03/01/2023
14/07/2025
Fiscal Dominance
The most overlooked and crucial price action in markets is happening in the long-end across the globe.
The market is surgically going after long-end bonds whose countries have the more acute ''fiscal dominance''
stories: the best way to visualize this is to compare 5y real yields with 30y nominal yields and here is why.
Fiscal dominance is a concept that implies back-to-back primary fiscal deficits that juice nominal growth
while the Central Bank doesn't tighten policy to offset such spending.
The result is that inflation expectations increase but front-end yields are pinned by a dovish CB (5-year real
yields are low) and the release valve lies in long-end bonds (30-year nominal yields) moving up fast.
The two charts below look at the US through the fiscal dominance lens:
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03/01/2023
The US fiscal dominance theme has gained a lot of traction since Trump won the election (first chart), but it’s
not really an untested theme: as we threw a gigantic amount of primary deficit while keeping real rates in
negative territory in 2021, the fiscal dominance chart went to the moon already back then.
The fiscal dominance theme has two release valves: long-end nominal yields up, and currency down.
The chart above shows how the USD has been weakening alongside the bond market representation of the
fiscal dominance theme. The big gap in Q4 2024 was related to the market understanding that tariffs were
going to be USD positive – so if anything, the USD has more catch-up to do against the fiscal dominance
theme now and it could weaken materially if this narrative really gains traction.
Here is a summary of fiscal dominance themes in various countries in 2025:
Country Fiscal Dominance FX REER 12-month Excess core Last 12-month
Bond Spread performance inflation vs target primary deficit
Japan 462 bps +5.8% +1.3% -0.6%
UK 457 bps -1.0% +1.5% -2.2%
US 347 bps -2.7% +0.7% -3.7%
France 339 bps +1.9% +0.4% -3.4%
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03/01/2023
The market is very upset about countries running fiscal deficits with inflation above target and a dovish-
biased Central Bank. It’s also smart about what release valves it’s using for the trade.
The BoJ would be ready to intervene in case of sharp JPY depreciations and hence the fiscal dominance
theme is showing more clearly at the long-end.
In the US, Bessent would engineer some buybacks or issuance drought to stop out shorts in 30-year bonds
and that’s why the USD has acted as the main release valve.
But the theme is alive and kicking, and there is no political capital to go back to austerity (see UK or Trump
running the economy hot ahead of mid-terms).
Commodities are another obvious release valve – take a look at Palladium:
This theme gets propelled by a more dovish Fed or higher odds of the Trump administration interfering with
the Fed independence. The ‘’Trump can’t get rid of Powell’’ camp is too crowded, and it once again
underestimates the extent to which Trump is ready to go to achieve his objectives.
I’ll write a separate piece on that, but it’s worth remembering that the Fed ultimately answers to Congress…
This was it for today. Be nimble, and remain hungry for macro.
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Alfonso Peccatiello
Founder & CEO, The Macro Compass – Institutional Macro Research. For inquiries: [email protected]
Founder & CIO, Palinuro Capital – Macro Hedge Fund. For inquiries: [email protected]
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Macro Research & Portfolio Strategy
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