Kevin Warsh has spoken and has given clarity. Not forward guidance, but that was never investors’ gripe — it was the Missing Reaction Function.

At Jackson Hole Warsh filled in many of the blanks. He gave a read on the economy, he raised key issues around AI that the Fed is grappling with, he outlined key data he was watching, and he stated key principles that should guide Fed decisions.

The tone of his remarks was distinctly hawkish and markets reacted accordingly. US 2-year yields rose 13bp and the probability of a hike at the September FOMC rose from about 35% to 60%.

But paradoxically, the new clarity around his reaction function raises an uncomfortable tension: the more hawkish Warsh sounds, the harder his previous reluctance to tighten becomes to explain.

And beyond that, the real questions investors now have to grapple with are:

Is he about to lead the FOMC and form a majority for tighter policy? Or is he anticipating that the balance of the committee is now leaning hawkish and he is positioning for that?

Can he fend off pressure from the White House not to raise rates, or does he even want to?

The (previously missing) reaction function

The frustration amongst investors after the July FOMC was not the lack of explicit forward guidance. It was that Warsh gave no real insight into what he thought about the economy or the key things he was watching in assessing it.

This time was different, significantly so.

On Friday he effectively outlined a scorecard on the US economy’s performance.

Growth is solid. Real consumer spending has been growing at a solid rate despite the shock to energy prices from the conflict in Iran. He has focused on the growth of private domestic final purchases (PDFP) (+3% this year) as evidence of the solid growth.

Business capex has been a significant driver of growth, heavily driven by AI-related buildout.

The labour market is stable. Although job growth has been low, the unemployment rate is also low, and he justified low job turnover as being driven by skills rematching between employees and employers.

The corporate sector is strong. S&P 500 profits have grown by over 20% in the last year, and profit margins are high relative to history.

But inflation is above target by all measures — both the CPI and the PCE and their core variants. Critically, he gave a sense of what he looks for in determining underlying inflation by focusing on the number of PCE components running above 3% year-on-year.

Over the last six months, 49% of goods and services in the PCE basket are experiencing inflation above 3% — below the post-pandemic highs but elevated relative to the two decades before the pandemic.

What’s more, when assessing financial conditions, he opined he’d be hard pressed to describe monetary policy as restrictive.

Summing up, he didn’t give forward guidance, but his conclusion was that unless the FOMC was confident inflation was moving towards target, clearly and at sufficient speed, the Fed had “more work to do.”

In the WSJ, former Fed Governor Don Kohn summed it up: going into the speech the default was that the Fed would be on hold in September barring a data surprise; post-speech the Fed could be expected to be tightening in September barring a data surprise.

The bigger picture

He also gave further insight into the big picture questions the Fed is grappling with, particularly in relation to AI and its economic impact.

Before being appointed, Warsh stated that he felt AI was a game changer for the economy, and a potentially significant disinflationary force.

This time, he again showed his optimism, suggesting that a kind of hyper Moore’s Law was underway, but on its economic impact he offered more questions than answers: would capital or labour grab the gains from AI? Will productivity pick up? When? Will token prices fall to their marginal cost?

The possibility that this could be a justification for easier policy down the line remained, but he did state that these factors wouldn’t influence policy decisions in the near term.

Where he did offer genuine insight was in the list of principles that would guide future decisions.

One might have guessed many of them — PCE is still the target; it’s the Fed’s role to deliver price stability; there is no inherent conflict for the Fed in achieving both price stability and maximum employment.

But the one that stood out was his assertion that money matters. It’s a theme he has alluded to previously. Notably, while he was careful not to nail his colours to a monetarist mast, he did emphasise that although it may be difficult to measure monetary aggregates, that was not a reason for ignoring money.

Precisely what a greater focus on money and money growth might mean for policy at the current juncture is difficult to say. A recent monetary analysis by Stephen Miran, Nouriel Roubini and Peter Ireland concluded that current money growth is approximately neutral in terms of its impact on inflation.

It’s not a factor of immediate importance for Fed deliberations but expect to hear more about this as Warsh’s tenure extends.

The implication for policy, and for markets

For all the detail and the hawkish noises, investors are still left with the fundamental question of what Warsh is likely to do.

Warsh has urged investors to look through the noise to focus on “what’s really going on” within the economy, but the million-dollar question for investors is “what’s really going on with Kevin Warsh.”

A naïve interpretation is that he gave a hawkish read on the economy, so we should expect higher rates.

But we had similar talk in June and then no action in July.

In fact, in three public appearances since taking on the job of Fed chair, Warsh has sounded hawkish. His bias has been more pronounced than that of, say, Chris Waller or John Williams, both of whom place more emphasis on how the incoming data play out, and can justify inaction on the basis of the last two weaker inflation prints.

Instead, Warsh justified inaction in July on the basis of waiting for further information on “investment flows, geopolitics and supply chains” — all quite vague factors that are unlikely to materially change between now and the September FOMC meetings.

After the June FOMC, Ed Yardeni referred to Warsh as a hawk in dove’s clothing. In reality, we still can’t rule out him being a dove in hawk’s clothing.

Context matters.

We can’t ignore the political pressure that has come to bear on the Fed from the administration in recent years. Warsh was keen to emphasise the possibility of lower rates in the months leading up to his appointment.

He has regular phone calls with Trump, something which has not characterised previous President–Fed Chairman relationships.

Is he willing to tighten policy in the face of political pressure? Could he sell voting for a rate increase to the White House on the basis that the majority has already shifted that way? Could he simply discard the political pressure and vote for higher rates because he believes it’s the right thing to do?

It’s hugely consequential for markets.

After the June FOMC the USD rallied, gold sold off and the curve flattened — all classic signs of confidence in the Fed and higher rates. But after the July meeting was the opposite — a weaker USD, higher gold and a steeper curve. After Friday the market has given him the benefit of the doubt, with the USD bouncing, gold selling off and the curve flattening.

But that heaps the pressure on for September.

There is no doubt that Warsh must feel pressure to establish inflation credibility by tough talk on price stability. But it has to be backed up.

Ultimately, a meaningful and credible reaction function requires policy decisions that can be reconciled with that reaction function. Warsh may still have left some wiggle room in this speech and bought time with a solid performance. But over time, action and outcomes will matter more.

The job of the central banker is to be unpopular — to take away the punch bowl as the party is getting going, as William McChesney Martin described it. The job is tougher when the party is in full swing and the President of the US is the DJ. Does he have the stomach for that?

My bias is that the market has given him more than the benefit of the doubt.

Scott Bessent wants a stronger yen and a weaker US dollar, without having to sell US dollars or US Treasuries.

His carefully choreographed recent foray into the JPY again highlights the dilemma the US faces: it seeks a weaker USD to support manufacturing, but a stable dollar to attract investors into the US Treasury market and keep yields stable.

But, as a former FX trader he will know that, when it comes to FX intervention, it’s a case of careful what you wish for. In 1998 US intervention to support the JPY ultimately saw a USD/JPY collapse from 136 to 111 in four days, amid a huge carry unwind. A repeat of that episode would not be helpful.

Threading the needle will be difficult and may ultimately rest on the actions of Kevin Warsh and the FOMC, rather than the BoJ and Treasury.

A historic intervention

The JPY weakened over the last two weeks as investors continued to digest the historic Fed/BoJ coordinated intervention in late July. The intervention was a success in terms of the magnitude of the initial move, but we’ve already seen a giveback of gains.

Although the US intervened to buy Argentine pesos in recent months, forays into FX markets are rare. It’s not an overstatement to label the joint BoJ/Fed intervention of late July as historic. In fact, you have to go back to 1998 to find the last time the Fed and BoJ jointly intervened to buy JPY.

But even at that, this was no ordinary intervention. Curiously, the Fed sold EUR to buy JPY (rather than selling USD/JPY), and the BoJ and Bessent agreed that the BoJ would tap the FIMA (Foreign and International Monetary Authorities) facility at the Fed for future interventions

Why sell euro/jpy?

The decision to sell euros rather than dollars was curious.

It was framed as a portfolio management decision for the Exchange Stabilisation Fund – the vehicle the US Treasury can tap into for FX trades. The US had bought euros in a previous joint intervention with the ECB in 2000, and EUR/JPY is about 80% higher than those levels now. The US can plausibly argue they were just taking profits and buying some cheap JPY.

However, it was notable that the US defied normal currency market and international monetary convention by not informing the ECB of the move beforehand. The fact that the US administration didn’t obey normal conventions in this matter is hardly a shock, but it is another reminder that relations between the US and Europe remain cool.

Some, like Barry Eichengreen, have argued that the decision to sell EUR not USD reflected a desire not to upset the Treasury market. That’s possible but in reality the US could have raised USD from any number of sources.

Of more significance is that the US still, officially, has a strong dollar policy. Intervening to sell dollars might have been seen as flying in the face of that policy, even if the market already suspects the US has a desire for a weaker USD.

