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One of the key macro concepts to familiarize oneself with is Fiscal Dominance.
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.
Basically, deficit spending happening while inflation is already above target risks pushing inflation expectations higher, and a Central Bank that refuses to tighten policy simply throws fuel on the fire.
The result is that inflation expectations increase, but:
A) Front-end yields are pinned by a dovish CB (5-year real yields are low)
B) The first release valve lies in long-end bonds (30-year nominal yields), moving up fast
C) The second release valve lies in the currency depreciating
The chart below shows the Fiscal Dominance theme in the US as expressed by bond markets.
The spread between 5-year real yields (symbolic of a dovish Central Bank) and 30-year nominal yields (release valve) is increasing materially.
Bond markets in Japan, the UK, and France are throwing a similar Fiscal Dominance tantrum.
Do you think this theme can extend further?
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