Must C: Money and Might 2.0 — Balancing Choices

In a new Must C note from Citi Research, we revisit our October 2024 report on global defense spending to account for how President Trump’s second White House term has shifted the landscape and ushered in different priorities from those of President Biden. As with our earlier report, our goal is to address the outlook for defense spending, provide insight into Western allies’ spending, and assess the players in this evolving landscape. 

NATO’s recent summit saw member countries announce a new higher target for defense spending, with outlays slated to reach 5% of GDP by 2035. If implemented, this rise in core defense spending would meaningfully raise NATO’s defense capability — though whether the new targets will be met strikes us as an open question. We note European Union (EU) financial instruments such as the Security Action for Europe and the loosening of EU fiscal rules on defense spending, but remain skeptical that the incentives offered will be enough to help persuade more reluctant countries to increase their defense spending significantly beyond the old NATO marker of 2% of GDP. Further incentives and more jointly funded initiatives may be needed. 

Beyond such incentives, security concerns often collide with economic constraints, as defense-spending goals are challenged by political realities, budget constraints and the significant rise in government debt levels in recent years. While it isn’t prudent to test the limits of markets’ patience with high debt levels, several major countries’ governments seem inclined to do so. 
Meanwhile, President Trump’s administration doesn’t view the threat environment facing the U.S. much differently than President Biden’s did: Russia, China, Iran, North Korea, and terrorist organizations remain the primary areas of focus. The difference is how these threats are addressed, with a notable shift away from leading European security and toward bolstering security leadership in the Indo-Pacific and fortifying the U.S. 

This change has driven NATO members’ new commitments but also altered U.S. budgets, with the new White House looking to shift spending to favor purchasing weapons systems that better assure warfighters are prepared for conflict. Defense Secretary Hegseth has endorsed a shift in resources away from support functions and toward warfighting, with the fiscal 2026 budget aligned with this view — an approach we see as supporting the growth outlook for defense names through the rest of the 2020s. 

While we explore changing White House priorities and geopolitical developments that have arisen since our original report, our October thesis remains intact: Global defense spending has risen over the last decade amid a return to great power competition, with the U.S. looking to leverage non-traditional sources of technological advantage, and conflicts in Ukraine and the Middle East sharpening the focus on such spending. Even as the outlook for legacy defense contractors has been bolstered, venture-backed companies have started changing the face of the industrial base ecosystem, with start-ups seeing a rise in funding and fundraising momentum since the election.

Recent developments we consider in this revised report include: 

• In the U.S., we note the 17 key priorities outlined by President Trump’s administration for the Defense Department and shifts we expect to see over time in the types of equipment acquired by the department. We note progress by defense companies that are key to the “Nuclear Triad” ensuring nuclear deterrence across land, air and sea. And we explore evolving U.S. priorities such as artificial intelligence and machine learning; the use of inexpensive UAVs and attritable aircraft; and the “Golden Dome” national missile-defense system.
• In Europe, we consider the step change in defense budgets; where this money will be spent; and how this increased spending will be funded. Europe is seen as not having enough defense equipment, with seven priority areas atop the list of needs that must be addressed. How to pay for this commitment is the next question: While countries such as Sweden and Germany are in relatively robust financial health, others face questions about government debt and fiscal deficits. Europe’s reliance on imported defense products is also a policymaking concern, as technological, productivity and other macro spillovers associated with spending on such products accrue mainly or even entirely to the country producing them.
• In the Indo-Pacific region, both Western and Eastern allies continue to address security risks stemming from China’s military modernization and North Korea’s nuclear missile programs. Countries in the region are deepening trilateral and quadrilateral cooperation, with an accelerating trend toward coalition deterrence. Several countries are also looking to step up as regional stabilizers, seeking to instill order through defense modernization, diplomacy and rules-based advocacy.