Yield Curve Control: Explained
This technique for capping yields could surprise treasury investors
Surprise: Treasuries Yield capped at ~5% ?
One of the big surprises I foresee happening to investors who own treasuries concerns the government’s potential to cap yields using yield curve control, as happened in the 1940s. In the 1940s, treasury yields were capped at roughly 2.5%, so as to prevent the government’s interest costs from spiraling out of control.
However capping treasury yields had the side effect of increasing inflation. If we look back at WWII, we can see the effects of yield curve control (along with price controls and patriotic bond buying).
WWII History: Inflation ran much higher:
Year Annual CPI. Inflation. Context
1942–1945 ~2–3% (low) Wartime price controls and rationing held inflation down despite massive spending.
1946 8.5% End of WWII price controls led to sudden release of pent-up consumer demand.
1947 14.4% (peak). Post-war inflation surges from demand shock, supply shortages, and wage growth.
1948 7.7%. Still elevated, but beginning to cool.
1949 -1.2% (deflation) Recession and monetary tightening cooled inflation.
Yield Curve control resulted in the government inflating away the value of treasuries, reducing wealth inequality.
In this cycle, yields would likely need to be capped at ~5% to prevent interest costs from spiraling out of control. It is also a variation on quantitative easing:
In quantitative easing, the Fed specifies the amount of bonds they intend to buy.
In yield curve control, the Fed specifies a target interest rate. They then buy as many bonds as necessary to achieve that target rate
ChatGPT Prompts:
You said:
» Q: What does the financial term "yield curve control" mean?
Yield Curve Control (YCC) is a monetary policy tool used by central banks to directly target certain interest rates along the yield curve—typically government bond yields—instead of (or in addition to) targeting short-term interest rates.
How it works:
A central bank commits to keeping interest rates on government bonds of a specific maturity (e.g., 3-year or 10-year bonds) at or below a certain level.
To enforce this, the bank buys or sells government bonds as needed. If yields rise above the target, the bank buys bonds to push the price up and yield down; if yields fall too low, it may sell bonds.
Why it's used:
YCC is used to:
Anchor borrowing costs for longer durations.
Support economic recovery when short-term rates are already near zero (i.e., after conventional policy tools are exhausted).
Control the shape of the yield curve, which affects things like mortgage rates, business loans, and government financing.
Example:
The Bank of Japan (BoJ) famously uses YCC, targeting 10-year government bond yields at around 0%. The Reserve Bank of Australia (RBA) also experimented with YCC during the COVID-19 crisis, targeting 3-year bond yields.
Difference from Quantitative Easing (QE):
QE: Buys a fixed amount of bonds to inject money into the economy, indirectly affecting yields.
YCC: Buys as much as needed to hit a specific yield target, directly controlling yields.
In short, YCC is about controlling the price of money (interest rates) at certain points on the maturity spectrum, rather than the quantity of money like QE does.
You said:
» When in history has yield curve control been used?
ChatGPT said:
Yield Curve Control (YCC) has been used at a few key points in economic history—mostly during times of crisis or when conventional monetary policy (like adjusting short-term rates) has been exhausted. Here are the most notable historical examples:
1. United States (1942–1951)
Context: During and after World War II, the U.S. needed to finance massive government spending.
Policy: The Federal Reserve agreed to cap interest rates on U.S. government debt:
Short-term rates at 0.375%
Long-term (10-year) bond yields at 2.5%
Goal: Keep borrowing costs low to support war spending and post-war recovery.
End: The 1951 Treasury-Fed Accord ended YCC as inflation pressures grew, restoring Fed independence.
2. Japan (2016–present)
Context: The Bank of Japan (BoJ) adopted YCC after years of ultra-low rates and Quantitative Easing failed to lift inflation.
Policy:
Targets 10-year Japanese government bond (JGB) yields at around 0%.
Also maintains a short-term policy rate at -0.1%.
Goal: Stimulate inflation and stabilize long-term rates while avoiding excessive bond buying.
