Yet the defining investment story of the coming decade may lie elsewhere. An era of ‘fiscal dominance’ may be emerging, in which rising government debt and deficits constrain monetary policy and shape broader financial conditions. In a world of ever-higher debt burdens, governments are becoming increasingly sensitive to borrowing costs, limiting how far central banks can tighten policy without creating wider strains for public finances.
Global debt has surpassed $350 trillion, driven largely by increased borrowing in the US and China. Governments face mounting spending demands, from defence commitments to providing for ageing populations and the green transition. The result is an increase in debt issuance that markets have so far absorbed. Rather than provoking a crisis, the adjustment has so far taken the form of a gradual rise in bond yields as markets absorb increasing levels of government debt issuance.
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Fiscal dominance matters because it changes the relationship between governments and central banks. While policymakers remain committed to controlling inflation, markets are increasingly questioning whether elevated interest rates can be maintained indefinitely when governments are carrying historically high levels of debt. As a result, investors are paying closer attention to fiscal sustainability and requiring greater compensation to hold longer-dated government bonds. This has contributed to a rise in the term premium, reflecting concerns that larger borrowing requirements and persistent fiscal deficits could place upward pressure on inflation, bond yields and future debt servicing costs.
Perhaps the most striking feature of recent years is not the rise in debt itself, but the willingness of markets to absorb it. The UK provided a reminder of how quickly sentiment can change during the gilt market turmoil that followed the Truss-Kwarteng mini-budget in 2022, when investors questioned the credibility of fiscal policy. Despite unprecedented borrowing requirements, government bond markets have remained broadly orderly, even as yields have moved higher.
Yet the implications extend beyond governments. The race to build artificial intelligence infrastructure is driving a new wave of corporate investment, with major technology companies committing vast sums to data centres, computing capacity and supporting networks. As governments issue greater volumes of debt, businesses increasingly compete for the same pool of capital. Artificial intelligence may dominate today’s headlines, but one of the defining investment questions of the next decade could be who ultimately funds rising fiscal deficits and at what cost.
For investors, this may mark a shift in the investment landscape. The post-financial-crisis period was characterised by falling interest rates, abundant liquidity and central banks willing to suppress bond yields through asset purchases. That backdrop provided a powerful tailwind for both equities and bonds. Fiscal dominance points towards a different environment, one in which government borrowing increasingly competes for capital and keeps long-term yields structurally higher.
Higher yields do not necessarily imply a negative outlook for markets. Fixed income once again offers meaningful income, while companies with strong balance sheets, pricing power and robust cash generation may prove increasingly valuable.
More broadly, investors may need to place greater emphasis on valuation discipline and capital allocation rather than relying on ever-lower discount rates to drive returns. Importantly, fiscal dominance is not simply a risk for investors. Financials, particularly banks, could be among the clearest beneficiaries of a world in which bond yields remain structurally higher, supporting lending margins and profitability.
Investors spent the last decade watching central bankers. The next decade may require them to pay much closer attention to finance ministers, debt auctions and government balance sheets. Monetary policy will remain important, but fiscal policy may play a much larger role in shaping market outcomes. That shift could reshape portfolio construction and asset allocation.
Fiscal dominance is no longer an academic theory. It is becoming one of the defining forces shaping markets, economies and investment returns.
Gareth Gettinby is an investment manager at Aegon Asset Management