Lessons learned from markets in 2025

Steven Abrahams | December 19, 2025

This material is a Marketing Communication and does not constitute Independent Investment Research.

The list of lessons taught by markets this year is a long one, many of them highlighted in this issue of US Portfolio Strategy. Some of the bigger or more interesting ones revolve around Fed independence, pernicious changes in MBS quality, the liquidity risks for private credit, the changing role of banks and a creative way for issuers to think about the maturity structure of their debt.

#1: Fed independence evolves

The Fed for most of my career has accounted for itself well to Congress but managed to steer clear of the hottest flames of politics. Well, not 2025. The consensus about Fed independence clearly is under siege, and that will matter for markets.

The Fed has always answered to Washington through testimony and consultation with Congress, the White House and Treasury. But markets have assumed the Fed would nevertheless operate—at least within its mandates— largely free of immediate political influence. The administration challenged that this year and Congress, for the most part, stood by.

This all suggests some level of dissatisfaction with the Fed at least in Washington. The administration clearly would like the Fed to line up with its political priorities, but this seems like another instance of being careful about what you wish for. The market would likely punish a blatantly political Fed with higher interest rates, and this administration does pay attention to markets. Instead, consensus seems more likely to gravitate toward preserving independence to set rates but narrowing the Fed’s scope in other areas.

A narrower version of the Fed would limit use of some of the powerful tools developed since the Global Financial Crisis—elements of QE, QT or various funding facilities that can tilt the political playing field. A number of proponents have made the case this year for a narrow Fed. The Fed has long read the room when it came to the mortgage market, for instance. Former Fed Governor Frederic Mishkin once described mortgages as the most political asset in America. That sensitivity is likely reflected in the Fed’s decision to let MBS holdings run off and replace them with Treasury debt.

For markets, the impact of a narrower Fed would fall on assets outside of Treasury debt where Fed support could separate winners from losers—MBS, ABS and even corporate debt, for instance. The Fed instead would let markets make the decisions. And without the Fed put they have enjoyed since the GFC, these assets would trade with a higher risk premium.

#2: TBA MBS can become race to the bottom

This year made clear that the Ginnie Mae MBS market is caught in a pernicious cycle. Because investors will pay a premium for more stable cash flows, originators have started creating custom pools either exclusively with relatively stable FHA loans or including comparable VA loans with low principal balances. The remaining more volatile loans go into the monthly TBA pool, hurting pool pricing and liquidity. My colleague, Brian Landy, has followed this closely.

The lesson here is that TBA can become what George Akerlof described as a classic market for “lemons”. Markets for lemons develop when sellers have incentives to deliver their worst product to buyers and hold out the good stuff for better prices. Usually that means keeping the good stuff off the market, but the MBS market allows sellers to package the good stuff and sell it as specified pools. As sellers deliver progressively worse goods and hold out anything better, the average quality of the delivery goes down. Sellers then hold out the new marginally better stuff, and the cycle keeps driving down the quality of the deliverable.

Markets for lemons eventually trade only the worst quality, if they trade at all. Ginnie Mae seems headed in that direction—all the more reason to be short the Ginnie Mae/Fannie Mae swap or short the Ginnie Mae TBA against specified pools. Even the TBA market in Fannie Mae and Freddie Mac MBS looks vulnerable as originators carve their loans into progressively finer types of specified pools. Originators win, investors win, but borrowers maybe not.

#3: Liquidity, not fundamentals, looks like the biggest risk to private credit

The broader impact of First Brands and Tricolor on credit spreads in October and November and even December concerns about Oracle debt needed to finance data centers showed that lenders are becoming nervous about loans where the value of the collateral is uncertain. That doesn’t mean the credit is necessarily good or bad, just that lenders may be quick to assume the worst. That creates risk of contagion for private credit. Banks in the last year have rapidly expanded lending to non-bank financial institutions, including private debt funds and business development companies. If the market sees more private credit defaults, banks or their regulators or both may be quick to pull back at least temporarily from lending. Tightening credit can push more balance sheets over the brink and tighten credit further. Liquidity is likely to move much faster than fundamentals.