Update: The BoJ has tweaked the framework multiple times (including widening the yield target band) due to market pressures and inflation shifts.
3. Australia (2020–2021)
Context: In response to the COVID-19 crisis, the Reserve Bank of Australia (RBA) introduced YCC.
Policy:
Targeted the 3-year government bond yield at 0.25%, later 0.10%.
Goal: Support economic recovery and reinforce forward guidance.
End: The RBA abandoned YCC in November 2021 as the market began testing the cap, and inflation pressures rose.
In all cases, YCC was used in unusual economic conditions where traditional tools weren't enough, and central banks needed a more direct way to influence borrowing costs across the economy.
You said:
» How likely is the the United States enact yield curve control within the next ten years?
ChatGPT said:
The likelihood that the United States will enact Yield Curve Control (YCC) within the next ten years is not high under current conditions—but it's not off the table. Here's a breakdown of how likely it is, what factors would push it into play, and why it remains a backup tool rather than a go-to policy.
🔹 Baseline Likelihood: Low to Moderate
Under normal economic conditions, the Federal Reserve is unlikely to use YCC, primarily because:
The Fed prefers market-determined long-term interest rates.
YCC carries reputational and credibility risks—if markets test the Fed’s resolve, it could require massive bond purchases to defend yield targets.
The Fed has other tools it prefers, like:
Forward guidance
Quantitative Easing (QE)
Short-term interest rate adjustments
Balance sheet management
🔹 When Might the U.S. Use YCC?
YCC could become likely only under specific scenarios, such as:
Severe recession + near-zero interest rates
If short-term rates are pinned at the lower bound and QE becomes ineffective, the Fed might adopt YCC to cap longer-term rates and guide borrowing costs.
Massive federal deficits + rising long-term yields
If yields on Treasuries spike and jeopardize fiscal sustainability, YCC could be used to suppress borrowing costs.
Market dysfunction
If bond markets become disorderly (e.g., liquidity dries up), YCC might be used temporarily to stabilize key points on the curve.
War or emergency financing
As in the 1940s, the Fed could be pressured into capping yields to help finance large-scale government spending.
🔹 Fed Commentary & Policy Signals
The Fed discussed YCC in 2020 during the COVID-19 crisis but ultimately rejected it in favor of QE and forward guidance.
Fed officials have expressed skepticism about YCC’s usefulness in the U.S. context, partly because:
It distorts market signals.
It can be hard to exit without disruption.
It requires explicit and credible commitment, which is politically and technically difficult in the U.S. system.
🔸 Bottom Line:
Unless the U.S. faces a major economic emergency, recession, or market dysfunction, Yield Curve Control remains unlikely but available as a contingency tool. Its probability over the next 10 years is low to moderate—perhaps 10–30%, depending on future conditions.
Let me know if you’d like a scenario analysis or a visual timeline projection.
You said:
» How likely are Massive federal deficits?
ChatGPT said:
The likelihood of massive federal deficits in the United States over the next 10 years is very high—not just possible, but widely expected by both government agencies and independent analysts.
Here’s a breakdown of why, how big, and what it means:
🔹 What Counts as “Massive”?
A “massive” federal deficit typically means annual budget shortfalls exceeding 5% of GDP, or dollar amounts in the trillions per year.
The U.S. has already been running deficits of this magnitude:
FY 2020: $3.1 trillion (~15% of GDP, COVID-related)
FY 2023: $1.7 trillion (~6.3% of GDP)
🔹 Why Massive Deficits Are Likely
Interest Costs Are Soaring
As debt grows and interest rates rise, the cost to service debt increases sharply.
The U.S. is expected to spend more on interest than on defense within a few years.
Aging Population & Entitlements
Social Security and Medicare costs are ballooning as the U.S. population ages.
Without structural reform, these programs automatically increase spending every year.
Weak Political Will for Austerity
Neither major political party shows serious willingness to cut spending or raise taxes substantially.
Budget deals often focus on the short term, with minimal structural change.