Tapping FIMA

But where the sensitivity around the US Treasury market really was apparent was in the announcement that the Bank of Japan would tap the Fed’s FIMA repo facility for any future interventions.

The announcement was startling for (1) effectively acknowledging that more BoJ intervention is likely and (2) highlighting the current sensitivity the US has towards any large holder of Treasuries liquidating their holdings.

The FIMA facility was originally designed as a facility to access USD liquidity, particularly for foreign central banks that didn’t have US dollar swap arrangements with the Fed.

Some have suggested that this amounts to QE in disguise – it’s not. It’s much more akin to standard open market operations. But the move does highlight Bessent’s pragmatic approach and greater coordination between the Fed and Treasury.

What’s the end game?

As I wrote previously, the US faces a currency trilemma. Bessent is trying to balance Trump’s desire for a weaker USD, maintain the US dollar’s reserve currency status and keep the dollar stable enough to attract inflows into the US Treasury market to fund ever-rising US issuance.

The current episode puts that trilemma in sharper focus.

Trump has previously been very vocal in his belief that the USD/JPY rate is misaligned. In 2024, prior to re-election, he gave an interview with Bloomberg Businessweek stating that “ we have a big currency problem because the depth of the currency now in terms of strong dollar/weak yen, weak yuan, is massive“.

That was in June 2024 when USD/JPY was in the high 150s, just before the USD weakened following a mini-unwind of the carry trade driven by an expectation of lower US interest rates.

From that perspective, it appears 160 may be a line in the sand in USD/JPY. Although the JPY has been on a weak trend since 2021, it has been in a 140-160 range since 2024. Just recently it had appeared to have broken out above 160. Bessent would have known that momentum can build quickly in FX markets – after 160, markets will look for 180 and 200.

The US-Japan rate differential

Key to the fundamentals is the US-Japan rate differential. The obvious cure for a weak yen is higher Japanese rates. If the BoJ were to more aggressively tighten policy that would likely be a more significant support for the yen than any BoJ or Fed FX intervention.

Japan Call Money/Interbank Rate

Source: FRED

Although the BoJ has raised rates from below zero, it has done so in a more gradual manner than other central banks, resulting in a positive rate differential that drives not just the carry trade amongst speculators but also capital flows from Japan.

Of course, JGB yields now offer a reasonable alternative at 2.8%. But yields continue to trend higher, suggesting demand is still lukewarm. Higher JGB yields may also be a thorn for the US, to the extent that they push up US yields at the margin.

Also, although Japan has emerged from deflation, the scars of decades of deflation still remain. The suspicion in markets is that Japan (and particularly new PM Takaichi) is comfortable with a mix of loose fiscal policy and accommodative monetary policy to try and supercharge the economy.

From the US perspective that’s not all bad. A strong Japanese economy is also beneficial to the US, increasing demand for US goods. But it’s a delicate balancing act to try and engineer a strong economy, stable yields and a stable currency.

Careful What You Wish For

As Treasury Secretary, Bessent will know, engineering a stable currency is not as easy as it sounds. Back in 1998, the last time the Fed intervened in the JPY alongside the BoJ, the move initially did produce stability and the JPY rose.

But then the Asian crisis escalated and led to the Russian debt default and the demise of LTCM. The Fed reacted and cut rates 75bp. A gentle downtrend in USD/JPY turned into a stampede, and USD/JPY fell from 136 to 111 in four frenetic days of trading.

It’s a warning sign of what could happen if there were a more widespread unwind of the carry trade.

What that episode also highlights is the importance of the FOMC. What happens from here is not just about Bessent or the BoJ, it’s about the Fed and Kevin Warsh.

If the US hikes in the next few months, the pressure for a stronger USD will likely resume. At the same time, if at some point the US economy turns down and the rate cycle turns, that would be a significant signal for a weaker USD (as we also saw in 2024).

Threading the Needle

For now, with the rate differential largely unchanged, the impulse for the market is likely to test the topside again and feel out the authorities’ resolve. After intervention in June 1998, the USD rebounded and tested the top of the range but couldn’t make new highs.

But in the bigger picture, what we can say is Bessent’s experience in FX can help him be pragmatic and tactical. We have already seen this in Treasury issuance.

But there is a limit. Market forces inevitably prevail. For USD/JPY, Warsh may ultimately prove to be the bigger player than Bessent or the BoJ.

The FOMC meets this week amid unusually high uncertainty.

According to the FT, markets are pricing a 38% chance of a rate hike up from 13% a week earlier. What’s more, the uncertainty around the outcome has translated into 50% more trading on fed funds futures versus the same meeting last year.

Whereas under Powell, the outcome may have been leaked via Nick Timiraos in the Wall Street Journal, Kevin Warsh has brought a communications revolution to the Fed. He has downplayed forward guidance and dot plots and instead wants markets to make their own assessment on where rates are heading.

The approach has merit. Forward guidance was a policy designed for a different era, when interest rates were near zero and shaping expectations became a policy tool in its own right.

But there is an important distinction between giving guidance on the path of rates and explaining the framework used to set them.

Warsh has withdrawn the former. Markets are still waiting for the latter. Until they get it, greater volatility, a higher term premium and questions over the Fed’s credibility are likely to persist.

The Warsh revolution

Before his appointment, investors were split as to whether Warsh would be a dove or a hawk as Fed Chair. That question has yet to be truly answered. But what is clear to date is that Warsh intends to take a radically different approach when it comes to Fed communications.

We already saw this at his first FOMC meeting In June. Unlike his FOMC colleagues, he declined to submit a forecast to the dot plot. The statement after the meeting was much shorter than before. And in the press conference following the meeting he offered little insight on his thinking about the economy or the likely path for monetary policy.

Warsh believes forward guidance can be a bad thing. It can box the Fed in and remove its policy flexibility. It also removes an important source of information for the Fed – the markets themselves.

He believes if markets can tap into the wisdom of the crowd, and formulate their own opinion on the likely path of interest rates, that can be valuable information for policymakers.

A policy for a particular time

There was a time when the Fed was much less transparent on its thinking. Greenspan was famously opaque with his guidance, and it was only in 1994 that the Fed started to issue a statement after the FOMC meeting.

It was Ben Bernanke who set out the case for greater transparency in a couple of speeches in 20041. Bernanke argued that the Fed only controls short term interest rates, and it was long-term interest rates that really mattered for the economy. In that era, before QE had become a policy option, better communications by the Fed could help the market calibrate future policy which, in turn, could help the Fed influence long-term interest rates.

When the Fed hiked in 2003-2006, perhaps conscious of not repeating the 1994 bond market meltdown, they emphasised rates would go up “at a measured pace”. And after the GFC when rates were already zero, they signalled rates would stay low “for an extended period” to try and anchor long-term rates as well as short-term rates.

But over time, guidance has evolved from a goal of influencing long-term rates to drip feeding every decision to the market, seemingly to reduce market volatility. It has had costs as well, arguably tying the Fed’s hands somewhat when they needed to tighten in 2021.

But we’re now in a different era. The Fed has other tools and there is a greater uncertainty. Tariffs, AI and supply shocks have all created policy dilemmas for central bankers meaning making commitments about where rates may be heading over a period of time has become fraught.

Two kinds of guidance

But there is a difference between forward guidance on interest rates and guidance on how the Fed is thinking about the economy. Less precommitment on rates may not be a bad thing but no guidance on the framework leaves a huge vacuum for markets.

The issue is particularly acute given the current macro backdrop. Tariffs and supply shocks have already made policy making more challenging, but AI is the real conundrum.

There is a demand element (investment in chips and data centres) and a supply side (greater output from higher productivity) element to AI. Currently the demand impact is more obvious and is pushing up inflation. Former Fed Vice Chair Rich Clarida, now at Pimco, estimates AI-related spending may have boosted core inflation by 0.5%.

For policymakers it creates a dilemma captured by the question:

What is the appropriate policy response to something that appears to be pushing up inflation in the near term but is likely to be disinflationary at some point down the line.

The textbook answer is that a productivity shock should translate into higher trend growth and higher interest rates, but Warsh has appeared sympathetic to the disinflationary arguments in the past. And at a recent central bankers’ event in Sintra he remained ambiguous about his answer.

The credibility question

Less transparency and guidance may have merit but for Warsh it has also offered some convenient breathing space.

To date he hasn’t been forced to lay out his take on the economy, the balance of risks or the appropriate policy. The question of whether he is truly a dove, a hawk, or a pragmatist remains unanswered.

Before his appointment there was real concern in markets about Fed independence. The possibility that Kevin Hassett, Director of the National Economic Council, may be appointed was seen as potentially damaging to Fed independence.

Warsh’s background as a former Fed governor has given him immediate credibility, and in his first press conference, he talked tough about price stability, assuaging those who were concerned he may insist on easier policy to satisfy Trump’s demands for lower rates.

His five taskforces, focused on everything from communication to inflation to the conduct of monetary policy, are also reasonable, but also provide a justification for inaction.

Why commit to a particular policy approach without first hearing what the taskforces come up with?