#4: The investment role of banks looks likely to keep changing

Banks these days face competition for deposits from money market funds, competition for handling payments from stablecoins and competition for making non-prime business and household loans from non-banks. That leaves progressively less room for traditional banks. Since banks hold $6.3 trillion in US debt securities, marginal changes to bank business models make a difference. The direction of travel seems to be toward fewer, bigger and more narrowly focused banks that would tend to hold the safest and most liquid assets. Money market funds and stablecoin providers would also likely crowd into safe, liquid and short assets. As for the non-banks doing a growing share of lending, they stand to turn toward banks for some leverage and securitization for the rest.

#5: Issuing debt is a risk-reward tradeoff

Some in the Treasury market have long thought about issuing debt as a risk-reward tradeoff, and I stumbled across their idea this year. The idea should get more traction than it currently does across all kinds of issuers.

The basic idea is that programmatic issuers like Treasury and others face a tradeoff between the cost of debt issued and the volatility of that cost. These issuers can minimize cost in most markets by funding with the shortest maturities, but that leaves the risk of rising costs in some markets. Treasury and others alternatively could lock in costs and limit volatility with longer maturities, but longer debt usually costs more.

A number of analysts have recommended that Treasury and other issuers focus on the expected cost of debt and the variability of that cost at different maturities. The analysis can also use historical results. The results often suggests that issuers can lengthen the maturity of issuance at surprisingly small additional cost while significantly reducing variability.

There’s little doubt that corporate issuers trying to fund specific projects are better off matching debt to the expected project. But for issuers trying to fund operating cash flows or other continuing spending, the Treasury’s risk-reward framework could help optimize the structure of funding.

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The view in rates

The year ahead could be a very slow one for Fed watchers. My colleague Stephen Stanley continues to expect no more cuts through 2026 as inflation continues to run above the Fed’s 2% target and the economy strengthens. It becomes hard for the Fed to cut under those circumstances. Anecdotally, others seem to be echoing similar themes. Then there’s the drama of appointing a new Fed governor in January and a new Fed chair in May. That looks likely to take up most of the Fed headlines until we have enough data to know where policy goes next.

It continues to seem better to own duration on the front of the yield curve than on the back, and the market has rewarded that positioning recently. The 2s10s Treasury slope broke out of its 50 bp to 60 bp range after the FOMC and has traded around 66 bp for the last week. The back of the yield curve has to wrestle with Treasury supply and the prospect of weaker demand from Japan as yields on Japanese government bonds rise and draw demand away from Treasury debt.

Key market levels:

• Fed RRP balances settled on Friday at $3 billion as other repo rates offer much higher yields
• Setting on 3-month term SOFR traded Friday at 369 bp, down 3 bp in the last week
• Further out the curve, the 2-year note traded Friday at 3.48%, down 4 bp in the last week. The 10-year note traded at 4.15%, down 3 bp in the last week
• The Treasury yield curve traded Friday with 2s10s at 66 bp, flat in the last week. The 5s30s traded Friday at 113 bp, steeper by 2 bp
• Breakeven 10-year inflation traded Friday at 224 bp, down 4 bp in the last week. The 10-year real rate finished the week at 189 bp, unchanged in the last week

The view in spreads

For investment grade corporate debt, the challenge next year looks like a sizable 9% to 11% jump in net supply in part to fund AI infrastructure. That could outstrip 5% to 7% growth in outstanding Treasury debt, widening the corporate-Treasury spread, and 2% growth in outstanding agency MBS, widening the corporate-MBS spread. Supply in MBS is even less after excluding Ginnie Mae custom pools, which are not included in the Bloomberg MBS index. The Bloomberg US investment grade corporate bond index OAS traded on Friday at 79 bp, wider by 2 bp in a week. Nominal par 30-year MBS spreads to the blend of 5- and 10-year Treasury yields traded Friday at 115 bp, down by 7 bp in the last week on a big drop in implied volatility. Par 30-year MBS TOAS closed Friday at 16 bp, tighter by 5 bp.

The view in credit

Bank lending to non-bank financial institutions, including private debt funds and business development companies, has expanded at an extraordinary pace in the last few years, raising the possibility that lending has outstripped experience and infrastructure for underwriting and monitoring. Bank regulators could ask banks next year to tap the breaks on that lending, tightening the private credit markets. Consumers in the lowest tier of income look vulnerable, and cuts to government programs next year should keep the pressure on. The balance sheets of smaller companies show signs of rising leverage and lower operating margins. Leveraged loans also are showing signs of stress, with the combination of payment defaults and liability management exercises, or LMEs, often pursued instead of bankruptcy, back to 2020 post-Covid peaks.