Slow Revenue Growth Relative to Spending
Even if the economy grows, current tax policy does not generate enough revenue to close the gap.
Many tax provisions (e.g. Trump-era tax cuts) are set to expire, but their extension would widen deficits.
Geopolitical & Climate Pressures
Increased spending on defense, climate resilience, and industrial policy (e.g. CHIPS Act, green tech) adds to the burden.
🔹 CBO & IMF Projections
The Congressional Budget Office (CBO) projects:
Annual deficits will exceed $2 trillion by 2033.
Federal debt held by the public will rise from ~100% of GDP today to over 115% by 2034.
The IMF (April 2024) warns the U.S. has the highest projected fiscal deficits among advanced economies, and that its debt path is unsustainable without reforms.
🔸 Bottom Line:
The odds of the U.S. facing massive federal deficits over the next decade are extremely high—likely over 80–90% barring major fiscal reform.
This has real implications for monetary policy, bond markets, inflation risks, and even the likelihood of Yield Curve Control or financial repression in the future.
Let me know if you’d like charts, historical comparisons, or a breakdown by budget category.
You said:
How likely are massive federal deficits and rising long-term yields?
ChatGPT said:
The likelihood of the United States experiencing both massive federal deficits and rising long-term yields in the next 10 years is moderately high to very high—depending on macroeconomic conditions, investor confidence, and Federal Reserve policy.
These two conditions are interrelated, and when they occur together, they create a feedback loop that can challenge both fiscal and monetary stability.
🔹 Likelihood of Massive Federal Deficits: Very High (85–95%)
As noted earlier:
Driven by rising interest costs, Social Security/Medicare obligations, and political gridlock.
The Congressional Budget Office and IMF both project structural deficits of $2+ trillion annually by the early 2030s.
✅ Conclusion: Highly likely unless major policy reforms are enacted (which appears unlikely in current political climate).
🔹 Likelihood of Rising Long-Term Yields: Moderate to High (60–80%)
Long-term Treasury yields rise when:
Inflation expectations increase
The Fed tightens policy
Investors demand a higher risk premium
Government borrowing (supply of bonds) increases faster than demand
Several of these forces are currently in play:
Federal borrowing is rising fast, with the Treasury issuing more long-dated debt.
Foreign demand for Treasuries is weakening, especially from China and Japan.
The term premium—which has been compressed for years—is now rebounding, meaning markets are demanding more compensation for holding long-term debt.
However, rising yields can be tempered or reversed by:
Recession or deflation fears (which boost demand for long-term bonds)
Fed bond-buying (QE or YCC)
Global capital flows into “safe haven” U.S. assets
✅ Conclusion: Rising long-term yields are not guaranteed but are increasingly probable, especially if inflation remains sticky or fiscal deficits become politically unaddressable.
🔸 Combined Scenario: Deficits + Rising Yields (65%-80%)
This is the fiscal doom loop risk:
Large deficits → More bond issuance → Higher yields → Higher interest payments → Even larger deficits
Under current trends, this combined scenario is plausible to likely (65–80%) over the next decade. If investor confidence in U.S. fiscal sustainability weakens (e.g. a downgrade, political dysfunction), yields could rise sharply and suddenly, triggering a funding crisis or forcing the Fed into action (e.g. Yield Curve Control).
🔸 Summary Assessment (40%-70%)
Condition
Likelihood (10-year horizon)
Massive Federal Deficits🔺 Very High (85–95%)
Rising Long-Term Yields🔺 Moderate to High (60–80%)
Both at the Same Time🔺 Likely (65–80%)
Would you like a visual chart of the dynamics, or a scenario-based analysis (e.g., “what happens if both occur vs. only one”)?
You said:
How likely is yield curve control due to massive federal deficits and rising long-term yields?
ChatGPT said:
If the U.S. experiences massive federal deficits and rising long-term yields simultaneously, the likelihood of Yield Curve Control (YCC) being implemented by the Federal Reserve over the next 10 years becomes moderate to high (40–70%)—depending on how severe and persistent the situation becomes.
