What the US can do to control rising yields

US 10-YEAR Treasury yields reached 4.7 per cent in May. Despite retreating to 4.4 to 4.5 per cent in June, the costs to service the now-US$39 trillion debt amid persistently large deficits continue to build.

Indeed, at 103 per cent of gross domestic product, US public debt as a share of the overall economy sits at its highest level since the war-fuelled debt accumulation in 1945.

Importantly, yields are beginning to consistently exceed consensus forecasts for US nominal GDP growth in 2027 of 4.4 per cent. Currently, the US five-year Treasury yield of 4.2 per cent is closing in on this target as well.

Recall that continental Europe faced a similar challenge in 2011. Sovereign funding costs exceeded nominal growth in heavily leveraged economies, necessitating forceful efforts to push the yields below nominal growth during the euro area sovereign crisis.

The US has faced a comparable challenge in its own history, when debt as a share of GDP last stood near current levels in the post-World War II era.

A 2023 paper by Julien Acalin and Laurence Ball highlighted that financial repression, similar to measures later employed by the European Central Bank, played a key role, alongside rapid economic growth and a primary budget surplus, in allowing the US to de-lever after the war.

Financial repression

With the US primary budget deficit forecast to remain at nearly 2 to 3 per cent of GDP through 2030, a strategy of financial repression combined with strong economic growth will likely need to be relied on more heavily to stabilise debt dynamics.

US President Donald Trump’s “Big Beautiful Bill” of 2025 appears to be delivering strong nominal growth in 2026. However, the recent rise in bond yields is challenging US financial repression efforts once again.

When benchmark 10-year yields approached 5 per cent in 2025, the Federal Reserve began deploying measures to more subtly intervene in bond markets and contain borrowing costs.

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This began with the August 2025 restart of the rate-cutting cycle and the end of quantitative tightening, a change in supplementary leverage ratio (SLR) regulations, and by December 2025, in a reprise of the 2019 “not QE (quantitative easing)” approach, outright purchases of short-dated Treasury bills.

However, the traditional American toolkit to contain rising yields appears more constrained. Elevated inflation amid the war with Iran and a strengthening renminbi are adding inflationary pressures to the US economy.

As a result, it is unclear that an additional rate-cutting cycle could be deployed imminently should yields rise again and threaten to outpace nominal growth into 2027.

Moreover, with Trump nominees occupying only three of the seven US Federal Reserve Board seats, and with only two of the five voting Reserve Bank presidents favouring an easing bias at the April Federal Open Market Committee meeting, a pivot from Fed purchases of short-dated bills to outright purchases of long-dated notes and bonds – that is, QE – appears unlikely absent a more acute crisis, as seen in the UK in 2022.

Thus, a new chapter in the policy experimentation playbook may need to be written – or, more accurately, resurrected – to maintain financial repression momentum.

Fed and Treasury partnership

Investors will recall that in both World Wars, the Fed and the US Treasury coordinated actively to ensure funding sustainability, as documented in central bank’s archives.

During World War II, commercial banks were enlisted to increase Treasury purchases, raising their holdings 24-fold. Yet, with Trump nominees lacking a majority on the Board of Governors, the Fed’s ability to further liberalise SLR regulations (as proposed by Trump nominated governor Michelle Bowman) – that might encourage greater bank purchases of Treasuries – appears constrained for now.

Given that the Fed is unlikely to reprise its wartime role as buyer of last resort, new areas of cooperation between the Fed and the Treasury may be needed to achieve similar outcomes.

One option would be for the Fed to continue and scale up its purchases of short-dated Treasury bills (T-bills) while anchoring policy rates near the inflation rate, effectively controlling short-dated funding costs.

While roughly 20 per cent of total US government debt outstanding consists of T-bills, in 2025 an estimated 84 per cent of net new issuance by the Treasury was in T-bills maturing within 12 months.

However, such an expanded policy could push long-dated yields sharply higher. Indeed, this dynamic was evident in Japan. As the Bank of Japan anchored short-term yields post-pandemic, while unwinding yield curve control, Japanese 10-year yields rose about 275 basis points from 2021.

Additional areas of cooperation may therefore be needed to contain long-dated yields. The Fed currently holds roughly US$2 trillion in mortgage backed securities (MBS), a legacy of post-2007-to-2008 market stabilisation efforts.

The Fed could seek to swop some MBS holdings for long-dated Treasuries via Fannie Mae and Freddie Mac, which remain under Federal Housing Finance Agency conservatorship with Treasury support.

This could provide operational benefits and, by increasing the share of long-duration Treasuries on the Fed’s balance sheet, offer greater flexibility in maturity management and coupon reinvestment to moderate long-end yield fluctuations.

Moreover, Michael Green, chief strategist at Simplify Asset Management, has proposed a sovereign debt optimisation facility allowing banks to voluntarily exchange old, low-priced long-dated Treasuries for current-coupon long-dated Treasuries. This would meaningfully expand upon the Treasury’s buyback programme that began in May 2024.

By scaling up the buyback programme, a Fed-Treasury partnership could effectively replicate Operation Twist, used to lower long-term borrowing costs in 1961 and briefly in 2011.

The key hurdle to deeper Fed-Treasury cooperation is that regulatory, administrative and potentially legislative changes would be required before implementation. Unlike the incremental tools deployed to proactively contain yields in 2025, these measures would entail longer lead times, reducing policymakers’ ability to quickly restrain renewed upward pressure on US debt service costs.

These constraints suggest that periodic spikes in bond volatility will likely remain a feature of the landscape.

As seen recently in the UK and Japan, policy responses may become increasingly reactive to bouts of volatility and market dysfunction, with an emphasis not on reversing rising yield trends, but on restoring market function and smoothing volatility as markets seek a new equilibrium amid worsening global debt and deficits.

For investors, this backdrop argues for prioritising credit risk over interest rate risk in generating bond returns.

Within fixed income, shifting away from the US dollar curve and towards select emerging market local currency curves may offer alternative, comparatively less correlated return drivers as the US seeks to stabilise its debt service profile.

The writer is group chief strategist at Union Bancaire Privee