The real test

To date markets have given him the benefit of the doubt. The curve flattened after the FOMC meeting, breakeven inflation rates have remained steady and gold fell as the debasement trade seemingly went out of vogue.

By strongly committing to price stability, he has won some initial credibility without action. But that will only last so long.

Many questions remain unanswered. Warsh has talked about underlying inflation without offering a definition and he has mooted balance sheet reduction without providing a framework. He has offered no real opinion on the economy. Markets have no sense of his reaction function.

And tough choices lie ahead. His FOMC colleagues are biased to higher not lower rates as evidenced in the last dot plot, as the labour market has stabilised while inflation remains above target. But with the mid-terms now coming into view a rate hike in the next few months would be politically exceptionally unpalatable.

Perhaps his calculation is that by December, when the taskforces report, oil prices will have fallen, the impact of tariffs will have rolled out of the inflation data, and there will be more evidence of AI-related productivity gains.

But that’s not without risk. If inflation remains above target and the economy is strong, the calls for higher rates will grow louder and investors will ultimately need a plausible reason as to why the Fed is not moving on rates.

Warsh may have bought some time, and no change remains the most likely outcome this week.

Ultimately, credibility is earned by action, a coherent policy framework and achieving policy targets. That, more than any communications strategy, will determine the credibility of the Warsh Fed.

After rising nearly 250% between October 2022 and January of this year, sentiment towards gold has shifted markedly. The metal was down 14% in Q2, its worst quarter since Q2 2013. Having traded over $5,500/oz in January it’s now close to $4,000/oz, almost a 30% decline from the highs.

Back in January all the talk was of the debasement trade, central bank buying of gold and growing retail demand. Many investors bought into gold on the view that it’s a store of a value, an inflation hedge and an asset that could be a diversifier for not only equities and bonds but fiat currencies as well.

Since then, gold has fallen out of favour. What’s more the US dollar is rising and with the new Fed Chair recommitting to price stability, suddenly the debasement idea has evaporated.

For investors, the question is: is it a temporary correction or the beginning of a larger reversal?

A blow-off top

With the benefit of hindsight, it is easy to say sentiment towards precious metals got to an extreme in January. Not only had gold posted strong gains, but silver rose by nearly 250% between August and January, clearly an unsustainable move.

But the warnings had been in place for gold too. Technical indicators like the 14-month RSI touched 95 in February, an extreme overbought condition and as of the end of January gold was about 45% above its 200-day moving average, the largest deviation from trend since the 1980 high.

From that perspective, a 30% drawdown, which just represents a 41% retracement of the move from the October 2022 lows can plausibly be seen as a natural correction in a multi-year bull trend.

Indeed, in the last mega gold move in the 1970s, gold rallied 450% from its Jan 1970 lows to December 1974 and then declined by just under 50% between Dec 1974 and August 1976, before commencing a multi-year accelerated rise to January 1980.

Shifting cycles

When I wrote “Gold’s Place in an All-Weather Portfolio” in November last year I highlighted the attractions of gold: low correlation to equities and bonds, its ability to retain its value over the very long term and strong returns particularly since 2020.

I pointed out that since 2000, re-allocating 20% of an allocation from the S&P 500 TR to gold (for an 80-20 equity/gold portfolio) would have reduced the portfolio volatility from 15.2% to 12.8% and increased the realised annualised return from 8.0% to 8.8%.

But, as I said in that piece, the challenge with gold is it is an asset that can outperform equities in one macro regime yet endure twenty years of negative real returns in another.

• It soared during the great inflation of the 1970s.

• Then came two lost decades as inflation fell and central banks became heavy sellers.

• It rallied again in the 2000s but was range-bound for much of the 2010s.

Amid the bullish sentiment of January of this year, when investors were focused on the returns and the positive narrative, few were highlighting the fact that between 1980 and 2000 spot gold prices fell 71% in nominal terms.

The problem with gold

Arguably, the issue with gold is less about how it behaves and more about how it is perceived.

Labels like safe haven asset and store of value give an impression of safety and stability. Yet the reality is gold is more volatile than most equity indices.

Over the long term its annualised volatility is about 17% but at times its 20-day volatility can get up to 30-40%, or even close to 60%, as it did earlier this year.

Gold: 20-day annualised volatility versus long-term annualised volatility

A decline of 12% in a month or 14% in a quarter is not unusual, statistically, for an asset with that type of volatility.

Over the very long-term gold has retained its purchasing power and been a hedge against inflation, but it has gone through large up and down cycles.

For investors it creates a real dilemma. Gold’s low correlation to equities and bonds encourages a meaningful allocation to the asset, but a 30% drop is painful.

In theory diversification is the only free lunch in investing but at times it can certainly feel uncomfortable.

What changed

It’s important to put the current moves in context. Even after the current drawdown, gold’s realised returns are strong. Since 2000, spot gold has risen at an annualized rate of 7.9% and since Jan 2020 spot gold prices have risen by 16.1% per annum.

And from a fundamental perspective some of the factors which have been supportive gold in the last few years have paused or even reversed of late.

Central bank buying for reserve management, due to concerns about the US dollar, has been one of the big fundamental supports. Global central banks bought about 1,000 tonnes of gold p.a. between 2022-2025 up from an average of about 470 tonnes p.a. between 2010-2021. But this year some central banks, such as the Central Bank of the Republic of Turkey, have turned sellers as they have needed to monetise profits due to budgetary pressures.

Momentum trades like CTAs would have been buying once the rally started in late 2022 and 2023. They would likely have been trimming longs late in the rally in 2025 and early 2026 as volatility increased. Once the price trend reversed CTAs would have exited remaining longs and started to turn short.

The large rise in gold also brought the metal increasingly to the attention of retail investors; ETF demand picked up notably last year and into early this year. But there is nothing like price to influence sentiment and as soon as prices stopped rising, and showed signs of reversing, ETF demand slowed and ultimately reversed.

That partially reflected a changed macro back drop. A weaker US dollar and a perception of low US interest rates were other supports, and those two factors have turned from tailwinds to headwinds.

Putting it together paints a picture of a market with real fundamental demand, on the theme of central bank reserve diversification, but with price subject to large cyclical variations based on momentum and the behaviour of retail participation.

The big picture: correction or regime change?

For all of those negatives the big picture still looks positive.

Yes, the US dollar is enjoying a cyclical rally, which could extend if the economy stays strong, inflation stays elevated and the Fed is forced to raise rates. But in the bigger picture the risks appear to be greater for dollar weakness as global investors remain overweight dollars.

Although concerns about US dollar debasement have eased for now, the US debt/GDP ratio is above 100% and that is before the looming wave of increased spending in relation to entitlements in the next few decades is factored in. Politically, there is no appetite to address the fiscal deficit, suggesting the default will be more spending and potentially more money printing over time.

Meanwhile, economic growth has been solid in the US, but the economy has become increasingly unbalanced and reliant on the AI boom. But if the AI capex cycle runs its course, at some point equities could fall and the wealth effect from rising stock prices would go into reverse. In that scenario we’d likely see even higher fiscal deficits and lower interest rates – both positive for gold.

Managing gold exposure

Is it a temporary correction or a fundamental change in trend?

History suggests the former is more likely. Gold’s boom-bust pattern has repeated for years, and a 30% drawdown after a 250% rally is well within that pattern, not outside it. In fact, another 20-25% decline from here wouldn’t be unusual either, and wouldn’t necessarily change the longer-term case.

In my original piece I highlighted the merit of a dual approach to hold exposure – maintaining a strategic long exposure to gold and combining that with active tactical exposure which can be achieved by allocating to trend following.

The tactical element would have added to overall exposure during the bull run but would have been incrementally reduced this year and is now providing a small offset to the core strategic long.

Gold is sold to investors on its label: safe haven, store of value, inflation hedge. But it should be sized and managed on its behaviour: a genuinely volatile asset that can swing 30% in a matter of months.

Investors who understand that distinction can hold gold through periods like this one. Those who don’t tend to chase it at the top and sell out in the drawdown.

With equities back at close to all-time highs, powered by the strongest two-month move in the S&P 500 since April 2009, the bulls are back in control.

The concerns that have weighed on stocks this year (the disruptive impact of AI and the stagflationary impact from the conflict in Iran) have both been pushed aside by the ebullience around AI.

It’s business as usual for the equity bull market that has been ongoing for seventeen years now.

Yet, from a macro perspective much has changed. As economist, Mark Blyth told me earlier this year, the hardware of global capitalism still runs, but the software is broken. It’s a topic I will pick up with him at our upcoming event.

So far, both bond markets and commodity markets have taken note of that change in software but equities have embraced the opportunities while largely overlooking the risks. Can that continue?

The Old Operating System

For decades, the global economy was shaped by the dominant ideology of neoliberalism, free markets and globalisation. The embrace of those principles emanated from the disappointment of the 1970s when stagflation was seen as a product of a more unionised, managed and closed system.