Here’s how to break that down:
🔹 Why YCC Might Become Likely in This Scenario:
Massive Deficits + Rising Yields Create a Fiscal Strain
As debt grows and interest costs rise, the federal government may struggle to finance itself affordably.
Higher long-term yields make Treasury borrowing more expensive—exponentially so when the debt is already large.
The Fed May Be Pressured to "Do Something"
Even if the Fed remains formally independent, market or political pressure could mount to cap yields in order to:
Protect fiscal sustainability
Stabilize mortgage and business loan rates
Prevent financial instability or a “debt spiral”
Historical Precedent: Post-WWII America
The U.S. used YCC in the 1940s–50s to cap yields and support federal financing needs after WWII. The situation is not identical today, but structurally similar pressures exist.
The Fed Has Limited Options
If long rates rise while inflation is still under control, the Fed could justify YCC as a stabilizing tool.
QE becomes less effective when markets doubt its intent or scale; YCC offers a stronger signal and more direct control.
🔹 Why YCC Might Still Be Avoided:
Credibility Risks
If the Fed commits to capping yields and markets test the cap, it might require unlimited bond buying, risking inflation or a loss of control.
Inflation Concerns
If long-term yields are rising due to inflation fears, capping them could be seen as reckless and undermine the Fed’s inflation-fighting credibility.
Fed’s Preference for QE and Forward Guidance
The Fed has shown strong institutional resistance to YCC, preferring flexible tools like QE.
Exit Risk
Once YCC is in place, getting out without market disruption is hard. Australia faced this in 2021 and abandoned its YCC experiment abruptly.
🔸 Conditional Probability Summary:
Scenario
Likelihood of YCC
Deficits without rising yields Low (10–20%)
Rising yields without fiscal strainModerate (20–40%)
Deficits + rising yields (gradual)Moderate (40–60%)
Deficits + rapidly rising yields or market disorder (bond panic) High (60–80%)
🔸 Bottom Line:
If the U.S. enters a sustained period of large deficits and rising yields, the Fed may be forced to consider YCC as a last-resort tool—especially if it faces a debt sustainability crisis or a breakdown in Treasury market functioning.
While not inevitable, the risk of YCC in this twin-pressure scenario is real and rising, particularly if markets begin to price in fiscal instability or if external demand for Treasuries weakens further.
Would you like a modeled scenario or simulation of how YCC might unfold under such conditions?
You said:
The US government would pay a very high amount of interest if it paid a high interest rate, such as 10%. If the US chose to use yield curve control, what rate (or rates) would the US likely target?
ChatGPT said:Fiscal sustainability
Historical precedents
Inflation expectations
Market functioning risk
🔹 Estimated “Pain Point” Yield Ceilings (YCC Trigger Points)
MaturityLikely Ceiling Trigger for YCCWhy This Level Matters2-year5.5–6.0%Above this level, it signals tight monetary policy and starts hurting refinancing, corporate credit, and bank stability.10-year5.5–6.5%Key benchmark for mortgages, corporate debt, and Treasury funding. At this point, debt service costs could become politically or fiscally unsustainable.30-year6.5–7.5%While less directly controlled, sustained 30-year yields this high would drastically raise long-term borrowing costs and could force indirect YCC via “curve smoothing.”
🔸 Why These Ranges?
Debt burden: With over $34 trillion in federal debt, every 1% increase in average borrowing cost adds ~$340 billion annually in interest expense.
Historical comparison: In the 1980s, yields reached 15% due to inflation, but debt was much smaller. Today, even 6% yields could trigger a debt spiral.
Market stability: Rapid rises beyond these thresholds can cause collateral liquidity crises (especially in repo markets and bank reserves), forcing Fed intervention even if inflation is still above target.
Political economy: Congress may pressure the Fed if interest expense crowds out other spending or panics the equity and housing markets.
