At the heart of this fragility are the twin deficits: a fiscal deficit running around 7% of GDP and a persistent current account gap. For years, these imbalances were masked by robust foreign capital inflows and the dollar’s central role in the global system. But this architecture is fraying. China has steadily reduced its holdings of U.S. assets. Private foreign appetite is waning. And while U.S. investors continue to buy Treasuries, they prefer the short end of the curve, leaving the long end more exposed to repricing.

The recent weakening of the U.S. dollar adds another dimension to this evolving picture. Traditionally, the dollar has strengthened during periods of market stress, serving as a safe-haven asset. Yet in April, the dollar fell alongside equities and Treasuries, suggesting that confidence in the U.S. policy framework is becoming less absolute. While some technical factors such as shifts in hedging demand and positioning played a role, the broader narrative points to rising concerns about the sustainability of U.S. fiscal and external balances. The weakening dollar reflects, at least in part, a market beginning to reassess the assumptions that have long underpinned its dominant role in global finance.

This comes at a time when the Fed finds itself cornered. Growth is slowing. Tariff-driven uncertainty is weighing on business sentiment and global trade. But doing nothing is also risky as the long end has become more volatile and less dependable as a safe haven, with yields moving sharply in response to supply concerns. As higher coupon issuance looms and debt servicing costs climb, the risks of disorderly moves increase. The Fed faces a dilemma: it cannot ease conventionally, yet it may still need to act to stabilize the functioning of the Treasury market.

Given current constraints, balance sheet policy may emerge as a more practical option than rate cuts. Quantitative easing could return, not only as a tool to support economic activity, but also to help stabilize a market facing pressure from increased Treasury supply. By expanding its holdings, the Fed can act as a consistent buyer of duration, supporting market liquidity and helping to contain term premia. This would partly offset reduced foreign demand for U.S. debt, while also contributing to easier financial conditions, and thus, stimulating growth. This evolution in policy thinking reflects broader structural shifts. QE, once viewed primarily as a countercyclical tool, may increasingly function as a mechanism to manage liquidity and absorb Treasury supply.

Repricing the Risk-Free

The term premium, long compressed by global demand for safe assets and central bank buying, is now reasserting itself. Recent market behavior reflects a shift in investor psychology: the compensation required to hold long-dated government debt is rising, not because of runaway inflation expectations, but due to uncertainty about future supply, fiscal sustainability, and the broader trajectory of policy. This repricing has made the yield curve more sensitive to fiscal news, auction results, and changes in risk appetite. For a market long conditioned by predictability, the reintroduction of doubt is destabilizing.

A key factor driving this dynamic is the evolving investor base. Foreign central banks and sovereign wealth funds, once the dominant marginal buyers of U.S. debt, are no longer as reliable. China has steadily diversified away from Treasuries, and Japanese investors, facing higher domestic yields, have scaled back their exposures. Domestically, money market funds, pensions, and banks have stepped in, but with different preferences: they favor shorter maturities, floating-rate instruments, or safer high-grade credit. The result is a gap at the long end - not a vacuum, but a thinning cushion, where small shifts in sentiment lead to outsized price moves.

Even so, it would be premature to declare the Treasury market dysfunctional. It continues to clear, and there is no sign of systemic breakdown. Yet liquidity has deteriorated at the margin, and the bid for longer-duration paper has become more erratic. Recent auctions have shown signs of soft demand, with larger-than-usual tails and increased reliance on primary dealers. Futures basis trades, once a source of steady support, have been unwound, amplifying volatility. These developments do not mark a crisis, but they point to a system that is more brittle than before. One in which risk is being repriced rather than redistributed.

That repricing is not necessarily a problem, but it is a signal. For years, markets assumed that the U.S. could finance itself at low cost indefinitely. The implicit belief was that demand for Treasuries was elastic, the Fed always credible, and the dollar always dominant. Those assumptions are now being tested, not in the form of panic or collapse, but through rising term premia and greater market sensitivity to fiscal drift.

When Trust Starts to Cost

None of this suggests an imminent downgrade or a collapse in the dollar’s status. U.S. Treasuries remain the world’s deepest and most liquid asset class. The dollar still accounts for the majority of global reserves. But the erosion of trust is rarely linear. It begins at the margins: in higher auction concessions, in basis point spikes, or in currency drift, before it crystallizes into a change in investor behavior. What April has shown is not that the U.S. is losing its standing, but that it may have to work harder to maintain it.

In that light, QE might become less a form of stimulus and more a tool of financial hygiene. It may be reintroduced not because the economy is collapsing, but because market functioning requires support, and because balance sheet expansion is the most politically neutral lever available. If long-end volatility remains elevated and foreign sponsorship continues to dwindle, the Fed’s next intervention may not be a rate cut, but a return to the toolbox it thought it had stored away.

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