The big bang deregulation of the 1980s, the embrace of free market principles by Thatcher and Reagan, China’s accession to the WTO, and the acceptance of the need for independent central banks were all landmarks on the road to a globalised, free trading world. It became known as the Washington Consensus.

The result was a low inflation economy where cheaper manufactured goods from the east kept inflation in check in the west. At the same time surpluses were recycled into developed market bonds, keeping yields subdued and supporting financial assets. The Great Moderation of solid growth, low inflation and low macro volatility of the early 2000s was the high point of the era.

But each macro regime sows the seeds of its own destruction, and the old regime was no different. The excess of free markets became apparent in the Global Financial Crisis, which left a housing bust and bankrupt banking system in its wake. The bill for the bailout came to the taxpayer.

The monetary response was large scale asset purchases (QE) and austerity in many cases. That backdrop was a boon for financial assets (and their holders) but produced a sluggish low-growth real economy fuelling a disquiet with neoliberalism. Occupy Wall Street, Brexit, Trump 1.0 and the rise of the far right were all emblematic of changed mood.

The New Macro Era

The disillusionment with neoliberalism has precipitated a shift in policy. An unfettered belief in free markets has been replaced by activist industrial policy. Free trade has been replaced by tariffs, fiscal conservatism by large deficits and free movement of labour by immigration restrictions. The need for independent central banks is being increasingly questioned given the more imminent need to keep government borrowing costs down.

That shift in ideology has come when the global economy faces a long list of structural challenges.

COVID exposed the limitations of just in time manufacturing and has placed a premium on supply chain resilience over efficiency. The result is a bias towards home near-shoring rather than outsourcing. The conflicts in Ukraine and Iran have exposed Europe’s energy and defence dependence. The need to shift from fossil fuels to alternative energy remains a priority for many economies

The net effect is a supply constrained economic system, more prone to inflation where the default policy response is higher spending.

What It Means For Markets

The profound shift in the macro and policy back drop is most obviously seen in global bond markets. In the 2010s weak growth combined with widespread asset purchases from central banks pushed government bond yields down relentlessly: trillions of dollars of government debt offered negative yields.

Cheap financing was a boon for private equity and public equities benefited from the valuation effect of lower discount rates, stock buybacks and liquidity flows from asset purchases. US equities annualised at 13.6% in the decade while bonds delivered solid, albeit unspectacular returns of 4% given the low starting yields. Gold produced modest returns and broader commodity indices were negative.

But COVID was the turning point. US 10-year yields touched 0.5% and bounced. US yields are now about 4.5%. In Japan yields went from 0% to 2.5% and in Germany from -0.5% to 3.0%.

Industrial commodities also reflect the new macro reality. Oil prices briefly traded below zero during COVID but over the 2010s WTI averaged about $60 a barrel. It is now around $100. Copper averaged about $7,000 a tonne in the 2010s, it’s now double that level.

Despite the higher yields and the higher input costs, equities have been resilient. The S&P 500 TR Index is up 220% since April 2020. Higher bond yields might have meant lower equity valuations, but it hasn’t been the case.

In theory, the new software of the global economy is less efficient, more inflationary and less market friendly than the old model. But equity returns in the decade to date are on a par with the low inflation secular stagnation of the 2010s, despite the adjustment on bond yields.

The Risks In The Capex Boom

Of course, the missing piece is AI.

Concerns about macro stability matter little in a world where AI capex spending is the dominant driver of markets, exerting a huge influence on earnings, growth and the longer-term outlook.

It’s not just the direct boost to earnings from the AI buildout, it’s a virtuous cycle where the second and third order impacts are as significant.

Rising spending on data centres and AI infrastructure is a support for economic growth and boosts equity earnings. The capex directly boosts investment spending in the GDP figures and boosts earnings of chip makers and hyperscalers.

Strong earnings growth pushes up equity prices. The US stock market capitalisation is now 250% of GDP meaning the wealth effect from rising equity prices is more significant than probably at any time in history. For context, in 2000 the stock market cap as a % of GDP peaked at about 150%.

The wealth effect encourages greater consumer spending, keeping the economy moving forward when the lower part of the “K shaped economy” is struggling with higher gas prices and rising debt delinquency.

Rising stock valuations encourage new issuance such as the coming SpaceX, Anthropic and OpenAI IPOs. They facilitate exits for insiders but also attract capital to be deployed in further capital spending.

It’s a classic Soros reflexive process that keeps going as long as the AI infrastructure build out continues.

But there are side effects to the process. Whereas buy backs were a feature and important support for equities in the 2010s, free cash flow is now directed towards capital spending.

Debt financed capex now competes with government borrowing requirements as a force pushing up global bond yields.

Back to Blyth

But the key question is what happens if the cycle turns down? Could the virtuous cycle go into reverse?

Once the data centre build out has run its course, capex will slow, directly reducing economic growth and employment. If the wealth effect then went into reverse the impact on growth via consumption could be even more profound.

Meanwhile, that could be the point at which the technology becomes more widely adopted, as companies seek to eke out efficiency gains amid weaker top-line growth. In that scenario already weakening demand and rising aggregate supply could be a serious headwind for the labour market, potentially compounding any downturn.

The old software of neoliberalism ran on fiscal restraint and asset purchases. But that playbook has now been thrown out.

Yes, government deficits are already stretched and at levels associated with a recession in the US, but as Blyth said to me, “if you focus too much on debt and deficits in the next downturn people will want to burn your house down, and rightly so.”

That may sound sensationalist, but it contains a kernel of truth. There is no appetite for fiscal restraint in a system where many already feel left behind. An economic downturn naturally pushed up deficits but in the current zeitgeist the clamour will be for even more fiscal supports. It may well be the point of fiscal dominance.

It’s both fascinating but also hugely worrisome. A sharp economic downturn and greater AI adoption could be hugely deflationary, but the policy response could be hugely inflationary. It’s the ultimate conundrum for investors.

Markets may be right. AI may ultimately deliver the productivity gains needed to offset the inflationary pressures of the new regime. But investors should recognise that the software governing the global economy is being rewritten in real time.

Bond and commodity markets have already adjusted. Equities have so far been rescued by the AI boom. The question is whether that boom ultimately proves durable enough to offset the inflationary and fiscal pressures of the new regime.

Are you in Dublin on June 17th?

For anybody in Dublin, I will pick up on the conversation with Mark Blyth on June 17 at a special in-person event to mark the launch of our new fund.

Register here: Link

Interested in the portfolio implications?

I will be delving into this topic and discussing the portfolio implications in a live webinar with Newstalk presenter Shane Coleman on Wednesday May 6th. Register here: Link

With equities bouncing sharply in April to hit all-time highs, many investors have been left wondering whether the market “knows more”, seeing through to an end of the conflict, or is simply ignoring the trouble ahead.

The real issue is that markets are being driven by two profound structural forces: the oil shock from the conflict in Iran and the productivity shock from AI.

February saw a widely read research report raise fears that AI would be transformative, particularly for white collar workers, pushing bond yields and software stocks down. March saw the conflict in Iran begin, pushing oil prices up, bond yields up and equities down. While the conflict rumbled on through April, hopes of a resolution coupled with a switch back to a focus on AI saw equities bounce back.

In simple terms the war in Iran represents an adverse supply shock, while AI represents a positive supply shock. But that oversimplifies the matter. Both shocks have significant impacts on demand, both create winners and losers, and both create dilemmas for policy makers.

What’s more, although we have seen both types of shocks in the past, they have rarely occurred concurrently. And this time they are unfolding in the midst of a changed macro regime, a regime already characterised by high and rising debt, supply constraints and a political bias towards more fiscal spending.

The big point for investors is not necessarily which shock dominates. But that both forces will likely push the US further along the path to fiscal dominance and the world more broadly towards greater macro volatility.

The Adverse Supply Shock

The oil shock from the conflict in Iran is the worst kind of shock for markets. In economic terms it is an adverse supply shock. The cost of production rises, translating into lower economic growth and higher prices - stagflation.

It creates a dilemma for policy makers, particularly the Fed, which is mandated to achieve maximum employment and price stability. Should it raise interest rates in response to higher inflation and risk accentuate a downturn, or cut rates in response to weaker growth and risk adding to inflationary pressures?

Central bankers have struggled with this dilemma before. In 2008 the ECB raised interest rates in May when oil prices spiked, only to have to cut rates later that year when the global financial crisis took hold.

The key risk for central bankers is inflation expectations. If expectations become de-anchored, the risk of higher inflation becoming embedded in the system becomes too great and they are forced to prioritise inflation over economic growth, regardless of the consequences for output.

AI: The Positive Supply Shock

AI, on the other hand, is a positive supply shock. As new Fed Chair Kevin Warsh said last year, “it makes everything cheaper”. In economic terms it represents an outward shift in the aggregate supply curve. Because it boosts productivity, overall output expands while unit labour costs decline, putting downward pressure on inflation. It produces disinflationary growth.

