US Economy Enters Era of Increasingly Dominant Fiscal Dominance

Illustration (Photo: ANTARA)

JAKARTA - Chief Investment Officer of DBS Bank Hou Wey Fook said that the United States (US) economy is entering an era of fiscal dominance that is increasingly prominent.

"Persistent deficits and rising debt have raised concerns that government financing will cloud monetary policy," he said, quoted by ANTARA, Wednesday, January 14.

Any weakening of the Fed's independence could reignite inflation fears and force markets to demand a higher risk premium.

If fiscal and monetary easing continues unchecked, he continued, price pressures will increase further because of the absence of a comprehensive fiscal framework to control public debt, not tariffs or supply constraints, which are the main drivers of inflation.

"For investors, this is not just a theoretical risk, but a practical challenge. Protecting portfolio value means investing in real assets. Infrastructure, property, commodities, and precious metals have historically performed better during inflationary cycles, making them an indispensable element of today's strategy," said Hou.

However, he said, inflation is not the only structural shift that is reshaping the market.

Deglobalization accelerated by protectionist policies such as "America First" has had two negative impacts, namely a weakening trade flow and higher production costs.

Despite facing these challenges, the macro momentum is said to remain strong thanks to a strong capital investment cycle.

Artificial intelligence (AI) and defense spending are leading this trend. Hyperscalers (cloud service providers) alone are expected to spend $1.4 trillion on AI infrastructure between 2025 and 2027, while NATO's defense budget is expected to rise from 2 percent to 5 percent of GDP by 2035.

This commitment is said to represent a structural breath of fresh air that has the potential to redefine the landscape of industry and technology.

On the other hand, the AI boom shows the characteristics of an euphoric market, including high valuations, concentration risks, and speculative enthusiasm.

However, unlike the dotcom boom, the current macro background and policies are much more solid. Big Tech's spending plan, although large, is still comparable to GDP.

"We recognize that complacency can be dangerous. The emergence of circular financing, a trend where companies fund each other's growth, is reminiscent of vendor financing practices in the late 1990s, and therefore needs to be closely monitored to identify potential systemic vulnerabilities," he said.

As the Fed shifts to rate cuts in a non-recessionary environment, the pressure on prices is likely to be pronounced.

Real assets remain the most effective hedge against persistent inflation. By comparing the relative performance of silver and the S&P 500 as proxies for real assets and the broader financial assets respectively, DBS sees investor positioning having reached extreme levels, creating an opportunity for diversification.

In short, continued Hou, including tangible real assets is a strategic step compared to just a defensive step.

Furthermore, speculative capital flows into the artificial intelligence (AI) and technology sectors have pushed high-risk stocks (high beta) to very high levels, supported by funds flowing into Exchange-Traded Funds (ETFs) that use leverage.

The credit market also showed superior performance of high yield bonds which have reached their limits.

"For the coming quarters, resilience will come from a focus on quality, leading to our recommendation to prioritize quality stocks and investment grade bonds," said the Chief Investment Officer of Bank DBS.