With the national debt nearing $40 trillion, Bank of America has a warning for bond investors

As the United States' national debt inches closer to the $40 trillion mark, Bank of America Research strategist Michael Hartnett's "Anything but Bonds" framework gains increasing relevance. Hartnett warns that the U.S. is accumulating excessive debt, leading the government to issue a large number of bonds. This in turn creates a demand for higher compensation among investors, making long-duration Treasurys less appealing compared to alternative assets.

The U.S. national debt reached around $39.9 trillion in mid-August, and it is anticipated to cross the $40 trillion threshold as early as this week. According to Treasury data, the debt includes both intragovernmental holdings and debt held by the public. Hartnett, Bank of America's chief investment strategist, has integrated this fiscal deterioration into one of his primary investment themes.

His "Anything but Bonds" call stems from his belief that investors should be cautious about long-duration government debt while the U.S. continues to run significant deficits and the market demands higher yields to finance them. He predicts the national debt will reach $50 trillion by 2029.

The issue lies not in the government owing a substantial amount of money, but rather in its ongoing need to refinance and issue more debt, which increases the supply of bonds that investors must purchase. Should investors become less inclined to buy that debt at existing yields, the government must offer higher interest rates to attract them. This dynamic is evident in the Treasury market, with the 10-year Treasury yield reaching 4.6% and the 30-year yield hitting 5.2%.

For bond investors, rising yields present a two-sided coin. New bonds become more attractive due to their higher income, but existing bonds lose value when market yields increase. The longer the bond's maturity, the more sensitive its price is to changes in interest rates. Consequently, long-duration Treasurys are particularly vulnerable if investors persist in demanding higher returns to offset fiscal and inflation risks.

Although Hartnett suggests that bonds may not be an appealing investment, the bond market can serve as a clear indicator of the economy's underlying health. Treasury yields reflect investors' expectations regarding inflation, economic growth, interest rates, and the government's ability to manage its finances. When yields rise, the consequences extend beyond bond portfolios, influencing various aspects of the economy, such as mortgages, corporate loans, and consumer credit, potentially slowing investment, housing, and spending.

During the first ten months of fiscal year 2026, the federal government has borrowed $1.8 trillion, including $432 billion in July alone. This borrowing generates a feedback loop, as more debt leads to higher interest payments and larger deficits. Consequently, the Treasury must issue even more securities to cover the borrowing.

With the interest bill on the national debt already reaching approximately $1.4 trillion over the past year, Hartnett contends that the "Anything but Bonds" strategy is unlikely to end until five-year Treasury yields fall below approximately 3.25%.