Rising US Debt Costs Spark Concerns Over Policy Options

The US government is facing rising borrowing costs as long-term Treasury yields approach two-decade highs, driven by persistent inflation and strong economic growth fueled by an AI investment boom. With deficits showing no signs of shrinking, the government is selling massive amounts of debt, pushing the annual interest bill to about $1 trillion on over $40 trillion in debt. For every $5 in tax revenue, $1 goes toward servicing this debt, a ratio that is expected to worsen.

Washington has several options to counter rising yields, ranging from mild to extreme. The Treasury is already relying more on short-term borrowing and making small buybacks of older debt to improve market liquidity. More drastic measures could involve the Federal Reserve buying long-term bonds on a large scale, similar to the 1961 Operation Twist, or even capping long-term yields outright, a tactic not used since World War II. However, these measures risk stoking inflation, which could lead to more pain for bondholders.

Jeffrey Gundlach, CEO of DoubleLine Capital, noted that the government is growing uncomfortable with current rate levels. Operation Twist, which involved selling short-term debt and buying long-term bonds, would require Federal Reserve cooperation. Fed Chairman Kevin Warsh has criticized large-scale bond-buying, suggesting a new accord between the Treasury and the Fed to clarify objectives for bond issuance and the Fed’s balance sheet.

If Operation Twist falls short, explicit yield curve control, where the Fed promises to buy unlimited debt to keep long-term yields below a set ceiling, could be the next step. While this would ease political pressure from deficits, it risks fueling inflation if investors lose confidence. Ultimately, cutting spending is the only way to fix the debt problem, according to Veronique de Rugy of the Mercatus Center. The US has only significantly cut its debt-to-GDP ratio twice since World War II, with bondholders faring differently each time due to varying economic conditions.