While stagflation is a nightmare for central bankers, disinflationary growth is a gift. It was this backdrop that allowed Alan Greenspan to hold off on raising interest rates in 1996 when the economy was gaining momentum but strong productivity growth was keeping inflation in check. Kevin Warsh and parts of the current administration have pointed to this precedent as supporting the case for lower rates today.

It Is Not That Simple

In theory the recent market gyrations reflect markets weighing the positive supply shock of AI, which dominated in February and April, against the adverse impact of the oil shock, which dominated in March.

But that oversimplifies matters considerably.

Both shocks have important demand dimensions that are easy to overlook. Higher oil prices raise gas and energy costs, reducing real disposable incomes and weighing on consumer spending. At the same time higher oil prices make a growing number of oil rigs commercially viable, potentially boosting spending on drilling and refining.

AI raises supply but also critically impacts demand. While there is enormous optimism about AI’s potential impact on productivity, to date it remains largely that: potential. Where the impact is already visible is in spending on chips, data centres and AI infrastructure. That has been a key driver of the equity rally in April.

But recently markets have taken a more questioning view on the likely return on investment from the large capital expenditure programmes at the likes of Meta in particular. Markets are assuming this capex splurge will last for years, but for that to materialise a material return on investment will need to be evident

Both shocks also have significant distributional consequences. Higher oil prices disproportionately hit lower income households, for whom spending on gas and energy represents a higher share of total expenditure. At the same time wealthy asset owners may benefit from exposure to high growth technology stocks. Both forces accentuate the K shaped nature of the US economy.

Debt, Disorder and the Macro Regime

Critically, both shocks are unfolding in a macro environment that is fundamentally different from the last time the world faced either.

The 1970s oil shock arrived before the era of inflation targeting and with debt levels a fraction of what they are today. The productivity boom of the 1990s unfolded against a backdrop of fiscal surpluses, contained geopolitical risk and a Fed whose independence was unquestioned.

None of those conditions apply now. The US is running a deficit of 6 to 7% of GDP with a debt to GDP ratio above 100%. The political zeitgeist, across the spectrum, is biased towards spending more not less.

Whether the priority is fiscal support for workers displaced by AI, military spending driven by geopolitical disorder, or energy investment prompted by supply insecurity, the pressure on the public finances points in one direction.

That matters because it constrains the policy response to whichever shock dominates. If the oil shock proves persistent and inflation expectations rise, the Fed faces the prospect of raising rates and debt servicing costs.

If AI proves as disinflationary as Warsh believes and the Fed cuts rates in response, it risks inflating an already elevated equity market and storing up a bust that the policy toolkit may no longer be able to contain. Household equity holdings now stand at around $40 trillion. The wealth effect works in both directions.

And it’s not just a matter of one shock dominating the other, they could conceivably interact in ways that could amplify the macroeconomic volatility.

For example, if the conflict in Iran rumbles on, and oil prices remain high, the immediate impact could be stagflationary. But if weaker economic growth then precipitates accelerated adoption of AI, lower hiring and job losses stagflation could quickly shift to being deflationary. That would likely necessitate an even more aggressive policy response both on the monetary and the fiscal side.

The result is a wider distribution of outcomes, a higher risk of policy error and a regime defined less by stable disinflation and more by macro volatility.

Some asset classes are already responding to this shift. Bond markets, commodities and gold have begun to reflect a world of higher macro uncertainty and fiscal pressure. Equities, for now, remain more anchored to the AI-driven growth narrative.

The key question is not whether AI offsets the oil shock or vice versa. It is whether policy can respond effectively in a world AI, of high debt, political pressure and competing shocks.

That is far less certain.

Interested in the portfolio implications?

I will be delving into this topic and discussing the portfolio implications in a live webinar with Newstalk presenter Shane Coleman on Wednesday May 6th.

Register here: Link

“Stocks and bonds slump in tandem as Iran shock leaves investors ‘nowhere to hide’” read the headline on the FT. “Traditional 60-40 portfolio of global equities and fixed income on course for worst month since 2022” was the subheading.

The performance of bonds in March has quickly brought back the uncomfortable memories of 2022 – a year when bonds and equities both suffered significant drawdowns, producing the worst year in decades for the 60/40 portfolio.

The discomfort is all the more acute given how differently markets behaved in February. Just over a month ago the idea that AI would be radically disinflationary saw bond yields fall and bonds rally. The long -duration Treasury ETF TLT was up 4% in a month when equities were down. It was as if bonds had resumed their traditional place in multi-asset portfolios as the dominant hedge to equity exposure.

But the war in Iran has prompted a re-assessment. Stagflation fears have resurfaced amid the negative supply shock of much higher energy prices. In March, equities were down over -5% and TLT was down -4%.

The bond sell-off has reignited the debate about the role of bonds in portfolios.

The traditional view is they remain a core holding based on safety and yield. The alternative view is that a changed macro regime means the bond equity correlation has structurally flipped and bonds are a less reliable diversifier for equities and should be avoided.

Rolling 3-year correlation S&P 500 and US Treasuries

For investors, the conundrum is: what is the optimal allocation in an environment where the macro regime is less favourable but potentially more volatile?

The answer is not a lot but not zero and, more importantly, tactically managed.

The importance of the macro regime

The idea of bonds as a core holding alongside equities has become almost a fundamental rule of investing. The 60-40 equity bond portfolio is widely seen as the benchmark balanced portfolio. But it hasn’t always been like this. Bonds’ role as a hedge to equities is a product of the macro regime. It is not a stable relationship; it depends on the inflation and policy backdrop.

In fact, between 1950 and 2000 the correlation between bonds and equities was positive. During World War II the Fed suppressed yields via yield curve control. But that stopped after the Fed Treasury accord of 1951 and US yields began a multi-decade increase.

Average Monthly Performance of Bonds When the S&P 500 was Down more than 2%

The 1960s and 1970s saw rising inflation, and bond yields trended higher meaning bonds didn’t serve as a hedge against equities.

In fact, in the 1960s and 1970s, in months when the S&P 500 was down more than -2%, the average monthly performance for bonds was -0.4%.

The macro regime then changed with Volcker’s rate shock in 1979, the fall of the Berlin wall, globalisation and China’s entry to the WTO. By the 2000s we were in the globalised disinflationary era of the Great Moderation and bonds became the great hedge for equities.

In the 2010s, in months when the S&P 500 was down more than -2%, the average monthly performance for bonds was +2.2%.

But since 2020 the macro backdrop has shifted again. It’s a regime of higher government spending, supply shocks and structurally higher inflation. US inflation has now been above the Fed’s target for five years with core inflation settled at 3.0% over the last 12 months.

Since 2020, in months when the S&P 500 was down more than -2%, the average monthly performance for bonds was -1.6%.

Positive Correlation, Higher Volatility, Higher Drawdowns

The impact of the change in landscape for bond investors is doubled-edged. On the one hand the shift has translated into higher yields meaning higher current income. But from a portfolio perspective the positive correlation means bonds offer less diversifying value to equity-heavy portfolios.

That upshot is that the volatility of the standard 60-40 has increased. Between 2000-2019, the annualised volatility of the US 60/40 portfolio was 8.2%; since 2020 it has jumped to 11.8%.

Critically, what comes with higher volatility is higher drawdowns.

In major equity drawdowns between 1990 and 2020, replacing 40% of an equity portfolio with an allocation to government bonds meaningfully reduced the total drawdown of the portfolio. For example, after the dotcom boom imploded, equities declined 45% peak to trough, but a US 60-40 declined by only -21%.

S&P 500 and US 60/40 Drawdowns: Jan 1990 - March 2026

But in 2022, when equities had a 24% drawdown, bonds offered less diversification: the US 60-40 portfolio still endured a drawdown of -20%. In fact, 60-40 portfolios that used long duration bond funds such as TLT suffered a bigger drawdown that a long equity only portfolio.

The specific case of credit

And the issue of coincident drawdowns between equities and bonds becomes even more accentuated when one tilts the bond portfolio to credit rather than government bonds.

Investors are often tempted to move into credit to boost yield. But the further down the credit spectrum you go, the lower the diversifying value of the bonds.

That’s because in an economic downturn, the likelihood of default increases and credit spreads widen reducing bond values.

In 2022 the drawdown for a US 60/40 portfolio using LQD ETF (high grade corporate bonds) instead of IEG ETF (US Treasuries) was -22.7% versus -23.9%. Investors in high yield bonds suffered larger drawdowns.

The case for the bonds

The experience of 2022 has rightly shone a light on the inherent limitations of 60-40. It’s an approach that worked very well in a particular macro era. And that era is now gone.

But does that mean have zero allocation to bonds? Not necessarily.

There are three reasons to maintain bond allocations despite the changed regime.

The obvious one is yield. Starting yields are the best indicator of future returns and for the US starting 10-year yields of 4.3% point to a reasonable expectation of nominal returns of something similar over the next 10 years.

If inflation averaged the Fed’s target that would mean real returns of 2.3% pa. Given that inflation has been above the Fed’s target for 5 years now, it seems reasonable to expect inflation to average more than 2% pa over the next decade, but TIPS offer real yields over 2%.

