversification does not assure a profit or protect against loss in a declining market.
Economic and market data. Figures cited regarding federal deficits, net interest expense, Treasury yields, national debt, private credit, CLO, high-yield, margin, and consumer debt balances are drawn from publicly available government and industry sources and are stated as of the dates indicated. PPS believes these sources to be reliable but does not independently verify them and makes no representation as to their accuracy or completeness. Data are subject to revision.
References to public officials and third parties. Any reference to a public official, government body, or third-party company reflects the author’s commentary on publicly reported matters. No such reference constitutes an endorsement by, affiliation with, or the approval of any person or entity named, and no security of any company referenced is being recommended.
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