Tag: Fiscal Dominance

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Gold Plunges

Key Points

  • Gold is trading at $4,230 per ounce, having breached primary support at $4,400.

Gold breached primary support between $4,400 and $4,600 per ounce, triggering further stop-loss selling.

Spot Gold

There are two primary reasons for the current sell-off:

  1. Gulf states are expected to liquidate reserves, including gold bullion, to support their finances as oil export revenues are curtailed.
  2. Long-term interest rates are rising in anticipation of an inflation spike caused by high energy prices from the Iranian blockade. High interest rates make bonds more attractive and reduce demand for gold.

Bullion sales will likely cause a temporary increase in supply, driving down gold prices until reserves are exhausted or Iran’s blockade of Gulf shipping ends. Demand is likely to increase thereafter as reserves are replenished.

Long-term Treasury yields are rising. Breakout of the 10-year yield above 4.3% indicates another test of resistance between 4.8% and 5.0%.

10-Year Treasury Yield

However, rising inflation and long-term interest rates will likely have less influence on gold demand because the two forces tend to offset each other. High inflation increases demand for gold as an inflation hedge, while high interest rates increase the opportunity cost of holding gold and suppress demand.

Our long-term bullish outlook for gold is based on the belief that precariously high US debt levels will eventually force the Fed to suppress long-term interest rates.

US federal debt jumped to $38.5 trillion at the end of 2025.

Federal Debt

The ratio of federal debt to nominal GDP is at an unsustainable 122.5%.

Federal Debt to Nominal GDP (%)

Moreover, the fiscal deficit will likely exceed $2 trillion for the current fiscal year. The deficit for the 5 months to February 2026 is at $1 trillion, but the next few months are about to blow a big hole in the budget.

Federal Deficit

First, the US Supreme Court has ruled that tariffs implemented by the Trump administration exceed the President’s constitutional powers, and most of the $144 billion in Customs Duties collected will need to be refunded.

Second, the newly renamed Department of War is about to present Congress with a $200 billion bill for the US war on Iran, so far. The war is only three weeks old, and the final bill will likely be a lot higher.

Third, rising energy prices threaten to crash the stock market. A crash would substantially reduce capital gains, a major component of Individual Income Tax revenue.

Finally, rising interest rates will further widen the ballooning deficit, with accelerating government debt-to-GDP ratios raising risk premia, which in turn drive interest rates even higher.

The Federal Reserve would be forced to prioritise the faltering US Treasury over the Dollar, thereby sacrificing its mandate to maintain price stability. Long-anticipated fiscal dominance would mean the Fed suppresses long-term yields to improve the Treasury’s ability to service its debt. The resulting sharp rise in inflation would undermine the Dollar and boost demand for gold and other inflation hedges.

Conclusion

We expect gold to test support at $4,000 per ounce.

However, our long-term outlook for gold remains bullish, with ballooning budget deficits and fiscal dominance likely to cause a steep rise in inflation and erode the purchasing power of the Dollar.

 

Acknowledgments

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Rising Crude and Gold warn of inflation

Brent crude continued its advance, closing at almost $89 per barrel on Tuesday. Our target is $94 per barrel would increase inflationary pressure in the months ahead and possibly delay Fed rate cuts.

Brent Crude

Rising crude oil prices have forced cancellation of plans to restock the strategic petroleum reserve (Bloomberg). US crude and petroleum inventory (including SPR) is testing the lows from January 2023.

Crude & Petroleum Inventory

Treasury Market

10-Year Treasury yields broke resistance at 4.35% but is retracing to test the new support level. Respect would confirm an advance to test resistance at 5.0%. Failure of support is less likely but would warn of another test of 4.05%.

10-Year Treasury Yield

Federal debt at 120% of GDP, deficits of 6% of GDP, and a growing interest rate burden limit the available options.

Federal Debt/GDP

The Fed can suppress long-term interest rates but the cost — in terms of inflation — is likely to be high.

Federal Debt Interest Burden

The US is well along the path to fiscal dominance as explained in this 2023 paper from the San Francisco Fed:

Fiscal dominance refers to the possibility that the accumulation of government debt and continuing government deficits can produce increases in inflation that “dominate” central bank intentions to keep inflation low….If global real interest rates returned tomorrow to their historical average of roughly 2 percent, given the existing level of US government debt and large continuing projected deficits, the US would likely experience an immediate fiscal dominance problem. Even if interest rates remain substantially below their historical average, if projected deficits occur as predicted, there is a significant possibility of a fiscal dominance problem within the next decade.

The essence of fiscal dominance is the need for the government to fund its deficits on the margin with non-interest-bearing debts. The use of non-interest-bearing debt as a means of funding is also known as “inflation taxation.” Fiscal dominance leads governments to rely on inflation taxation by “printing money” (increasing the supply of non-interest-bearing government debt).

The rise in Gold — currently at $2270 per ounce — reflects bond market fears of an inflation rebound.

Spot Gold

The same inflation fears are also driving demand for stocks.

S&P 500

US Economy

The US economy continues to display resilience, with job openings holding steady at 8.8 million in February, exceeding unemployment by a wide margin of 2.3 million.

Job Openings & Unemployment

Light vehicle sales remain robust at a seasonally-adjusted 15.8 million annual rate in February, reflecting consumer confidence.

Light Vehicle Sales

However, heavy truck sales (41.6K in February) are trending lower — with the 6-month moving average crossing below the 12- month MA — reflecting declining business confidence.

Heavy Truck Sales

Conclusion

The economy remains robust but fears of an inflation rebound are growing, fueled by rising crude oil prices and large fiscal deficits. The odds of Fed rate cuts in the second half of the year are shrinking but there are still two possible scenarios:

  1. A sharp decline in economic activity could still prompt the Fed to cut rates despite inflationary fears. That would be a strong bear signal for stocks.
  2. Fiscal dominance, with the deliberate use of inflation as a tax in order to restore the ratio of debt-to-GDP to more sustainable levels. This involves shrinking the public debt in real terms by expanding GDP through inflation. A strong bull signal for real assets such as Gold, Stocks and Commodities.

Acknowledgements

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