9th October 2026
We try to read and digest a lot of investment analysis written by people we respect even if (or especially if) it jars with our positioning or when those people tackle investing from a completely different viewpoint. Top-down or macro investing is one such example of the latter. Over the past year, we have been increasingly intrigued by the views of some US-based independent macroeconomic thinkers (Luke Gromen and Lyn Alden to name two) – not least because they have been forewarning of a dynamic that appears to be playing out: the breakdown of the usefulness of monetary policy as a tool to control inflation. The implications are significant and worth spelling out.
The grossly oversimplistic precis of the thinking is as follows. The US (and to a similar degree, much of the western world) has a large stock of debt held at government level. The government is running persistent annual deficits (tax receipts below spending), has done for some time, and is doing so whether the economy is booming or in recession. In addition, the economy is becoming increasingly “K-shaped”, as high-income earners and asset owners continue to do well whilst low-income earners and renters struggle. Most of the population are in the latter group and are feeling miserable given rising cost of living and stagnant wage growth. This situation is worsening, not getting better (i.e. the discrepancies are becoming larger).
Meanwhile, in the US especially, the economy is booming but doing so thanks mainly to the narrow AI-related growth impetus. Stock markets are performing well despite ever higher bond yields (which tend to put downward pressure on stock valuations via higher discount rates on future cash flows), which demands an explanation beyond a simple: “the economy is doing well and higher yields are a healthy reflection of a strong economy and resulting inflation” narrative.
The answer lies in the concept of “fiscal dominance”. This occurs when the government holds such a high proportion of an economy’s total debt relative to the private sector that it impacts the central banks’ ability to control inflation through setting interest rates. Traditionally, interest rate hikes lead to falls in economy-wide demand (higher borrowing costs, less credit creation) and thus falling inflation. But what if rate hikes actually stimulated more inflation due to who holds the debt and who holds the wealth?
Governments today have built up huge cumulative entitlements and promises – e.g. via benefits and pension payments, rising healthcare costs and higher spending on defence. These are hard, if not impossible, to cut. We are taught in A-level economics, that governments can pay down their stock of debt in times of economic booms when tax receipts exceed expenditure. But as a result of all these factors, and the politician’s desire to over-promise to win votes, in recent cycles governments have rarely run surpluses and used them to pay down debt. So when independent central banks raise rates to meet inflation targets, the stock of debt at government level is so large that the interest expense increases, which in turn widens the annual deficit and increases the stock of debt.
In fiscal dominance, interest rate rises do not combat inflation. If the private sector isn’t very indebted – or more precisely has a balance sheet relative to the government that is just healthy enough – the hike in interest rates is actually stimulative! Imagine a wealthy individual, earning a high salary, with lots of cash in the bank, and maybe a mortgage fixed at low rates with a long maturity. A hike in interest rates increases the cash flow to that person via cash on deposit. Indeed, if the new stock of US Bills and Treasuries are issued at higher rates to this part of the economy the impact is a flow of money from the Treasury to the private sector. These cash flows might then be invested into financial assets like equities (as they accrue to wealthy individuals who already have disposable income).
There will be some parts of the private sector where activity is dampened by the increase in borrowing costs, but if the K-shape is advanced enough, this contractionary impulse is more than offset by those parts of the private sector that benefit and are indeed stimulated.
Finally, remember that markets are discounting mechanisms. The dynamic explained above may not be in play today, but if the mathematics are clear enough (high stock of debt, clear annual government deficits, no political will to rein in spending) then market participants will price in fiscal dominance ahead of time. Without a sea-change in political will, “nothing stops this train”. Deficits will stay wide, the economy will remain stimulated, the K-shape will worsen.
If this is happening, then you wouldn’t expect interest rate hikes to pull down longer-term rates via the usual dampening of economic activity / inflation mechanism. And the evidence from the recent past suggests this is exactly what is playing out.
If that is the case, what does it mean?
- You don’t want duration in your fixed income allocation.
- You want to own scarce assets (inflation is not under control – own real assets that can appreciate in line with inflation)
- You want to beware of debasement (if the yield curve is responding the “wrong way” to monetary policy, we might see even more fiat debasement and financial repression)
- You want to own companies with strong economic moats and margins that can cope with increasing input costs – but perhaps not those which might become the target of the disenfranchised K-shaped economy (i.e. those that are might be seen as profiteering or not paying their way via tax avoidance).
The funny thing is that that is very close to how we are positioning our portfolios – yet from a completely opposite (bottom up) way of thinking!
We don’t see the need to be taking on lots of duration risk when yields at the very short end and in high-quality floating rate securities are high enough (as well as giving us lots of potential dry powder). We have recently introduced dedicated commodities exposure and have plenty of real asset exposure as we’re sure you know (infrastructure, shipping, renewable energy). We have healthy allocations to gold and gold mining shares. And this year we bought into so-called “quality” equity funds for the first time in years (as valuations had become attractive again). Meanwhile we avoid those areas of the market where valuations are stretched and reliant on the continuing AI boom.
To conclude, we find it a source of comfort that some writers, thinkers and investors who we respect and who come at the puzzle of investing with a completely different method, end up constructing portfolios not widely different to our own. We also must recognise a potentially vastly different world in which we’re investing. If interest rate hikes are stimulative, it means we must not be tempted to lengthen our duration too early. We must recognise that equity markets can stay richly valued for longer (not necessarily ideal for our valuation-centric process). And we must manage our investor expectations accordingly.
Ben Conway – Head of Fund Management
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