If one was particularly negative on equities over the next decade given heightened valuations, bond allocations could conceivably be justified on an expected return basis.

And, even in the 1970s, the higher yields at times offset the capital losses to generate positive returns. For example, bonds had positive total returns in 1973 and 1974, when equities sold off, even though yields rose in both years.

The second reason is that even if we remain in the current macro regime of supply shocks and sticky inflation, it is not impossible that we get periodic demand led downturns where inflation declines when growth weakens, allowing central banks to ease and bonds to rally.

Third, we could see a shift in the macro regime. That seems less likely given the structural trend of higher defence spending, higher government spending and supply constraints. But only in February did the market consider the possibility of a disinflationary positive supply AI shock.

It’s not inconceivable that an adverse supply shock (such as the war in Iran) driven economic downturn could be accentuated by AI related job losses. That scenario could be initially stagflationary but then deflationary.

Against that other tail scenarios need to be considered. The assumption that higher yields translate into higher total return rests on the assumption that bonds are repaid at par.

But in a world of fiscal dominance and financial repression that assumption could also be questioned. In a fiscal crisis, not only might the authorities resort to higher inflation to reduce the real value of debt, but restructuring and defaults could be conceivable.

Re-thinking bond allocations

For investors thinking about building robustness and resilience it’s clear that a changed macro regime requires a fundamental rethink of the size, composition and nature of fixed income exposure.

It’s not just a matter of owning less bonds but how to own them. A total portfolio approach requires thinking about how bond exposure and duration risk is obtained across the portfolio, not just through core allocations.

Many multi-asset portfolios may already have duration risk via other asset classes like infrastructure and high growth stocks. But those exposures mix economic growth risk with duration.

Hedge fund allocations can provide a more direct way to get active fixed income exposures. For example, allocating to global macro or systematic trend following provides tactical regime dependent active exposure to bonds. That may be an effective way of layering active bond exposure on top of a smaller core allocation.

The benefit of that approach is that it provides a natural mechanism for the portfolio adapting to any regime shift. If we are in a prolonged regime of rising yields, trend strategies will tend to stay short bonds. But if at some point if the regime changes and deflation takes hold, trend strategies would adapt to that as soon as the scenario is reflected in price trends.

Conclusion

The changed macro environment doesn’t mean bonds will never work as a diversifier to equities, but it does mean they are a less reliable diversifier for equity portfolios.

The case for credit is even weaker given the tendency to correlate with equities even more in economic downturns.

In a more unstable macro environment, static allocations are less reliable. That argues for using dynamic adaptive strategies to modulate fixed income exposure alongside smaller core holdings. The question is not just whether to own bonds, but how to own them.

With equities continuing their relentless rally after another strong year, the question taxing investors is: how long can it continue?

Yes, valuations are high, but valuations tend to be a poor predictor of the near-term path of the market. And with productivity growth now picking up, it has become popular amongst commentators to draw a parallel with the booming equity markets of the 1990s.

Although the dotcom boom ultimately turned to bust, the rally continued much longer than many envisaged. Could the current backdrop be closer to 1995 than 1999 as the optimists seem to believe?

The similarities with the 1990s

Certainly, there are obvious parallels with the 1990s. A new technology is spurring hopes of a fundamental change in how the economy operates. Back then it was the internet, this time it is AI. The effect on sentiment is the same: a fear of missing out and the belief that high multiples are justified continue to support equities.

But it isn’t just AI hype supporting stocks. Hundreds of billions of dollars of investment have poured into chips, data centres and AI infrastructure, like the capex boom in internet infrastructure of the 1990s. AI related capex has been a significant driver of US growth in the last year and has materially boosted earnings for stocks like Nvidia.

Productivity is another element. In the 1990s greater use of personal computers powered strong productivity growth and Greenspan’s new paradigm economy. To date, the productivity gains from AI have been more anecdotal but strong US productivity numbers in Q3 have raised hopes of a more meaningful trend.

And there are parallels in monetary conditions. Equities dipped in 1994 when the Fed raised interest rates aggressively before recovering and then accelerating with rate cuts in 1995. Similarly, the 2022 rate hiking cycle triggered a meaningful correction in equities but once the tightening was done the market recovered. The rate cuts in 2024 and 2025 have supported the rally.

Equally, in retrospect the Fed was arguably overly easy with policy, cutting rates amid capital markets concerns after the Russian debt default in 1998. Then monetary easing provided a final fillip for the bull run. Now, with the Fed easing policy even with inflation above target, the suspicion is policy may also remain supportive.

What is different this time

Yet, while the comparison with the 1990s is seductive, the reality is that a unique set of circumstances and a particular macro regime drove the extraordinary gains in stocks in the late 1990s.

Although economic growth has been solid, we’re not yet in anything like a new paradigm with growth of 4%+ like we had in the 1990s. With US labour market slowing and payroll growth falling to an average of about 50k per month, growth of 2-3% seems more realistic.

A bigger issue is that the economy is much more unstable and vulnerable when one looks beneath the surface. Much of the growth in the US economy has been driven by large and ever-rising deficits. In contrast, in the mid/late 1990s conservative fiscal policy and a strong US economy saw the fiscal deficit trend down and ultimately a fiscal surplus was produced in 2000.

What’s more, the US economy is increasingly imbalanced, K-shaped and levered to the performance of the stock market. US households own $40trn of equities but those holdings are concentrated in the hands of the wealthy. Rising equities translates into a meaningful wealth effect, boosting sentiment and wealth levels for the top 10%. That has kept the economy moving even as lower income households battle with the affordability crisis.

US Debt/GDP Ration versus Shiller CAPE 1960-2025

The coincidence of high debt at a time of high asset valuations creates an inherent vulnerability for the economy. If ultimately the AI spend weakens and equities turn down, the impact on consumer demand and economic growth could be materially greater in this cycle in the past. The wealth effect would go into reverse at a time when the economy might already be grappling with reduced investment spending.

After the dotcom bust the Bush administration cut taxes to help support the economy. But in 2000 the US debt/GDP ratio was 54%, now it is about double that. Should we see a downturn now there would be much less fiscal space.

The macro regime is fundamentally different

That fragility matters because we are in a fundamentally different macro regime in 2025 than we were in 1995. It’s an environment where policy is more constrained and driven less by sound economic imperatives.

In the mid-1990s, globalisation and disinflation gave central banks considerable freedom to ease policy in times of stress. After the dotcom downturn, the Fed cut rates meaningfully from 6.5% in 2000 to 1% in 2003 to reignite the economy. At the time the Fed was starting to consider the threat of deflation which justified the aggressive move. Today, rates already have been reduced from 5.4% to 3.6% and although inflation has come down, it remains somewhat sticky and above trend.

In the 1990s economic and monetary policies were more conservative and more credible. Bill Clinton won the confidence of the bond markets with higher taxes and the US ultimately ran a fiscal surplus in 2000. Meanwhile, at the Fed, Alan Greenspan was arguably the most influential policymaker on the planet, respected by both the market and political classes.

Today, that credibility is weaker. The political will or ideology doesn’t exist for sensible policies to tackle the deficit and we have a Fed Chair under criminal investigation and about to be replaced, potentially by somebody subject to influence by the administration.

Indeed, the administration is running up against the constraints of its own ideology. It wants to lower costs but lowering the cost of money risks accentuating inflationary pressures. It wants less immigration that means a smaller labour force and lower trend growth. It is loath to address the deficit given the political cycle but ongoing high deficits risk tipping the economy towards debt unsustainability. It wants a weaker dollar to promote manufacturing but a stable dollar to attract buyers of Treasuries.

An economic downturn would accentuate all of this potentially ramping up the tension between the administration and the Fed, exposing the lack fiscal space and increasing the bias towards more money printing and spending.

In short it could be the momentum when policy flexibility runs out and fiscal dominance steps in.

Back to the 1970s

Viewed from that perspective and the appropriate parallel may be more with the late 1960s than the 1990s. Like now, a set of high-quality stocks, the Nifty Fifty, were driving the equity market. Just as now they were highly profitable companies that investors “had to own”. But valuations became stretched, particularly when the benign macro environment of the 1960s was replaced with the macro volatility of the 1970s.

For sure, the structure of the economy now is not the same as the 1970s. There is less unionism and less reliance on oil and the economy is more service oriented. But the failure of the 1970s was not structural but political. Policymakers repeatedly deferred difficult decisions, allowing imbalances to build.

Just like now, the late 1960s and early 1970s saw a President increasingly desperate to deal with rising domestic costs. Nixon initially tried price controls and interest rate caps but ultimately released them. Fed Chair Arthur Burns was cajoled and bullied into maintaining easier policy. Speaking at the end of the 1970s, Burns bemoaned the lack of political will during the decade to truly tackle inflation.

The Dollar’s central role in Bretton Woods became increasingly unsustainable given the trade deficit and the US’s inability to maintain the link with gold. Ultimately Nixon had to let the USD float.

