Request interest rates of analysis-stump put ‘fiscal dominance’ in the market spotlight

When the US debt swell and the White House relying on the Federal Reserve to cut interest rates, investors weigh the risk of “fiscal dominance,” a scenario where the government to finance cheap eclipse struggles against inflation.

The Budget Bill that was passed last month by the Congress controlled by the Republican party will pile up trillions to the burden of US debt which is swollen to increase the cost of the debt service. Meanwhile, US President Donald Trump has made an explicit call to Fed to cut interest rates, some to reduce the cost of US government interest.

The White House pressure campaign has caused concern that administration wants Fed to return to the past when it remains low to allow lower -cost loans.

“(Fiscal dominance) is a problem … there is a risk in the horizon, both from the perspective of increasing debt load and probability for higher structural inflation, or minimal, more inflation volatility,” said Nate Thooft, head of investment officers for equity and multi-asset solutions in Manulife Investment Management.

“The reason why Trump administration and politicians in general … want to see lower rates, because it actually requires a lower rate to be able to pay the level of debt we have,” he said.

The US experienced fiscal dominance during and shortly after the Second World War, when the Fed was asked to keep the interest rates low for war loan efforts. The inflation surge that was followed caused an agreement that was given a 1951 Treasury food that restored the independence of the central bank.

High -term treasury results and sliding dollars have reflected that economic arrangements, some analysts say, because investors need more compensation to withstand US assets that can lose value if inflation rises.

“Administration wants to go beyond the debt … But another way to deal with debt is to expand,” said Kelly Kowalski, head of investment strategy at Massmutual, who saw the dollar continued to weaken.

Higher inflation will mean the real value of the government’s debt shrinks.

Trump said last month that the Fed benchmark interest rate had three points of a percentage lower than the range of 4.25% -4.50% at this time, with the reason that such a reduction would save $ 1 trillion per year. He separately said the central bank can raise interest rates again if inflation rises. Within 12 months to June, inflation measured by the price index of personal consumption expenditure rose 2.6% – still above the 2% Fed target.

Chairman of Fed Jerome Powell, however, has explicitly said that the US central bank does not consider managing government debt when establishing its monetary policy.

Some investors argue that fiscal dominance lies in an uncertain horizon, with an increase in debt to trigger an unsustainable interest rate, while others see it already seeping into the market because long -term results continue to increase even in the midst of the hope of cutting Fed interest rates.

White House spokesman Kush Desai said Trump’s administration respected Fed’s independence, but that, with inflation had fallen significantly from the highest in recent years, Trump believed it was time to reduce interest rates.

The US central bank has so far rejected these demands, although it is expected to reduce the loan costs at the September 16-17 meeting.

It refused to comment on this story.

Fed mandate
The dollar fell by about 10% this year against a basket of the main currency while the premium the term treasury-requesting additional compensation investors to hold long-term debt, even when recent results dropped in the midst of slowing economic growth.

“It is difficult to become a long bullish bond in this environment,” said Oliver Shale, an investment specialist at Ruffer, citing government spending that can keep inflation high and erode the value of bonds.

“If you have an economy that runs on natural output, it will cause inflation or have important implications for inflation, interest rates, and maybe the currency,” he said.

Thooft in Manulife said he was bearish in the long treasury dated because higher inflation would require a higher term premium.

Despite years of economic growth, the US deficit continues to be balloons. Debt is now in more than 120% of GDP, higher than after the Second World War.

The Fed usually manages inflation while the Congress maintains fiscal discipline. The balance was reversed under the fiscal dominance scenario, with inflation driven by the fiscal policy and a Fed who tried to manage debt burden, said Eric Leeper, an economic professor at the University of Virginia.

“The Fed cannot control inflation and keep interest payments low in debt. That is conflicting,” Leeper said.

One red flag for investors is a narrowing gap between interest rates and economic growth. The 10 -year benchmark results have floated around 4.3% in recent weeks, while the nominal GDP has grown at an annual level of 5.02% in the second quarter.

When interest rates exceed the growth rate, debt as a percentage of gross domestic product usually rises even without new loans, making the debt increasingly unsustainable.

“The risk to feed independence originating from high fiscal dominance,” said Deutsche Bank Analyst in a recent note, citing a high deficit and long-term level close to nominal GDP growth.

‘Bias Dovish’
History offers a warning story. Extreme fiscal dominance triggered hyperinflation in Germany in the early 1920s and in Argentina in the late 1980s and early 2000s. Recently in Türkiye, the pressure on the central bank to keep the interest rates low in credibility of policies that are not underestimated and triggers a currency crisis.

The majority of economists surveyed by Reuters last month said they were worried that Fed’s independence would be under threat. Apart from a series of criticisms from Trump and administrative officials, Powell has vowed to remain the Head of Fed until his term of office ended in May 2026.

“It seems that it is relatively clear that whoever is nominated for the chair, regardless of whatever view they support in the past, it is likely to articulate Dovish biases to be nominated,” said Amar Reganti, a fixed income strategy expert at Hartford Funds and former Treasury officials.

However, lower interest rates may only be a temporary improvement.

Administration may hope for “nominal growth juice,” despite the risk of creating higher inflation, to get to a place where real growth makes the path of debt sustainable, said Brij Khurana, a fixed income portfolio manager at Wellington.

“The problem they have is … The central bank says: ‘I don’t want to bet with you.'”
Source: Reuters