The US government is bearing increasing borrowing costs, while having fewer easy options to reduce these costs.
Long-term US Treasury bond yields are approaching their highest levels in two decades, and the reasons for this rise do not appear to be temporary. Washington is selling huge amounts of debt to finance deficits that are not declining, while the decline in inflation slows. The boom in investment in artificial intelligence also keeps the economy strong enough to prevent interest rates from falling, despite the suffering of the housing and auto sectors, according to Reuters.
The result is an interest bill of about $1 trillion annually on debt exceeding $40 trillion.
Washington has tools to limit the rise in borrowing costs, starting with increased reliance on short-term borrowing, and in extreme cases reaching the Federal Reserve to intervene to put a ceiling on long-term bond yields. But the more policymakers use these tools, the greater the risk of stoking inflation; Which could mean more losses for bond holders.
Torsten Slok, chief economist at Apollo Global Management, said that the government spends one dollar on servicing the national debt for every five dollars it receives in tax revenue. He added: “This is a very high number, and it will continue to rise.”
US President Donald Trump said in an interview with Time magazine on September 28 that the debt can be repaid through growth or inflation, among other means.
But if those options don't work, the Treasury has other tools that range from limited measures to more radical interventions. It already relies more on issuing short-term treasury bills, and also conducts limited repurchases of existing bonds in order to enhance liquidity in the market.
In a worse scenario, the next steps will require intervention from the Federal Reserve. One option is to buy large amounts of long-term bonds, similar to Operation Twist in 1961. The other option is to impose a direct ceiling on long-term bond yields, a measure that the United States has not resorted to since World War II. The further up the list policymakers move, the more they can keep interest rates low, but at the cost of increasing the risk of inflation worsening.
“We are approaching the point where it has become quite clear that the government is becoming uncomfortable with the level of interest rates,” Jeffrey Gundlach, CEO of DoubleLine Capital, said during a recent investment event.
Based on procedures tested previously, the first step in escalation is likely to be a full revival of Operation Twist. This was a strategy followed in 1961, which consisted of selling short-term debt and buying long-term bonds with the aim of flattening the yield curve.
Executing an effective “twist” would require help from the Federal Reserve, which may be reluctant to intervene unless there is a clear financial emergency. Slouk said the Treasury Department “has limited resources to lower interest rates” without using the Federal Reserve’s balance sheet.
But Federal Reserve Chairman Kevin Warsh criticized the central bank's large holdings of Treasury bonds and other securities, warning that large-scale bond purchases could blur the lines between monetary policy and government debt management.
Warsh called for a new agreement between the Treasury and the Federal Reserve, under which the Chairman of the Federal Reserve Board and the Secretary of the Treasury would publicly announce the goals of the central bank’s balance sheet and Treasury issuances.
If Twist-style purchases do not produce the desired results, the next step would be to impose outright yield curve control. In this case, the central bank pledges to buy unlimited amounts of government debt to keep long-term bond yields below a specified ceiling.
The Federal Reserve had imposed a cap on long-term Treasury bond yields at 2.5 percent to help finance World War II and support the post-war recovery, from 1942 until the Treasury and the Federal Reserve agreement in 1951. The Bank of Japan also implemented a version of this policy between 2016 and 2024.
By keeping interest rates artificially low, yield curve control mitigates the political cost of deficits, but its success depends on investors not being afraid to redeem dollars that have lost part of their value due to inflation. Once this confidence is shaken, purchases aimed at lowering yields may become a factor that fuels the inflation they were intended to hide.
Veronique de Rugy, a senior researcher at the Mercatus Center at George Mason University, said that ultimately cutting spending is the only way to address the debt problem. “Congress must implement fiscal adjustment, austerity, in other words,” she added. “The Federal Reserve cannot do this alone.”
The United States has reduced its debt-to-GDP ratio meaningfully only twice since World War II, and the situations for bondholders have been very different each time, says John Higgins, chief economic adviser at Capital Economics.
After the war, the debt ratio fell from about 106 percent of GDP in 1946 to 23 percent by 1974, while the 10-year bond yield rose from 2.2 percent to 7.5 percent. In the 1990s, the debt ratio fell from 48 percent to 32 percent of GDP, and returns declined at the same time.
What made this difference?
After the war, capped borrowing costs and relatively high inflation contributed to higher nominal growth than Treasury yields; This led to a reduction in the debt ratio without the need for a great deal of financial discipline. In the 1990s, interest rates were slightly higher than the growth rate. Therefore, controlling spending and increasing revenues took over the task of reducing debt.
The options presented today follow the same two paths: austerity with declining returns, or financial repression and inflation, where returns rise even as the debt-to-GDP ratio improves.
Mandatory expenditures now constitute a larger share of the budget than in the 1990s, and Congress does not want to increase taxes or reduce spending. Therefore; Higgins argues that the risks are “skewed towards” an inflationary path that hurts bondholders.
European Union Trade Commissioner Maroš Šefčović heads to Beijing on Thursday for two days of talks with Chinese officials; In an attempt to avoid escalating the disputes into a trade war, Brussels is toughing it out in the face of what it sees as unfair competition that threatens vital European industrial sectors.
The negotiations come after months of talks that began last June, amid growing European warnings of a “China Shock 2.0,” referring to Chinese companies moving from exporting low-cost products to competing with Europe in advanced industries. Including cars, machinery, chemicals and technology.
Brussels seeks to achieve three main goals: The most prominent of which is limiting the significant increase in Chinese exports to the European market, especially in strategic sectors, and increasing European companies’ exports to China, in addition to reaching a more stable system for export licenses for rare earth metals and other vital products.
The trade deficit is a main focus of the dispute, as the European Union's trade deficit with China reached about 360 billion euros during 2025. Brussels says that machinery, textiles, basic metals and chemicals are among the sectors that are witnessing "continuous and abnormal" increases in imports.
European Union trade official Denis Redonnet said that worrying trends are currently emerging in about a quarter of the bloc's imports, driven largely by Chinese goods.
Europe favors voluntary arrangements to manage Chinese exports, including hybrid cars, with the possibility of expanding them to other products. But Beijing announced its strong opposition to the import quota system.
Expectations do not appear high regarding achieving a comprehensive breakthrough during the meetings.
Experts suggest the possibility of reaching understandings on specific files, rather than a broad settlement of trade relations.
At the same time, Brussels is preparing for the possibility of negotiation failure by developing new tools to protect European industry; Among them is a trade mechanism similar to the American “Section 301”, which allows investigation of trade practices considered discriminatory and taking countermeasures.
China warned that it would respond “firmly” to any discriminatory restrictive European measures. Beijing has previously responded to the European Union's moves by imposing duties on European cognac and conducting anti-dumping investigations into pork and dairy products. Brussels is also working on a mechanism to finance European companies. With the aim of diversifying its suppliers into vital sectors, and reducing dependence on China.
The extent of escalation that the European Union can bear remains a matter of internal disagreement, especially with Germany's caution due to its extensive trade relations with China. However, Berlin's position has become more stringent with the mounting fears of the impact of China's surplus production capacity on its export-dependent economy. Thus, the Beijing meetings represent a test of the ability of the two sides to make specific concessions before Brussels moves from the negotiation stage to strengthening trade protection measures, a path that may open the door to Chinese responses and increase the risks of the outbreak of a broader trade confrontation between the two largest global trade poles.
