What is the U.S. government most afraid of right now? A continued rise in long-end Treasury yields, represented by the 10-year note.
Over the past decade or so, the U.S. market has assumed that a normal interest rate range was roughly 0%–2%. A yield above 3% on the 10-year Treasury was considered high, and anything above 5% was nearly indicative of a crisis.
But now, an increasing number of people are beginning to question whether the U.S. economy may have entered an era of 'high nominal growth and high interest rates,' with the long-term neutral rate shifting from 2% to 4%.
Why? Because the U.S. is currently experiencing several factors rarely seen together in the past: sustained fiscal expansion, a surge in AI-related capital expenditures, manufacturing reshoring, increased energy investment, tight labor markets, and deglobalization…
In particular, the super-cycle of AI-driven capital spending—encompassing data centers, power infrastructure, and other related investments—requires massive capital demand, which pushes up real interest rates.
Thus, the current situation in the U.S. is one where the government and AI companies are competing for borrowed funds, making it difficult for interest rates to fall.
While many worry about an AI-related debt bubble, Trump and Bessent are more immediately focused on the U.S. government’s own borrowing costs. U.S. public finances are entering a dangerous state: interest payments on new debt are rising sharply, maturing debt is being continually rolled over at higher rates, interest expenses now exceed military spending, and the fiscal deficit is widening further.
Do Trump and Bessent have any means to control bond yields?
Theoretically, there are six options—but each comes with significant side effects.
Option one: Force the Federal Reserve to cut interest rates.
This is Trump’s preferred approach. He has consistently pressured Powell publicly.
However, the issue is that the Federal Reserve is currently focused on inflation and preparing to raise rates, while Iran has targeted oil prices—a key vulnerability for Trump—making a rate cut highly unlikely.
Although Wallsh advocates for rate cuts—and this is likely why he was chosen—decisions require a vote by the Federal Open Market Committee (FOMC). Among the 12 voting members, several favor rate hikes.
Of course, in practice, the Fed Chair wields immense influence; historically, there has never been a case of an outright override. The Chair controls the agenda-setting power (e.g., whether to cut rates and by how much), communicates with committee members in advance to build consensus before the vote to avoid public discord, and shapes market expectations through press conferences. Finally, in the event of a 6–6 tie, the FOMC Chair casts the deciding vote.
Thus, it’s not impossible—but the side effects would be too severe.
Option two: Allow the Federal Reserve to raise interest rates
Yes, you read that correctly: both rate cuts and rate hikes can suppress long-term bond yields—they just operate through different mechanisms.
Rate cuts lower short-end rates, pulling down the entire interest rate curve, which typically causes long-term bond yields to decline as well—this is how rate cuts suppress U.S. Treasury yields.
But raising rates is actually the more fundamental solution.
Long-term interest rates are fundamentally determined by expectations for economic growth and inflation. If the economy clearly cools, long-term bond yields will fall—as has been the case in China over the past decade or so, where long-term bond yields have been on a steady downward trend.
How can the economy be cooled down? Either tighten fiscal policy or raise interest rates.
When interest rates were raised in 2023, the yield curve inverted—short-term yields exceeded long-term yields—and this inversion persisted for two years. Raising rates under such conditions risks triggering an economic collapse, as short-term rates rise while long-term rates relatively decline.
Before 2010, China’s economy frequently overheated, pushing interest rates higher. The so-called 'rectification and readjustment' policies at the time essentially involved raising interest rates to curb economic growth.
Therefore, the essence of 'raising rates to suppress long-term bond yields' is actually to engineer a recession, which would naturally drive down long-term bond yields.
However, the side effects of this approach could be even more severe than rate hikes themselves, especially since the U.S. is still implementing fiscal stimulus. Pursuing both fiscal stimulus and lower long-term bond yields simultaneously entails inherently contradictory policy objectives.
The third option: active yield curve management by the Treasury Department
This is precisely what Bessent is currently doing: when issuing debt, the U.S. Treasury adjusts its issuance structure—issuing fewer long-term Treasuries and more short-term bills—to alleviate supply pressure on long-term bonds. Much of the recent surge in long-term bond yields stems from excessive supply.
