The U.S. government’s balance sheet keeps getting worse by almost every measure investors track. Yet one of Wall Street’s largest banks says that story is only half the picture.
A closer look at who actually owes the money tells a very different story than the headlines about mounting national debt suggest, and it could matter a lot for how markets handle higher interest rates from here on out.
Morgan Stanley says households and companies can handle higher yields
Morgan Stanley expects major developed economies to keep running wide fiscal deficits and adding public sector leverage in the years ahead. But the firm’s research highlights a sharp divergence between public and private financial health.
In the U.S. specifically, the firm’s most recent forecast shows the federal deficit climbing from 6.3% of gross domestic product in 2025 to 7.1% in 2026, representing an increase of roughly $310 billion year over year, according to Morgan Stanley. The U.S. debt-to-GDP ratio now stands at approximately 125%, putting it above France, China, and the United Kingdom.
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Private balance sheets tell a different story entirely. U.S. corporate debt relative to GDP has barely moved over the past decade and sits below its pandemic peak, while household debt has dropped significantly relative to both income and GDP over the same stretch.
That said, the picture is not uniformly rosy at the household level. Total U.S. household debt was nearly $19 trillion in the second quarter, even as household debt relative to GDP has continued improving, CNN reported.
That gap between rising public leverage and falling private leverage is the crux of Morgan Stanley’s call. The firm believes consumers and businesses are well insulated enough to navigate higher yields without facing meaningful constraints on borrowing, spending or investment.
The public debt side of the ledger looks a lot worse
While households and companies hold up well on paper, the federal government’s own numbers tell the opposite story. Total U.S. public debt surpassed $40 trillion for the first time on Aug. 19, marking roughly a one-third increase in less than five years, CNBC reported.
That growth pace has been striking. The debt hit $39 trillion just five months earlier in March, and it was at $38 trillion five months before that in October 2025. The country has been adding a trillion dollars in debt roughly every five months, according to Fortune.
July’s deficit came in at $432.3 billion, the worst single month since March 2021. That pushed the fiscal year-to-date shortfall to nearly $1.8 trillion, CNBC noted. The government is not just borrowing more. It is borrowing faster.
Debt held by the public, the measure economists typically use to compare a nation’s debt against the size of its economy, has already exceeded U.S. GDP for the first time in decades.
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Why the U.S. stands out and why the U.K. doesn’t
Among the major economies Morgan Stanley analyzed, only the United Kingdom is forecast to see its fiscal deficit materially smaller in 2027 than it was in 2025.
The U.K.’s debt-to-GDP ratio stands at 96%, meaningfully below the U.S. at 125%, France and China at 120% each, Italy at 138%, and Japan at 208%. Year-to-date, 10-year bond yields in the U.K. have also risen less than yields in the U.S. or Japan, according to Morgan Stanley.
That gap matters in practice. When a government keeps borrowing heavily, it is competing with its own private sector for the same pool of investor capital. That competition pushes rates up. Higher rates then slow down the very private-sector borrowing that was supposed to be healthy.
Morgan Stanley’s own economists have separately noted that AI-related spending could amount to one of the largest waves of investment ever recorded, with investments by large technology companies expected to increase significantly between 2024 and 2027, according to TheStreet.
On the equity side, Morgan Stanley’s broader outlook echoes the same theme of underlying strength. Recent market gains have been driven mainly by earnings growth rather than expanding valuations, according to Andrew Slimmon, head of the firm’s Applied Equity Advisors team.
“Companies are actually doing better than expected,” he said, calling it a healthy, fundamentally driven environment, Morgan Stanley noted.
Slimmon added a caveat, however. A more restrictive monetary policy stance could still challenge that constructive backdrop if higher rates eventually begin weighing on corporate profits, even with balance sheets currently in good shape.
The firm has also warned that tariffs and fading fiscal support could weigh on consumption and economic growth.
What it means for investors
Private balance sheets are fine. Corporate debt is manageable. Household debt relative to income has fallen. Morgan Stanley is not worried about the private sector.
What it is pointing at is the gap between that healthy story and what is happening on the government side, and how long that gap can hold before it starts pulling the private side down with it.
On the government side, the bill keeps growing. Net interest costs hit $857 billion in fiscal 2026 through June alone, as TheStreet reported. Every time the government rolls over old debt at today’s higher rates, that number climbs, leaving less money left for anything else.
The government borrowed its way through the last decade. Most households and companies did not.
That gap is the whole story. It is why Morgan Stanley thinks the private sector can take more heat than the national debt headlines suggest. Whether that gap holds is a different question entirely.
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