Long-term US Treasury yields are hovering close to their highest levels in two decades, and the forces driving them higher do not appear to be temporary.

Washington is issuing enormous amounts of debt to cover a fiscal deficit that has not been shrinking, inflation is cooling only slowly, and an artificial intelligence (AI) investment boom is keeping the economy strong enough that interest rates are hard to bring down.

As a result, with more than $40 trillion in total debt, the US government is paying roughly $1 trillion a year in interest expenses.

Torsten Slok, chief economist at Apollo Global Management, noted that for every $5 in tax revenue the government collects, $1 goes toward servicing Treasury debt, calling it "a very, very high number" that will keep climbing.

The US government's borrowing costs are rising, and the easy options for containing them have nearly run out. President Donald Trump said in a September 28 interview that the US can repay its debt through means including economic growth or inflation.

If growth and inflation cannot solve the problem, the Treasury still has a range of policy options running from mild to aggressive, from relying more on short-term borrowing to, in extreme cases, having the Federal Reserve cap long-term yields.

Already, the Treasury has leaned more heavily on short-term 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 approach would be large-scale purchases of long-term bonds, similar to the 1961 "Operation Twist." Another would be directly setting a cap on long-term yields, something the US has not done since World War II.

This means policymakers effectively face a dilemma: the further down this list of policy tools they go, the more they can push down interest rates, but the more they risk stoking inflation and further undermining investor confidence in US Treasuries.

Jeffrey Gundlach, CEO of DoubleLine Capital, said at a recent investment event: "We are approaching the point where it is quite obvious that the government is uncomfortable with the current level of interest rates."

Operation Twist

If yields keep climbing, 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 past measures, 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 such an 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 the relatively mild first line of defense for policymakers. 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 government debt could themselves spark debate over policy boundaries. Fed Chair Warsh has criticized the Fed's large holdings of US Treasuries and other securities, arguing that massive bond buying 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 openly communicate about the Fed's balance sheet and the Treasury's debt issuance objectives.

The core question behind this is: when fiscal financing pressure grows, to what extent should the Fed help the Treasury stabilize the bond market?

Yield Curve Control

If purchases akin to "Operation Twist" still prove insufficient, the next step would be explicitly implementing yield curve control.

In that case, the central bank would commit to buying government debt without limit to keep long-term yields below a set ceiling. This would be a far more forceful policy than "Operation Twist," because the central bank would effectively promise the market that no matter how many bonds it must buy, it will ensure long-term yields do not break above the ceiling.

The US is not without similar experience. From 1942 until the 1951 Treasury-Fed Accord, the Fed capped long-term US Treasury yields at 2.5% to help finance World War II and the postwar recovery. The Bank of Japan implemented a similar policy from 2016 to 2024.

However, the biggest risk of yield curve control stems precisely from its biggest advantage—pushing down financing costs.

By artificially suppressing interest rates, yield curve control can ease the political pressure from fiscal deficits. But such a policy only works as long as investors are not worried that they will ultimately be repaid in dollars diluted by inflation.

Once that confidence cracks, bond purchases meant to push down rates could instead drive up inflation—precisely 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 ultimately 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 it 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 episodes in US history when debt ratios fell happen to show two very different paths.

Diverging Paths

John Higgins, chief economic adviser at Capital Economics, said that since World War II, the US has only twice truly reduced its debt-to-GDP ratio substantially, 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 declined as well.

What caused the 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 pushed nominal economic growth above US Treasury yields. That meant that even without particularly strong fiscal discipline, growth in the economy and price levels helped reduce the debt-to-GDP ratio.

By the 1990s, the situation had changed. Interest rates were slightly above the economic growth rate, so spending controls and higher tax revenue became the main forces driving the debt ratio down. In other words, this time what truly worked was fiscal consolidation, not inflation.

Today's policy path is still broadly unfolding along 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 wants neither to raise taxes nor to cut spending.

This means that if the US is unwilling to solve its debt problem through fiscal austerity, the remaining policy space may increasingly depend 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 US truly 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.