The bond market is smelling trouble.
The chart below shows my proxy for the US Fiscal Dominance theme.
The bond market is clearly smelling trouble by pricing an aggressive resurgence of Fiscal Dominance – a combination of aggressive fiscal primary spending with a politically biased dovish Fed.
How is the Fiscal Dominance proxy calculated?
It’s the minus the .
This is why it makes sense to use this metric to proxy the fiscal dominance theme.
When 5-year real yields drop rapidly, it often happens as a combination of inflation expectations going up but nominal yields moving down – markets are basically repricing inflation higher, but they are aware that a dovish-biased Fed will not react to higher .
The rare combination of inflation expectations up + nominal yields down is happening as we speak.
Then, the release valve for the fiscal dominance becomes the long-end.
When 30-year nominal yields increase rapidly while 5-year real yields remain low, this is often a sign that investors are paying attention to the unorthodox combination of strong fiscal spending and a dovish Central Bank.
Bond markets are starting to smell trouble.
Do you think this fiscal dominance theme will extend further or not?
***
This article was originally published on The Macro Compass. Come join this vibrant community of macro investors, asset allocators and hedge funds – check out which subscription tier suits you the most using this link.