As we mentioned in our recent Midyear 2025 Outlook: Pragmatic Optimism, Measured Expectations, we expect bond market action to continue to swing between concerns over slowing economic data (lower yields) and larger debt/deficit dynamics (higher yields). But according to recent analysis from the Congressional Budget Office (CBO), tariff revenue could meaningfully impact both sides of the bond market pendulum, which on net, could be beneficial to the Treasury market.
As noted by the CBO, total government outlays for 2025 are roughly $7 trillion, with 2025 revenue equal to around $5.2 trillion, resulting in a budget deficit of nearly $2 trillion per year (or over 6% of gross domestic product (GDP)). With the recent signing into law of the Republican’s One Big, Beautiful Bill Act, initial estimates suggest, in a best-case scenario, that deficits will continue to run in the 6%-7% range of GDP, suggesting Treasury issuance will need to remain elevated to fill the budget gap. The U.S. government has $37 trillion in total debt outstanding, and that number grows by $1 trillion every six months or so. Bigger budget deficits equal more Treasury issuance, all else equal.
Budget Deficits Are Expected to Remain/Worsen Over Time
But tariffs generate direct revenue for the federal government, creating an alternative income stream to traditional taxation. This additional revenue can reduce the Treasury’s borrowing needs. With tariff collection expected to increase revenues/decrease deficits by $4 trillion over 10 years, the Treasury Department can scale back its bond issuance accordingly. This reduced supply of new Treasuries, all else equal, tends to support bond prices and can help contain yields. For a government managing substantial debt levels, this revenue diversification provides fiscal flexibility that markets generally view favorably.
The mechanical relationship is straightforward: every dollar collected through tariffs is potentially one less dollar the government needs to borrow. During periods of significant tariff implementation, Treasury auction sizes may decrease, particularly in shorter-duration bills and notes where adjustments can be made more dynamically.
Rating agency S&P Global Ratings, which recently affirmed its AA+ rating, acknowledged tariffs as credit-positive and highlighted how rating agencies weigh these competing factors. S&P’s analysis suggests that the revenue generation aspect of tariffs, combined with their potential to reduce trade deficits, outweighs near-term growth concerns from a creditworthiness perspective.
Moreover, from a pure market dynamics perspective, tariff implementation creates what could be considered an ideal scenario for existing Treasury holders. On the supply side, revenue generated from tariffs directly reduces the Treasury’s funding needs. But simultaneously, tariffs increase costs somewhere along the manufacturing/distribution/consumption process. So, as tariffs increase business costs and consumer prices, economic growth is set to slow, which has historically benefited Treasuries.
Of course, it isn’t all positive for fixed income markets as tariffs increase price pressures. And, as Fed Chair Jerome Powell noted recently, tariff effects will be short-lived but not necessarily felt all at the same time. It will likely take time for tariff increases to work their way through supply chains and distribution networks, prolonging a return to the Fed’s 2% inflation target. Moreover, tariff income is still expected to be only a drop in the bucket compared to the amount of debt outstanding and is unlikely to replace the need for income taxes. But, it helps.
Love them or hate them, it sounds like tariffs are here to stay (in one way, shape, or form) and that, on balance, could be good for Treasury markets. The combination of technical factors (less supply) and fundamental factors (slowing growth, potential Fed accommodation) creates multiple pathways for Treasury market tailwinds. Even if tariff revenue disappoints or growth impacts prove milder than expected, reduced issuance alone could provide a supportive floor for prices.
While risks certainly exist — particularly if tariffs spark significant inflation requiring monetary tightening — the near-to-medium term setup appears more favorable for Treasury investors now than it did without tariff revenue.
Lawrence Gillum, CFA, guides the fixed income view for LPL Financial Research and has over 20 years of investing experience.
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