US Treasury yields approach 20-year highs! America's debt dilemma enters the "danger zone." What options does Washington still have?

US long-term Treasury yields are approaching their highest levels in 20 years, and the drivers pushing yields higher do not appear to be temporary. Washington is issuing debt heavily to fill a fiscal deficit that has not shrunk. Inflation is also cooling only slowly. In addition, the artificial intelligence (AI) investment boom is keeping the economy strong enough that interest rates are difficult to cut. The result is that, with more than $40 trillion in debt, the US government's annual interest expense is about $1 trillion. Torsten Slok, chief economist at Apollo Global Management, said that for every $5 of tax revenue the government receives, $1 goes to paying interest on Treasury debt. "That is a very, very high number, and it will continue to rise." The US government's borrowing costs are rising, and there are few easy options left to contain them. US President Trump said in an interview on September 28 that the United States can repay its debt, including through economic growth or inflation. And if economic growth CKH HOLDINGS inflation cannot 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, in extreme cases, having the Federal Reserve cap long-term yields. At present, the Treasury has already become more reliant on short-term Treasury bill issuance and has conducted small-scale buybacks of old debt to help improve market liquidity. In a worse scenario, the next step would require the Fed to act. One way would be large-scale purchases of long-term bonds, similar to the 1961 "Operation Twist." Another would be directly setting a ceiling on long-term yields, something the United States has not done since World War II. This means policymakers are effectively facing a dilemma: the further down this list of policy tools they go, the more they can push down interest rates, but the more likely they are to stoke inflation and further weaken investors' confidence in US Treasuries. Jeffrey Gundlach, chief executive of DoubleLine Capital, said at a recent investment event: "We are approaching the point where it is quite clear that the government is uncomfortable with the current level of interest rates." Operation Twist If yields continue to climb, the question is no longer just how the Treasury manages its debt, but whether the Fed needs to re-enter the bond market. Based on measures taken in the past, the first escalation would likely be a full revival of "Operation Twist." The 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 directly influencing the long-term bond market by adjusting the maturity structure of the Fed's balance sheet. If long-term yields remain persistently high, this may be policymakers' relatively moderate first line of defense. But the problem is that a meaningful "Operation Twist" would require help from the Fed, and unless there is a clear financial emergency, the Fed may hold back. Without the Fed's balance sheet support, Torsten Slok said, the Treasury has "limited resources to lower interest rates." More importantly, large-scale purchases of Treasuries could themselves spark controversy over policy boundaries. Fed Chair Warsh has criticized the Fed's large holdings of US Treasuries and other securities, arguing that large-scale bond purchases could blur the line between monetary policy and government debt management. He has called for a new "Treasury-Fed agreement," in which the Fed chair and the Treasury secretary publicly communicate about the Fed's balance sheet and the Treasury's debt issuance objectives. The core question behind this is: as fiscal financing pressure grows, to what extent should the Fed help the Treasury stabilize the bond market? Yield curve control If purchases similar to "Operation Twist" are still not enough, the next step would be explicit yield curve control. In that case, the central bank commits to unlimited purchases of government debt to keep long-term yields below a set ceiling. This would be a far more powerful policy than "Operation Twist," because the central bank is effectively promising the market that no matter how many bonds it must buy, it will ensure long-term yields do not break above the set ceiling. The United States is not without similar experience. From 1942 until the Treasury-Fed Accord in 1951, the Fed set a ceiling of 2.5% on long-term US Treasury yields to help finance World War II and the postwar economic recovery. The Bank of Japan implemented a similar policy from 2016 to 2024. However, the biggest risk of yield curve control comes precisely from its greatest advantage: suppressing financing costs. By artificially holding down interest rates, yield curve control can ease the political pressure created by fiscal deficits. But such a policy can only work if investors are not worried that they will ultimately be repaid in dollars diluted by inflation. Once that confidence cracks, bond purchases used to suppress interest rates may instead push inflation higher, which is exactly the problem the policy was originally trying to mask. Veronique de Rugy, a senior research fellow at George Mason University's Mercatus Center, said that in the end, the only way to solve the debt problem is to cut spending. "Congress needs to make a fiscal adjustment. In other words, implement austerity. The Fed cannot do this alone." That is, once monetary policy tools gradually reach their limits, what ultimately determines whether the US debt situation can stabilize is still fiscal policy. And the two periods in US history when the debt ratio fell happen to show two very different paths. Divergent paths John Higgins, chief economic adviser at Capital Economics, said that since World War II, the United States has only twice truly significantly reduced its debt-to-GDP ratio, and bondholders fared very differently in those two periods. After World War II, 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% over the same period. In the 1990s, the US debt-to-GDP ratio fell from 48% to 32%, and yields fell as well. What caused this difference? The answer lies in different combinations of economic growth, inflation, interest rates, and fiscal discipline. After World War II, constrained borrowing costs and relatively high inflation made nominal economic growth higher than US Treasury yields. This meant that even if fiscal policy did not show particularly strong discipline, growth in the economy and price level could help push down the debt-to-GDP ratio. By the 1990s, the situation had changed. At that time, interest rates were slightly higher than economic growth, so spending controls and increased tax revenue became the main forces driving the debt ratio lower. In other words, this time what really worked was fiscal consolidation, not inflation. Today's policy path still broadly follows the same two roads: one is reducing debt through fiscal austerity, accompanied by falling yields; the other is relying on financial repression and inflation, tolerating yields staying flat or even rising while the debt ratio improves. The problem is that, compared with the 1990s, today's fiscal environment is more complex. Mandatory spending now accounts for a larger share of the federal budget than in the 1990s, and Congress neither wants to raise taxes nor cut spending. This means that if the United States is unwilling to solve its debt problem through fiscal austerity, the remaining policy space may increasingly rely on financial repression, inflation, and administrative intervention in yields. Therefore, John Higgins believes the risk is "tilted" toward the inflation path, which would harm bondholders. In the end, what the United States really needs to face may not be the question of "how to push Treasury yields down," but how to put debt back on a sustainable path without sacrificing fiscal credibility and without reigniting inflation. Otherwise, whether it is the Treasury or the Fed, the more policy tools they can use, the higher the long-term cost may be.