US Treasury yields approach 20-year highs! The U.S. debt dilemma enters a "danger zone"—what options does Washington have left?

According to Zhitong Finance APP, US long-term Treasury yields are approaching their highest levels in nearly 20 years, and the factors pushing yields higher do not appear to be temporary. Washington is massively issuing debt to cover a fiscal deficit that has not been reduced. Inflation is cooling only gradually. In addition, the artificial intelligence (AI) investment boom is keeping the economy strong enough to make it difficult for interest rates to fall.

As a result, with debt levels exceeding $40 trillion, the US government now pays around $1 trillion annually in interest. Torsten Slok, chief economist at Apollo Global Management, pointed out that for every $5 the government collects in tax revenue, $1 goes towards paying interest on national debt. “This is an extremely, extremely high number, and this number will continue to rise.”

The cost of borrowing for the US government is rising, while the easy ways to curb it are diminishing. In an interview on September 28, President Trump noted that the US can repay its debt through economic growth or inflation. If growth and inflation can’t solve the problem, the US Treasury still has a range of policy options, from moderate to aggressive—ranging from greater reliance on short-term borrowing to, in extreme cases, the Federal Reserve capping long-term yields.

Currently, the Treasury has increased reliance on issuing short-term Treasury bills and is conducting small-scale buybacks of old debt to help improve market liquidity. In a worse scenario, the next step would require action by the Federal Reserve. One option would be large-scale purchases of long-term bonds, similar to the “Operation Twist” of 1961. Another would be to directly set an upper limit on long-term yields, something the US has not done since World War II.

This means policymakers are facing a true dilemma: the further down the policy toolbox they go, the more they can suppress interest rates—but the greater the risk of intensifying inflation and further eroding investors’ confidence in US Treasuries.

Jeffrey Gundlach, CEO of DoubleLine Capital, stated at a recent investment event: "We are approaching a point where it is quite apparent that the government is uncomfortable with the current level of interest rates."

Operation Twist

If yields continue to rise, the issue will no longer be just the Treasury’s debt management, but whether the Federal Reserve needs to intervene in the bond market again. Based on historical practice, the first escalation would likely be a full restoration of “Operation Twist.” This 1961 strategy involved selling short-term debt and buying long-term bonds to flatten the yield curve.

In other words, the core of this operation is not simply expanding the money supply, but influencing the long-term bond market directly by adjusting the maturity structure of the Fed’s balance sheet. If long-term yields remain elevated, this may be the first relatively moderate line of defense for policymakers.

However, the problem is that a meaningful “Operation Twist” requires support from the Fed, and unless there is a clear financial emergency, the Fed may be reluctant to engage. Without the balance sheet backing of the Fed, Torsten Slok noted, the Treasury has “limited resources to lower rates.”

More importantly, large-scale Treasury purchases may spark debate over policy boundaries. Former Fed Chair Laurence Meyer criticized the Fed’s substantial holdings of Treasuries and other securities, warning that large-scale bond buying could blur the line between monetary policy and government debt management. He called for a new “Treasury-Fed accord,” with public communication between the Fed Chair and the Treasury Secretary regarding objectives for the Fed’s balance sheet and Treasury issuance. The core question is: as fiscal financing pressure mounts, how much should the Fed help the Treasury stabilize the bond market?

Yield Curve Control

If measures such as “Operation Twist” still prove insufficient, the next step would be explicit yield curve control. In this scenario, the central bank commits to buying unlimited government debt to keep long-term yields below a set cap.

This would be a much stronger policy than “Operation Twist” because the central bank is essentially assuring the market that, no matter how many bonds it must purchase, long-term yields won’t break the set ceiling.

The US isn’t entirely inexperienced with this. From 1942 until the Treasury-Fed Accord of 1951, the Fed set a cap of 2.5% on long-term Treasury yields to help finance World War II and post-war economic recovery. The Bank of Japan also implemented a similar policy from 2016 to 2024.

However, the greatest risk of yield curve control comes from its greatest benefit—lowering financing costs. By artificially suppressing rates, yield curve control relieves political pressure from fiscal deficits. But this policy only works if investors aren’t concerned they’ll ultimately be repaid in dollars devalued by inflation. Should such confidence falter, the bond purchases used to press down rates may instead fuel inflation—the very problem the policy aimed to obscure.

Veronique de Rugy, senior research fellow at the Mercatus Center of George Mason University, stated that ultimately, the only solution to the debt problem is cutting spending. "Congress needs to make fiscal adjustments. In other words, tightening fiscal policy. The Fed cannot do this alone."

In other words, once monetary tools approach their limit, it is still fiscal policy that ultimately decides whether US debt levels can stabilize. The two main declines in US debt ratios in history also demonstrate two divergent paths.

Divergent Paths

John Higgins, chief economic advisor at Capital Economics, observed that since World War II, the US has only significantly reduced debt-to-GDP ratios twice, and bondholders’ fortunes were very different in each period.

After WWII, the US debt-to-GDP ratio fell from about 106% in 1946 to 23% in 1974, while the 10-year Treasury yield rose from 2.2% to 7.5%. In the 1990s, the debt ratio dropped from 48% to 32%, and yields also fell.

What explains this difference? The answer lies in the varying combinations of economic growth, inflation, interest rates, and fiscal discipline.

After WWII, constrained borrowing costs and relatively high inflation allowed nominal economic growth to outpace Treasury yields. This meant that even without extraordinary fiscal discipline, the growth of the economy and price levels helped suppress the debt-to-GDP ratio.

By the 1990s, the situation had changed. Then, interest rates were slightly higher than the economic growth rate, so spending controls and rising tax revenues drove the debt ratio lower. In other words, in that period it was fiscal consolidation rather than inflation that played the decisive role.

Today, the policy paths remain much the same: one path tightens fiscal policy to reduce debt while yields fall; the other relies on financial repression and inflation—improving the debt ratio while tolerating sustained or even rising yields.

The problem is that the fiscal environment today is more complex than in the 1990s. Mandatory spending now makes up a higher proportion of the federal budget, while Congress is reluctant to raise taxes or cut spending. This means if the US is unwilling to use fiscal tightening to solve its debt problem, the remaining policy space will increasingly rely on financial repression, inflation, and administrative interventions on yields. Thus, John Higgins believes, the risk is "tilted" towards the inflationary path, which will hurt bondholders.

Ultimately, the true question the US faces may not be “how to push down Treasury yields,” but how to restore debt to a sustainable path without sacrificing fiscal credibility or reigniting inflation. Otherwise, the more policy tools available to the Treasury or the Fed, the higher the long-term costs may be.