🔹 Fed Would Likely Act Gradually
The Fed wouldn’t jump straight to hard caps. Likely steps before formal YCC:
Verbal jawboning: Signaling intent to maintain “orderly functioning” of bond markets.
Balance sheet reinvestment or targeted QE.
Soft YCC: Implicit caps via flexible bond purchases (like Bank of England during the pension crisis).
Formal YCC: Explicit rate caps at defined maturities (e.g., “10-year Treasuries will not exceed 2.5%”).
🔸 Bottom Line:
If Treasury yields approach 5.5–7% across key maturities, and especially if this coincides with rising federal deficits and weakening investor demand, the Fed may be forced into Yield Curve Control—first implicitly, and then possibly explicitly.
Would you like to see a modeled debt service scenario at those yield levels, or a visual of projected interest costs under different interest rate caps?
You said:
How would these rates affect the debt levels and interest on the debt?
ChatGPT said:
Here’s how different interest rate levels would impact annual interest costs on the U.S. federal debt (approx. $34 trillion):
Average Interest RateAnnual Interest CostCurrent Avg (~3%)$1.02 trillionRising (5%)$1.70 trillionHigh Stress (6%)$2.04 trillionSevere Stress (7%)$2.38 trillion
🔸 Implications:
At 5% or higher, interest becomes the largest single federal budget item, likely exceeding defense, Medicare, or Social Security.
At 6–7%, the federal government may enter a fiscal spiral, where:
Interest payments increase borrowing needs
New borrowing occurs at higher rates
Debt and deficits grow even faster
This is exactly the kind of scenario that could force the Fed to consider Yield Curve Control to prevent an uncontrollable surge in borrowing costs.
Let me know if you'd like to break this down by what portion of the budget interest would consume or how it compares to tax revenue.
You said:
In the 1940s, when the government used yield curve control to cap interest rates at 2.5%, what was the peak inflation rate?
ChatGPT said:
During the 1940s, the U.S. implemented Yield Curve Control (YCC) to support wartime borrowing and post-war reconstruction. The Federal Reserve capped long-term Treasury yields at 2.5%, beginning in 1942 and continuing into the early 1950s.
🔹 Peak Inflation During 1940s YCC Era
Peak inflation rate:
14.4% in 1947
🔸 Timeline & Context
YearAnnual CPI InflationContext
1942–1945. ~2–3% (low) Wartime price controls and rationing held inflation down despite massive spending.
1946. 8.5% End of WWII price controls led to sudden release of pent-up consumer demand.
1947 14.4% (peak). Post-war inflation surge from demand shock, supply shortages, and wage growth.
1948 7.7%. Still elevated, but beginning to cool.
1949 -1.2% (deflation) Recession and monetary tightening cooled inflation.
🔹 Why Inflation Spiked Despite YCC
Post-war pent-up demand: Americans had saved money during the war (rationing, lack of consumer goods), and after 1945 they began spending aggressively.
Supply shortages: Wartime production focused on military goods, so consumer goods were scarce at war’s end.
Labor market dynamics: Wages rose sharply as unions pushed for higher pay after years of wage controls.
Fed held rates artificially low: The Fed kept long-term yields capped at 2.5%, limiting its ability to combat inflation with higher rates.
🔸 Takeaway for Today
The 1940s show that Yield Curve Control can coincide with double-digit inflation if:
Monetary policy is subordinated to fiscal needs
Supply constraints exist
Demand surges sharply after economic shocks
While today’s economy is structurally different, the 1940s remain the clearest historical precedent for understanding inflation risks under long-term YCC.
Would you like a visual of 1940s inflation compared to yield control policy, or a breakdown of how long it took to bring inflation back down?
Questions:
What would be the effect on bond prices if the US experience yield curve control similar to what the Fed enacted from 1941 - 1951?
What if issues with trade reshoring also resulted in inflationary pressure?
In the news (Oct 12, 2023)
Already in Oct 12, 2023 commentators talked about US Need for Yield-Curve Control