But the problem is that short-term debt isn’t a free lunch—it matures quickly and requires continuous rollover financing.
Thus, substituting short-term financing for long-term financing is somewhat akin to 'paying off one credit card with another,' carrying higher long-term risks.
The fourth option: financial system absorption
In simple terms, use policy measures to compel the financial system to absorb government debt—for example, by relaxing bank capital rules, encouraging pension funds to increase their holdings of Treasury securities, and adjusting regulatory metrics to make it easier for banks to hold U.S. Treasuries.
This is the most likely scenario over the next few years, as U.S. debt levels are so large that the free market alone may not be able to absorb them. Consequently, the government may increasingly resort to 'semi-market-based Treasury financing.'
This approach is actually not uncommon historically. After World War II, the U.S. adopted similar measures, and Japan is doing something comparable today—beyond Yield Curve Control (YCC), it also directs commercial banks to purchase government bonds to suppress long-term interest rates.
It remains uncertain whether this strategy would work in the U.S., as financial institutions hold the initiative—and U.S. financial institutions are far less compliant than Japanese banks.
Moreover, the side effects could be substantial: if commercial banks hold excessive amounts of long-duration bonds, sharp fluctuations in interest rates could easily trigger financial instability.
Fifth approach: engineer a 'flight to safety' by inciting panic in risk assets.
In fact, the government does not need to actively push down interest rates—it only needs to instill fear in the market.
Once equities plunge, credit risk rises, and global investors seek safety, capital naturally flows back into U.S. Treasuries, driving yields lower. Indeed, many historical declines in U.S. Treasury yields have coincided with market crises.
Warsh wouldn’t actually raise rates, but he never softens his rhetoric—he hopes the market will scare itself.
Rising U.S. Treasury yields are essentially a 'disease of affluence'—akin to human 'three highs' (hypertension, hyperlipidemia, hyperglycemia)—and a few lean years would resolve it.
There is, in fact, a self-correcting mechanism in the market: as Treasury yields rise, investor panic triggers a stock market decline, prompting capital to flow into bonds as a safe haven, which then pushes yields back down—this is the classic equity-bond seesaw.
But this could be described as a harmful tactic: a slight uptick in inflation merely makes life harder for the poor, whereas every one-percentage-point drop in GDP comes at the cost of increased unemployment and higher mortality among society’s most vulnerable.
Hidden here is also the ‘too big to fail’ secret of government debt: in times of inflation, debt is diluted; during recessions or crises, interest rates are suppressed, and debt rollovers reduce interest burdens.
The sixth tool: the ultimate measure
Restarting quantitative easing (QE)—this is the final weapon.
If fiscal pressures spiral out of control in the future, long-term bond yields surge, and the financial system falters, the Federal Reserve may ultimately resort to restarting QE—meaning the central bank re-enters the market to purchase long-term Treasuries.
This is the most direct and effective approach, as QE essentially amounts to 'printing money to suppress interest rates.'
The side effects are also evident: uncontrolled inflation several years later, and more troublingly, repeated rounds of QE could lead markets to question the long-term value of the U.S. dollar, potentially causing Treasury yields to rise rather than fall at some point in the future, alongside a weakening dollar.
Precisely because this ultimate tool carries the most unpredictable side effects, it will not be deployed unless absolutely necessary.
These six policy tools—and their associated side effects—essentially reflect trade-offs among competing policy objectives: Waller seeks balance sheet reduction, a return to market-determined interest rates, and restoration of the dollar’s credibility, whereas Trump aims to address the debt crisis and excessively high borrowing costs; these goals are inherently conflicting and require difficult choices.
Thus, the U.S. Treasury and the Federal Reserve have numerous tools at their disposal to push down U.S. Treasury yields—potentially as low as they wish. Modern governments can be said to be capable of almost anything; the only constraint is the 'cost.'
How much cost is the U.S. government willing to bear to suppress long-term Treasury yields? This hinges on whether interest rates have already become a pressing threat to fiscal sustainability and the stability of the dollar system.
Under normal circumstances, the U.S. government would not incur excessive costs, as the U.S. economy currently appears able to withstand high interest rates.
Edited by Joryn