The era of "fiscal dominance" has arrived, and central banks around the world can only "passively cooperate," while the market is "on high alert."

Bridgewater's Ray Dalio and other well-known investors are increasingly warning that the world's major economies are entering a new "fiscal-dominated" era. In this new paradigm, sharply expanding government debt and rising borrowing costs are putting immense political pressure on central banks, potentially forcing them to keep interest rates artificially low, thereby undermining their primary mission of controlling inflation. This trend is most evident in the United States. On August 20, the Financial Times reported that U.S. President Trump has repeatedly urged the Federal Reserve to cut interest rates to alleviate the government's debt repayment burden. This direct political pressure is exacerbating market concerns about the future independence of the Federal Reserve. The market has begun to vote with prices. Analysts point out that following the recent release of U.S. inflation data, the response in the Treasury market has been highly unusual: while short-term Treasury yields fell due to rate cut expectations, long-term Treasury yields, such as the 30-year, rose against the trend. This divergence suggests that the market is deeply unsettled by the potential for political interference in ongoing government fiscal spending and monetary policy. This predicament is not unique to the United States. Harvard University professor and former chief economist of the International Monetary Fund (IMF) Kenneth Rogoff stated, "We have entered a new era of fiscal dominance." This shift challenges the long-held principle of central bank independence and poses significant risks for investors, who are on high alert, closely monitoring whether monetary policy will yield to fiscal demands. Record Government Borrowing Intensifies Pressure on Central Banks The pressure of fiscal policy on monetary policy stems from the globally expanding government balance sheets. The Organisation for Economic Co-operation and Development (OECD) projects that sovereign borrowing in high-income countries will reach a record $17 trillion this year. In 2024, it is expected to be $16 trillion, and in 2023, $14 trillion. This has put central banks, which are trying to "normalize" their balance sheets, in a dilemma. After years of quantitative easing (QE), central banks are attempting to shrink their balance sheets by selling bonds (i.e., quantitative tightening, QT). However, this move would push up bond yields, directly increasing the government's debt servicing costs, thus creating a policy conflict. Investors are closely watching the Bank of England to see if it will significantly reduce its bond sale plans in next month's decision. Mahmood Pradhan, global macroeconomic head at asset management firm Amundi, stated, "The dilemma for central banks is that if financial conditions tighten due to government fiscal policy, they cannot be seen as accommodating this fiscal policy." He believes the Bank of England will "strongly resist fiscal-dominated pressures." In the UK, long-term borrowing costs are particularly high, with the yield on 30-year UK government bonds at 5.6%, close to a 25-year high. Even Germany, known for its fiscal discipline, has seen its 30-year government bond yield rise above 3% due to government plans to increase borrowing for infrastructure upgrades and defense spending, marking the highest level since 2011 Market Concerns Over Political Intervention Rise In the United States, market concerns over political intervention are manifesting through multiple indicators. Currently, the yield spread between 2-year and 30-year U.S. Treasury bonds has widened to its largest level since early 2022, reflecting market expectations for short-term rate cuts while also worrying about long-term inflation and debt risks. Analysts at Capital Economics believe that the market's unusual reaction to a lackluster inflation report suggests what might happen if the White House takes measures to exert more control over monetary policy. Additionally, Milan, who is seen as someone likely to advocate for rate cuts, has been temporarily appointed as a Federal Reserve governor. Trevor Greetham, head of multi-asset investing at Royal London Asset Management, believes this indicates that "the risk of U.S. fiscal dominance is increasing." Macquarie Group's global interest rate strategist Thierry Wizman points out that the futures market has already priced in expectations for five rate cuts by the end of next year, which seems "excessive" given that the economy is not in recession. He believes this reflects a belief that "we are about to have a structurally dovish Federal Reserve Chair and Federal Open Market Committee (FOMC)." Extreme Risks of a "Debt Death Spiral" In the long run, fiscal dominance could trigger more extreme risks. Noted investor Ray Dalio warns that, in extreme cases, some countries could fall into a "debt death spiral," where governments are forced to borrow more to pay soaring interest. Dalio explained in an interview that if bond yields are "too high, central banks will need to intervene again, printing money and buying bonds in an attempt to lower rates." He added that the ultimate result of such actions would be "currency devaluation." These concerns could undermine the value of "major reserve currencies" like the dollar and euro relative to gold. This year, gold prices have reached historic highs. Meanwhile, Matthew Morgan, head of fixed income at Jupiter Asset Management, pointed out that market volatility makes it more difficult for governments to issue long-term bonds, which may prompt them to turn to riskier short-term debt, making the country's fiscal situation more susceptible to interest rate fluctuations