U.S. Faces Rising Debt Costs as Treasury Yields Surge to Two-Decade Highs

The U.S. government is facing rising borrowing costs as long-term Treasury yields near their highest levels in two decades. The surge in yields is driven by massive debt issuance to cover growing deficits, persistent inflation, and an AI-driven economic boom that keeps interest rates elevated despite struggles in sectors like housing and autos. This has led to an annual interest bill of about US$1 trillion on a debt exceeding US$40 trillion, with servicing the debt consuming one-fifth of tax revenue.

Washington has several options to manage the situation, ranging from mild to extreme. The Treasury is already increasing short-term borrowing and making small buybacks of older debt. More drastic measures could involve the Federal Reserve reviving Operation Twist, a 1961 strategy of selling short-term debt to buy long-term bonds, or implementing yield curve control, where the Fed caps long-term yields. However, these actions risk stoking inflation and could lead to more pain for bondholders.

Jeffrey Gundlach of DoubleLine Capital noted that the government is becoming increasingly uncomfortable with high rates. While Operation Twist 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. Yield curve control, last used during World War II, could artificially lower rates but risks fueling inflation if investors lose confidence.

Experts argue that the only long-term solution is fiscal adjustment. Veronique de Rugy of the Mercatus Center emphasized the need for Congress to cut spending. Historically, the U.S. has reduced its debt-to-GDP ratio only twice since World War II, with bondholders experiencing vastly different outcomes each time. Today, the path forward is likely to involve either austerity with falling yields or inflationary policies that hurt bondholders.