US Debt Crisis Sparks Debate on Radical Bond Market Interventions

The rising cost of US debt is pushing Washington to consider risky bond-market interventions as borrowing expenses soar. Currently, one in every five tax dollars collected goes toward interest payments, with the US spending about $1 trillion annually to service its $40 trillion debt. Yields on long-term US bonds have reached their highest level in two decades, driven by persistent budget deficits, gradual inflation slowdowns, and economic support from the AI investment boom.

Policymakers are debating various tools to manage the debt burden, ranging from modest steps to large-scale Federal Reserve interventions. The US Treasury is already increasing short-term Treasury bill issuance and conducting small bond buybacks. More radical measures, such as large-scale purchases of long-term bonds or setting yield ceilings, could lower interest rates but risk fueling inflation and causing losses for bondholders.

One potential intervention is reviving 'Operation Twist,' a strategy used in 1961 to narrow yield gaps between short- and long-term bonds. However, such a program would likely require Federal Reserve involvement. Critics like Kevin Warsh argue that large-scale bond purchases could blur the lines between monetary policy and debt management, suggesting a new coordination agreement between the Treasury and the Fed.

If yield curve control becomes necessary, the central bank could pledge unlimited bond purchases to cap yields, similar to post-WWII policies or Japan's approach from 2016 to 2024. While this could ease political pressure from deficits, it relies on investor confidence in repayment value. Experts like Veronique de Rugy emphasize that long-term solutions require spending cuts, as the Fed cannot address the debt problem alone.

The US has historically reduced its debt-to-GDP ratio through either spending cuts and revenue increases or financial repression with inflation. Today, the risks favor an inflationary scenario, given Congress's reluctance to cut spending or raise taxes. As yields rise, Washington faces a choice between unpopular austerity measures or interventions that could temporarily contain rates but increase inflation risks.