The 1970s ultimately saw a payback for the fiscal largesse of the 1960s. Inflation and a weaker US Dollar were the valves where the pressure was ultimately released, but the impact was felt in the bond market and in a lost decade for equities.

Navigating the new macro regime

Now, it is again the unwillingness to make the tough fiscal decisions which hangs over the market like a sword of Damocles. The hope is AI can raise productivity sufficient to boost growth, keep the deficit in check and justify the equity valuations. But the range of estimates of how much AI can boost productivity range from minimal to transformative. And even some AI advocates doubt whether Large Language Models can truly realise the optimism invested in them.

For investors the key to keep in mind is not that there may be parallels with the 1990s, there certainly are and they could certainly keep the market elevated. The issue is the current macro regime is inherently less stable, policy flexibility is much more diminished, and the risks of fiscal dominance are more meaningful.

That calls for building portfolios that can participate in the equity rally if the good times continue but still be adaptive and flexible to navigate a more uncertain set of macro conditions. That philosophy is behind our Regime-Adaptive Portfolio which we introduced in our recent paper available here.

For investors, the risk this time is not that the music suddenly stops, to use Chuck Prince’s oft-quoted analogy. It is that a period of calm gives way to a rising crescendo of volatility. What begins as a familiar lullaby slowly builds into something louder, faster, and harder to interpret, until the melody is lost in a cacophony of noise.

For four decades, the 60–40 portfolio was the default solution for balanced investing. Equities delivered growth, bonds provided defence, and the combination produced exceptional risk-adjusted returns.

That success, however, was not timeless. It was the product of a very specific macro regime: the globalised, disinflationary era from roughly 1980 to 2020.

Both equities and bonds benefited from falling inflation and declining interest rates, and, crucially, their correlation turned negative. When equities struggled, bonds typically provided an offset.

That dynamic has now changed. Bonds and equities increasingly move together, particularly during periods of inflation stress. More broadly, three forces have fundamentally altered the macro backdrop.

Yet many portfolios remain rooted in an approach designed for that earlier era. What is required instead is a portfolio structure that can adapt as regimes shift.

Inflation is no longer stable

First, inflation has become structurally more unstable. Many of the forces that pushed inflation steadily lower for decades — globalisation, expanding labour forces, the peace dividend — have stalled or reversed.

In this environment, inflation shocks are more frequent and less predictable. That matters because it limits the ability of central banks to cut interest rates aggressively when growth slows. When inflation is sticky, rate cuts are no longer a reliable stabiliser for markets, and bonds cannot be relied upon to hedge equity risk in the way they once did.

Debt has reached a tipping point

Second, public debt levels may have reached a tipping point. The current combination of high public debt and high equity valuations is unprecedented in the post-war era.

US Debt/GDP Ration versus Shiller CAPE 1960-2025

US equities are as richly valued as they were in 2000, but the fiscal backdrop is entirely different. At the peak of the dot-com boom, US debt-to-GDP was roughly half today’s level and the government was running a surplus. Today, debt levels are far higher and deficits are structural.

At the same time, the US economy has become increasingly sensitive to equity markets. Households hold over $40 trillion in equities, creating powerful wealth effects when markets rise — and sharp negative feedback loops if they fall.

Every recession since the war has pushed debt-to-GDP higher. Another downturn could be the one that brings bond market discipline back into focus, pushing yields higher even as growth weakens.

Policy credibility is under pressure

The third fracture compounds the first two: the erosion of central bank independence.

In a world of high debt and low political tolerance for austerity, central banks may increasingly come under pressure to contain rising bond yields rather than inflation. This is the essence of fiscal dominance — and it represents a material shift in the policy regime investors have grown accustomed to.

Taken together, these forces imply a macro environment that is structurally less stable than the one investors enjoyed in the 2010s.

The Limits of Conventional Diversification

For investors, the implications are clear. Many portfolios are still built for the world of the last decade rather than the one ahead. They appear diversified but are dominated by exposures that rely on benign growth and stable inflation.

Once you look through asset labels and focus on underlying economic drivers, the lack of true diversification becomes obvious. Credit, high yield, emerging market debt and even many so-called alternatives tend to behave like equity risk when stress arrives.

In effect, they are designed for stability, not regime change.

A more resilient architecture requires three components, not two:

• growth exposures for long-term wealth creation

• diversifying assets that behave independently when the cycle turns

• adaptive strategies that respond to changing conditions rather than holding static positions

The third category is the one most under-represented in traditional allocations.

The missing piece: adaptiveness

Adaptive strategies, such as systematic trend following and global macro, expand the opportunity set. They can go long or short, shift exposure dynamically and operate across equities, bonds, commodities and currencies.

A useful way to think about them is as the midfield of the portfolio. Growth assets are the forwards; diversifying assets like bonds or gold are the defenders.

Adaptive strategies operate between them, behaving more like growth when trends are favourable and becoming more defensive when conditions deteriorate.

They bring responsiveness and adaptiveness to the overall portfolio. That responsiveness is critical when the macro regime is shifting but the precise path forward remains uncertain.

A Regime-Adaptive allocation

The Regime-Adaptive Portfolio sets out a different approach to structuring multi-asset allocations for a world where inflation, correlations and policy constraints behave differently from the last forty years.

It differs from conventional approaches in four ways:

1. It groups assets by regime behaviour rather than asset label. Labels like traditional versus alternative reveal little about how exposures behave when growth weakens or inflation surprises.

2. It gives adaptive strategies a meaningful share of total portfolio risk. They are treated as a core component, not a small hedge or satellite.

3. It uses capital-efficient instruments, primarily futures, to construct a more balanced risk mix. This avoids the equity-dominant outcome common in a fully capital-constrained framework.

4. It allocates by risk, not capital weights. This gives greater balance to the portfolio and less sensitivity to a narrow range of macro outcomes.

The objective is not to forecast regimes but to build a structure that can function across them. Growth exposures remain essential, but they sit alongside genuine diversifiers and adaptive strategies that can shift the portfolio’s stance as conditions evolve.

The real risk

The dominant risk today is not volatility. It is relying on portfolio structures built for an environment that no longer exists.

A behaviour-based, regime-aware approach offers a more robust foundation for the decade ahead. It recognises that correlations are regime-dependent, that inflation risk can no longer be ignored, and that adaptiveness is no longer optional.

The full white paper expands on this framework and the practical implications for portfolio construction and can be accessed here: The Regime Adaptive Portfolio.

Gold is having a moment.

In a year when policy credibility is fraying and investors are questioning the foundations of fiat money, the world’s oldest asset has become one of the hottest macro trades.

Few assets provoke such extremes of opinion. Warren Buffett has never been a fan; Ray Dalio sees it as the ultimate store of value. For some, gold’s scarcity and permanence are its greatest strengths. For others, it’s a metal with no yield and no clear valuation anchor.

In its favour, gold has stood the test of time. Yet it has also swung through long cycles of boom, bust, and recovery.

• It soared during the great inflation of the 1970s.

• Then came two lost decades as inflation fell and central banks became heavy sellers.

• It rallied again in the 2000s but was range-bound for much of the 2010s.

Now, it’s booming once more. It is up over 50% this year and is compounding at 18% per annum since 2000. In an era of fiscal dominance and mounting concern over monetary debasement, the appeal is obvious.

But long-term allocators and students of history can’t ignore the other side of the cycle.

Between 1980 and 2000, spot gold prices fell 71% in nominal terms. With U.S. CPI averaging 4% per year over that period, the real drawdown was roughly –84%, or –8% per annum in real terms.

So much for gold’s inflation-hedging reputation during those decades.

Perhaps that’s why so few investors hold it in size. The most recent UBS Global Family Office Survey reports an average allocation of just 2% among large family offices to gold and precious metals, despite gold having outperformed the S&P 500 since 2000.

So how should investors think about an asset that can outperform equities in one macro regime yet endure twenty years of negative real returns in another?

For long-term allocators, and anyone building an all-weather portfolio, the challenge is twofold: understanding gold’s portfolio characteristics and interpreting them in the context of today’s macro environment.

In this piece I’ll look at:

1. The Case – the portfolio rationale for holding gold.

2. The Macro Context – its role in a portfolio and what history can teach us about sizing in the current regime.

3. The Call – how much exposure makes sense in an all-weather portfolio.

The Case: Uncorrelated returns

The most obvious reason to consider an allocation to gold is uncorrelated returns.

Despite the severe drawdown in the 1980s and 1990s, since 1975 spot gold has produced annualised returns of 6.2%[i]. Since 2000, returns have been even higher at 9.7% p.a. But critically, the correlation between gold and the S&P 500 has been 0.02, making gold a hugely attractive asset to hold from a portfolio diversification perspective.

Even if gold’s future returns fall short of the 6.2% delivered since 1975, the close to zero correlation to equities means that combining gold with equities will significantly enhance the risk adjusted return of the portfolio.

