This article is part of Macro Hive’s 2025 Grey Swan series, where we let our imaginations loose to try and predict low-probability, high-impact events that almost no one expects. You can read the full list here.
The Gibson
24 December 2025 – Treasury Secretary Bessent steps out of his official car in front of the Fed Mariner Eccles building. The Secretary carries a large, ribboned package. He is headed to his last weekly meeting of the year with the Fed Chair. The Fed Chair/Treasury Secretary breakfasts, bi-weekly occasions under Biden, have turned into weekly affairs.
The Chair is already waiting for the Secretary. Bessent hands his package to Powell. ‘A small token of the Treasury’s gratitude,’ he says. Powell protests, but the Secretary insists. Powell opens the package – a Gibson guitar! ‘It belonged to Jerry Garcia,’ says the Secretary. The Chair – a diehard Grateful Dead fan – is lost for words. What a fitting end to an extraordinary year!
Promises Delivered
The year started well enough, with markets barely noticing the inauguration on 20 January. Right away, Congress and the administration started working feverishly on the budget. Within three months, the House and Senate had adopted a budget with all the tax cuts Trump had promised on the campaign trail. Not just the extension of the Trump 1.0 tax cuts; they had also adopted the exemption of taxation for tips, overtime, social security benefits, the restoration of the full SALT deductions and a few more items on the list. Congress can be so creative!
Of course, there was the small matter of the CBO scoring – it showed a 2ppt of GDP increase in the deficit to 9%. But what are 2ppt of GDP among friends? Besides, everybody knows the CBO is an overly conservative agency. If you believe it strongly enough, tax cuts always end up paying for themselves…
Trouble Brewing
The first signs of trouble appeared when the budget parameters got leaked to the press in late March. Bonds sold off across the curve, and 10Y yields settled into a 4.75–5.00% range. Then there were the two long-tailed auctions in April. 10Y yields moved to a 5.00–5.50% range. Secretary Bessent made some soothing noises, and yields fell back to near 5.00%.
President Trump, however, was not pleased with the Fed’s refusal to cut rates and let his displeasure be known in no uncertain terms. Concerned over Fed independence, debt debasement and monetary financing of the deficit, investors demanded higher term premia. 10Y yields rose to 5.75%.
And then the failed 10Y auction happened. In principle, failed auctions cannot happen since primary dealers are obligated to bid. In normal auctions, they tend to get about 10–20% of the total. But on that day, the bid from direct and indirect bidders was almost nonexistent, leaving most of the auction to the primary dealers. Those promptly communicated to the Treasury that they would be unable to bid without breaching their regulatory ratios.
The Treasury market suffered an unprecedented selloff. The Fed had to set up an emergency liquidity facility, and it had soon supplied more than the $1.6tn it supplied during the March-April 2020 Treasury crisis. Markets froze across asset classes. The dollar went into freefall.
Crisis Averted?
Eventually, market stability was restored, though 10Y yields remained above 6% on a combination of unprecedented money printing and jawboning. President Trump promised to respect Fed independence, and Chair Powell was invited to the White House for a special photo op. Bessent, Powell, and the primary dealers declared that they had the market back. Meanwhile, the Fed kept buying, bringing its balance sheet to $10tn – well above the pandemic $9tn peak.
With the benefit of hindsight, there were clear crisis markers. The Trump administration inherited the largest budget deficit since WWII outside of recessions (Chart 1). Unstable debt dynamics had already taken root, with interest payments representing already close to 20% of expenditures.
While the US was busy bringing debt to unsustainable levels, foreigners had started moving away from dollar assets. The share of the dollar in global reserves had been falling, and so had the foreign bid in Treasury auctions (Chart 2). Although they were very quiet about it, BRICs countries, including traditional US allies, had been making plans to weaken their reliance on the dollar and were reducing their purchases of Treasuries.
Against these vulnerabilities, the Treasury market liquidity had been worsening. Primary dealers’ balance sheets have not kept up with the explosion in public debt (Chart 3). In addition, three quarters of trading is now handled by algorithmic firms that do not have balance sheets and cannot provide liquidity in times of market stress. These leave the Fed as what is effectively the marker maker of last resort.
As they were savoring their cappuccinos, the Chair and Secretary basked in the satisfaction of a crisis averted, for now…
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)