Prominent investors including Bridgewater's Ray Dalio are increasingly warning that major global economies are entering a new era of "fiscal dominance." Under this emerging paradigm, rapidly expanding government debt and rising borrowing costs are creating enormous political pressure on central banks, potentially forcing them to keep interest rates artificially low and thereby undermining their primary mandate of controlling inflation.

This trend is most evident in the United States. On August 20, reports indicated that President Trump has repeatedly urged the Federal Reserve to cut interest rates publicly in order to reduce the government's debt servicing burden. Such direct political pressure is intensifying market concerns about the Fed's future independence.

Markets have already begun voting with their wallets. Analysts point out that following recent U.S. inflation data releases, the Treasury market's reaction has been highly unusual: while short-term Treasury yields declined due to rate cut expectations, long-term bonds such as 30-year Treasuries moved higher against the trend. This divergence suggests deep market unease about continued government fiscal spending and potential political interference in monetary policy.

This predicament is not unique to the United States. Harvard University Professor and former International Monetary Fund (IMF) Chief Economist Kenneth Rogoff states, "We have entered a new era of fiscal dominance."

This shift challenges the long-established principle of central bank independence and presents significant risks to investors, who are now bracing for impact while closely monitoring whether monetary policy will bow to fiscal demands.

Record Government Borrowing Intensifies Central Bank Pressure

The pressure from fiscal policy on monetary policy stems from expanding government balance sheets worldwide. The Organisation for Economic Co-operation and Development (OECD) projects that high-income countries will reach a record $17 trillion in sovereign borrowing this year, up from $16 trillion in 2024 and $14 trillion in 2023.

This places central banks attempting to "normalize" their balance sheets in a difficult position. After years of quantitative easing (QE), central banks are trying to shrink their balance sheets by selling bonds (quantitative tightening, or QT). However, this action pushes up bond yields, directly increasing government debt servicing costs and creating a policy conflict.

Investors are closely watching the Bank of England to see if it will significantly reduce its bond selling program in next month's decision.

Mahmood Pradhan, Global Head of Macro at asset management firm Amundi, states: "The central bank's dilemma is that if financial conditions tighten due to the government's fiscal policy, the central bank cannot be seen as accommodating that fiscal policy." He believes the Bank of England will "very strongly resist fiscal dominance pressures."

In the UK, long-term borrowing costs are particularly high, with 30-year gilt yields at 5.6%, near 25-year highs.

Even Germany, known for fiscal discipline, has seen its 30-year bond yields rise above 3% - the highest since 2011 - as the government plans to increase borrowing for infrastructure upgrades and defense spending.

Rising Market Concerns About Political Interference

In the United States, market concerns about political interference are manifesting through multiple indicators. Currently, the yield spread between 2-year and 30-year U.S. Treasuries has widened to near its broadest level since early 2022, reflecting market expectations of near-term rate cuts while also expressing concerns about long-term inflation and debt risks.

Capital Economics analysts believe the market's unusual reaction to bland inflation data suggests what might happen if the White House takes steps to exert more control over monetary policy. Additionally, the interim appointment of Milan, a White House insider considered likely to push for rate cuts, as a Federal Reserve Governor leads Trevor Greetham, Multi-Asset Investment Director at Royal London Asset Management, to believe this indicates "increasing risks of U.S. fiscal dominance."

Macquarie Group's Global Interest Rate Strategist Thierry Wizman notes that futures markets have already priced in expectations of five rate cuts by the end of next year, which appears "excessive" given the absence of economic recession. He believes this must reflect "some people thinking we're going to have a structurally dovish Fed Chair and Federal Open Market Committee (FOMC)."

Extreme Risk of "Debt Death Spiral"

Looking ahead, fiscal dominance could trigger more extreme risks. Renowned investor Ray Dalio of Bridgewater warns that in extreme scenarios, some countries could fall into a "debt death spiral," where governments are forced to borrow more money to pay soaring interest costs.

In an interview, Dalio explained that if bond yields become "too high, central banks will need to intervene again, printing money and buying bonds to try to suppress rates." He added that the ultimate result of such behavior would be "currency devaluation."

Such concerns could weaken "major reserve currencies" like the dollar and euro relative to gold. Gold prices have reached record highs this year.

Meanwhile, Matthew Morgan, Head of Fixed Income at Jupiter Asset Management, points out that market volatility makes it more difficult for governments to issue long-term bonds, potentially pushing them toward riskier short-term debt and making national finances more vulnerable to interest rate fluctuations.