US Treasury yields are approaching a 20-year high! The US debt dilemma enters the “danger zone” What other tricks does Washington have?

The Zhitong Finance App learned that the yield on US long-term treasury bonds is close to the highest level in 20 years, and the reason driving the yield higher does not seem to be temporary. Washington is issuing large amounts of debt to cover the unabated fiscal deficit. Inflation is also slowly cooling down. Furthermore, the boom in artificial intelligence (AI) investment has kept the economy strong enough to make it difficult to lower interest rates.

As a result, with more than $40 trillion in debt, the US government spends about $1 trillion in interest each year. Torsten Slok, chief economist at Apollo Global Management, said that for every $5 in tax revenue the government receives, $1 is used to repay interest on treasury bonds. “This is a very, very high figure, and this figure will continue to rise.”

The US government's borrowing costs are rising, and there are few easy ways to curb borrowing costs. US President Trump said in an interview on September 28 that the US can repay its debts, including through economic growth or inflation. And if economic growth and inflation don't solve the problem, the US Treasury still has a range of policy options, from moderate to aggressive, from relying more on short-term borrowing, to having the Federal Reserve limit long-term yields in extreme cases.

Currently, the Ministry of Finance has relied more on issuing short-term treasury notes and is buying back old bonds on a small scale to help improve market liquidity. In a worse scenario, the next step would require action from the Federal Reserve. One way is to buy long-term bonds on a large scale, similar to the 1961 “Operation Twist” (Operation Twist). Another approach is to directly cap long-term returns, and the US has not adopted this practice since World War II.

This means that policymakers actually face a dilemma: the further down in this list of policy instruments, the more they can lower interest rates, but at the same time, the more likely they are to increase inflation and further weaken investors' confidence in US Treasury bonds.

Jeffrey Gundlach, CEO of “Dual Tier Capital,” said at a recent investment event: “We are nearing a point where it is quite obvious that the government is uneasy about current interest rates.”

Torsion operation

If yields continue to rise, the question is not just how the Treasury manages debt, but whether the Federal Reserve needs to re-enter the bond market. Based on measures taken in the past, the first step of the upgrade is likely to be a full resumption of “reverse operation.” This strategy in 1961 was to sell short-term debt and buy long-term bonds to flatten the yield curve.

In other words, the core of this operation is not simply to expand the money supply, but to directly influence the long-term bond market by adjusting the term structure of the Federal Reserve's balance sheet. If long-term yields remain high, this may be a relatively moderate first line of defense for policy makers.

The problem, however, is that a meaningful “reversal operation” requires the help of the Federal Reserve, which may be reserved unless there is a clear financial emergency. Without balance sheet support from the Federal Reserve, Torsten Slok said the Treasury “has limited resources to lower interest rates.”

More importantly, large-scale purchases of treasury bonds themselves may also trigger controversy over policy boundaries. Federal Reserve Chairman Walsh has criticized the Federal Reserve for holding large amounts of US Treasury bonds and other securities, believing that large-scale bond purchases may blur the line between monetary policy and government debt management. He called for a new “Treasury - Federal Reserve Agreement” where the Chairman of the Federal Reserve and the Treasury Secretary will publicly communicate the goals of the Federal Reserve's balance sheet and Treasury debt issuance. The core question behind this is: To what extent should the Federal Reserve help the Treasury stabilize the bond market when fiscal financing pressure is increasing?

Yield curve control

If purchasing measures such as “reversal operations” are still insufficient, the next step will be to clearly implement yield curve control. Under these circumstances, the central bank promises to buy an unlimited amount of government debt to keep long-term yields below a set limit.

This would be a far stronger policy than “reversing operations,” because the central bank is actually promising the market that no matter how many bonds it needs to buy, it will ensure that long-term yields do not break through the set upper limit.

The US is not without similar experience. From 1942 to 1951, when the Treasury-Fed Accord (Treasury-Fed Accord) was reached, the Federal Reserve set a 2.5% yield cap on long-term US Treasury bonds to help finance World War II and post-war economic recovery. The Bank of Japan implemented a similar policy from 2016 to 2024.

However, the greatest risk in controlling the yield curve comes precisely from its greatest advantage — reducing financing costs. By artificially lowering interest rates, yield curve control can ease the political pressure brought about by fiscal deficits. But this policy only works if investors don't worry that they will end up being paid in dollars diluted by inflation. Once this confidence is fractured, bond purchases used to lower interest rates may instead drive up inflation, and this is exactly what this policy was trying to cover up.

Veronique de Rugy, a senior researcher at the Mercatus Center at George Mason University, said that in the end, the only solution to the debt problem is to cut spending, “Congress needs to make fiscal adjustments. In other words, implementing austerity policies. The Federal Reserve cannot do this alone”.

In other words, when monetary policy instruments gradually reach their limits, what actually determines whether the US debt situation can be stabilized is ultimately still fiscal policy. And the two declines in the US's debt ratio in history also show two very different paths.

The path of differentiation

John Higgins, chief economic adviser at Capital Economics, said that since World War II, the US has only actually drastically reduced its debt-to-GDP ratio on two occasions, and the situation of bondholders during these two periods was quite different.

After the end of World War II, the ratio of US debt to GDP fell from about 106% in 1946 to 23% in 1974, while the yield on 10-year Treasury bonds rose from 2.2% to 7.5% during the same period. In the 1990s, America's debt as a share of GDP fell from 48% to 32%, and yields fell accordingly.

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

After World War II, limited borrowing costs and relatively high inflation made the nominal economic growth rate higher than the yield on US Treasury bonds. This means that even if fiscal policy does not show particularly strong discipline, economic and price growth can help reduce debt as a share of GDP.

By the 1990s, things changed. Interest rates were slightly higher than the economic growth rate at the time, so spending control and increased tax revenue were the main forces driving the debt ratio down. In other words, what really works this time is fiscal consolidation, not inflation.

Today's policy path still follows roughly the same two paths: one is to reduce debt through fiscal austerity, which is accompanied by a decline in yield; the other is to rely on financial suppression and inflation to tolerate the maintenance or even rise in yield while debt ratios improve.

The problem is that today's fiscal environment is more complex than it was in the 1990s. Today, mandatory spending accounts for a larger share of the federal budget than in the 1990's, and Congress wants neither to raise taxes nor cut spending. This means that if the US is unwilling to resolve its debt problem through fiscal austerity, the remaining policy space is likely to rely more and more on financial depression, inflation, and administrative intervention in yield. Thus, according to John Higgins, the risk “tends” towards an inflationary path, which would hurt the interests of bondholders.

Ultimately, what the US really needs to face is probably not the “how to reduce treasury yield” problem, but rather how to put debt back on a sustainable path without sacrificing fiscal credibility or reigniting inflation. Otherwise, whether it is the Treasury Department or the Federal Reserve, the more policy tools they can use, the higher the long-term costs may be.