Yields on 30-year U.S. Treasury bonds recently reached a 19-year peak of 5.35 percent amid ongoing concerns over the country’s expanding budget deficits and shifting demand for government debt. The United States has been running annual budget deficits around 6 percent of GDP, causing interest payments as a share of GDP to double to 3.2 percent over the past two decades. Currently, the federal government’s net interest bill exceeds $1 trillion annually, surpassing defense spending by 16 percent.

The rising borrowing costs reflect more than just an increase in debt volume, experts say. The relationship between debt growth and interest rates demanded by investors appears nonlinear, with higher debt levels accelerating yield increases. A significant factor behind this dynamic is the changing profile of Treasury bond holders.

Nineteen years ago, about 76 percent of U.S. Treasury bonds were owned by price-insensitive investors—such as central banks—that purchased debt primarily for stable foreign exchange reserve management. Today, that figure has dropped to just 45 percent. The majority of Treasury holdings now belong to price-sensitive buyers, including households and investment funds, who demand higher returns in response to growing government debt and inflationary pressures.

This shift has been driven by changes in global central bank behaviors. China, a major Treasury holder historically, has reduced its US bond holdings relative to issuance growth and diversified into gold. Geopolitical factors, including the expansion of U.S. financial sanctions and the weaponization of the dollar, have contributed to caution among foreign official investors. Japan’s share of Treasury holdings has also shrunk from 18 percent in 2004 to 4 percent due to slowed reserve accumulation. More broadly, the pace of global dollar reserve accumulation has slowed significantly since the early 2000s.

As a result, the issuance of Treasuries needed to finance U.S. debt is outstripping demand from these traditionally reliable, price-insensitive buyers. The reliance on more yield-sensitive private investors means the government must offer increasingly higher interest rates to attract buyers.

These challenges could intensify if the Federal Reserve, under new Chair Kevin Warsh, proceeds with plans to reduce its holdings of Treasury securities. The last period of Fed balance sheet reduction, from 2022 to 2025, saw a 17 percentage point increase in the share of Treasuries held by price-sensitive investors and an 11 percentage point rise in the term premium—the extra yield investors require for holding long-term debt. Further Fed reductions in Treasury holdings could push yields even higher.

Higher borrowing costs would amplify the federal deficit by increasing debt-service payments, which in turn would necessitate additional Treasury issuance, creating a feedback loop driving yields up further. The Congressional Budget Office estimates that each one percentage point increase in interest rates above current projections would add $3.2 trillion to cumulative federal interest expenses over the next decade.

In response, some analysts call for a combination of policy measures to stabilize debt dynamics. These include establishing a medium-term fiscal consolidation plan in Congress that automatically triggers spending cuts when the debt-to-GDP ratio exceeds a set threshold, reinforcing long-term fiscal credibility. Additionally, reducing the use of tariffs and sanctions could ease geopolitical tensions and slow the global trend of “de-dollarization.” Finally, the Fed might consider moderating or postponing its balance sheet reduction plans to avoid exacerbating Treasury market pressures, relying instead on conventional interest rate policy to manage inflation.