Since 2000, re-allocating 20% of an allocation from the S&P 500 TR to gold (for an 80-20 equity/gold portfolio) would have reduced the portfolio volatility from 15.2% to 12.8% and increased the realised annualised return from 8.0% to 8.8%. Since 1975, the impact is not as strong but risk-adjusted returns would have been enhanced.

Intuitively, it adds to portfolio resilience. Gold and equities perform well in different environments. Equities are financial assets whose performance is driven by company earnings. Equities tend to do well in periods of stable or solid growth and stable or falling inflation. Gold is a real asset that can do well in inflationary periods (like the 1970s) and in more challenging periods for equities. Both assets can do well in periods of excess liquidity and concerns over fiat money (as we have today).

Looking at 5-year periods since 1975, we can see that gold performed well in the two 5-year periods when equities struggled (2000-2004 and 2005-2009). Equally in the periods when gold struggled, equities performed well (1980-1984 and 2010-2014), highlighting their different return profiles.

Gold’s relatively high volatility is another interesting aspect. Its annualised volatility since 1975 is 18% and although it has come down slightly it is still 16% since 2000. High volatility is a doubled-edged sword. It means a reasonably sized allocation can meaningfully add or detract from the overall portfolio performance, unlike some low volatility assets like short duration bonds.

However, it is important to highlight that a close to zero correlation to equities over the long term does not mean gold is a hedge to equities over shorter term periods. In periods of stress mass liquidations have at times seen gold becoming more positively correlated with equities such as in October 2008, at the height of the Global Financial Crisis, when both equities and gold were down over -11%.

The Macro Context

What’s clear from the past analysis is that gold can be either very additive or detractive for the portfolio depending on the macro regimes. To understand why, we need to have a better sense on what have been the drivers of gold historically.

Asset or currency?

The debasement trade has been all the rage this year. After repeated attacks on the Fed from the US administration and pressure to cut rates, markets are waking up to the risk that monetary policy may be directed at debt sustainability more than price stability going forward.

A less independent Fed may keep rates lower than otherwise, allowing inflation to drift higher, with obvious implication for the purchasing power of the dollar over time. Gold has long been seen as an alternative to fiat money. It is a store of value and in the past has been a unit of account and medium of exchange (fulfilling the three standard functions of money). Critically its supply is more limited than fiat currency. For many it can be viewed as a hard currency, like the Swiss franc. And indeed of all the major currencies gold is most correlated to the CHF.

From this perspective, confidence in central banking can be a critical driver of its value. The Burns’ Fed of the 1970s saw inflation spiral and gold rally, whereas the discipline and monetary tightening of Volcker saw credibility return to the Fed, continuing under Greenspan and coinciding with gold’s bleak two-decade drawdown. The onset of QE post GFC provided another fillip and the excess fiscal spending and monetary accommodation since 2020 has provided a perfect positive storm.

Linked to this, as a hard currency quoted against the USD its trajectory is also influenced by the general trend in the USD. Sometimes the movement in the Dollar is intertwined with policy credibility concerns, as it was in the 1970s and at times in 2025. But more generally when the US dollar has been strong (such as in 2022), the long-trend uptrend in gold has corrected until USD strength has subsided.

Real yields

As an asset without any yield (and practically speaking a negative yield, once the cost of storage is factored in) it makes sense that the yields available on other assets may be an influence on gold.

The performance of gold has, up until recently, been broadly in line with that. Gold’s rise in the 2000-2011 period coincided with a trend decline in US real yields. Gold corrected and was in a range as real yields then rose until 2018. Another lurch lower in yields up until early 2020 saw the gold rally resume, while rising yields saw gold correct in 2022.

But since mid-2024, gold has been more heavily influenced by other drivers. Real yields have stabilised and come off their highs but, at about 2%, US 10-year real yields remain attractive relative to levels seen in the last two decades. However, gold has taken off, more than doubling since the start of 2024, and rising in periods both when real yields are rising and falling.

Central bank purchases (to some extent driven by fears of the weaponization of the US dollar), concerns over debasement, USD weakness and a shifting investor sentiment have all been more important than real yields.

Inflation, debasement and market psychology

The simplest reason for considering gold that is often put forward is as an inflation hedge. As gold is a real asset, that can be used commercially as well as a store of value, it makes sense that its value should move in line with inflation. And over very long periods gold has retained its purchasing power.

But the term “inflation hedge” can be misleading. A hedge evokes the idea that if the asset being hedged goes up, the hedge goes down and vice versa. Gold’s relationship with inflation is not that tight. For one, gold is much more volatile than inflation and second as we have seen, gold had a two-decade decline between 1980 and 2000 while US inflation averaged 4.0% per annum.

A better way to think about is that over the very long-term gold is likely to preserve its value in real terms but over shorter periods, returns may vary depending on whether inflation and/or debasement concerns are dominant market themes and drivers.

In the 1970s, persistently high inflation became embedded in investor psychology and gold benefited as investors searched for assets that could protect their portfolios. But as Volcker won the war over inflation, and globalisation added a disinflationary force, investor demand moved to financial assets like bonds and equities which benefited more directly from the disinflationary trend.

A recent article from Robert Armstrong in the FT suggested that the debasement trade didn’t make sense. Yes, he argued, it seemed plausible that gold might benefit from debasement concerns but why were we not seeing the same reaction in the Dollar and US Treasuries?

The reality is that markets are nonlinear, adaptive systems which defy such neat explanations. Market psychology plays a huge part. If gold becomes the chosen expression of inflation or debasement anxiety, the response can be reflexive and self-reinforcing. There’s nothing like price to shape sentiment: investors are buying gold because it’s going up, while inflation and debasement concerns supply the story after the fact.

But another conundrum for investors at the current juncture is that although the macro narrative is favourable, the rally has taken the real gold price to elevated levels. And historically, periods of very strong returns have sometimes, but not always been followed by more subdued performance.

The Allocation

Bringing these factors together there are a number of points to consider when allocating to gold:

· There is a compelling case that gold will retain its purchasing power in the face of inflation over the long term

· Realised returns over the last 25 and 50 years have been much higher than just inflation but, against that, after a strong move up its real price is now considerably higher

· There is some evidence of lower forward returns after periods of strong returns, but it is a weak relationship

· Gold’s low correlation to equities makes it very attractive from a portfolio perspective particularly for an all-weather investor

· However, low correlation doesn’t mean it is a hedge to equities or guaranteed to deliver “crisis alpha”

· Gold has delivered attractive returns but that has to be balanced by the huge real drawdowns we have seen in the past

· Gold’s high volatility is a plus and minus in that it can have a meaningful impact on portfolio performance when doing well but can also meaningfully detract

· The current macro backdrop of fiscal dominance, debasement concerns ongoing liquidity provision and concerns about the US dollar is a favourable backdrop

· With a more dovish Fed Chair expected and debt sustainability concerns likely to remain a theme over multiple years the risks seem skewed to the upside.

· But any upside surprise to US growth, less monetary easing or a surprise need to tighten policy in the US next year could radically change the outlook particularly given the overextended nature of the move

From an allocation perspective it makes sense to approach gold from two angles:

1. Maintaining a core allocation as a portfolio diversifier - the zero correlation to equities and return profile make it a natural addition to an all-weather portfolio even with the risk of prolonged drawdowns.

2. Having a mechanism to get tactical exposure that varies depending on the market theme and narrative can make a lot of sense for an asset that has had such prolonged boom bust cycles. Systematic trend following strategies provide that systematic tactical allocation and an allocation to trend would naturally increase the overall gold exposure in times when it is trending higher and reduce the exposure when it is correcting.

Of course, if one ran a gold/equity/bond optimiser based on the last 25 years it would give a high allocation to gold but that ignores the 1980-2000 drawdown. Ultimately it is a value call. For me a core allocation of 10-15% with the ability of tactical systematic strategies to take that to 25% makes sense and balances the opportunity and the risks.

Conclusion

The current macro backdrop of fiscal dominance, debasement concerns, ongoing liquidity provision and a softer USD makes gold’s setup attractive. Yet history reminds us that strong narratives can lead to overextended moves. Position sizing, balancing strategic conviction with tactical flexibility, matters more than ever.

Gold’s value to an all-weather portfolio isn’t just about its potential for return — it’s about the pattern of those returns. It is one of the few assets whose drivers sit outside the growth–inflation nexus that governs most markets. Its independence — from policy, from earnings, from credit — is what gives it meaning. In an age of fiscal dominance and fading trust in institutions, that quality is scarce.

But all-weather investors must keep the downside in mind as well. Gold’s shift from top-performing to worst-performing asset between the 1970s and 1980s is a cautionary tale. The key is to hold enough to make a difference, but not so much that it dominates — pairing a strategic core allocation with a tactical overlay is the best way to balance opportunity and risk.

[i] Gold was fixed against the dollar during the Bretton woods regime and was not investable for US investors between 1934 and 1974 after Roosevelt Executive order of 1934 required US residents to surrender gold. The prohibition on owning gold was ended in December 1974 by Nixon.

With equities at record highs, investors face a familiar dilemma. The long-term rewards from equities are compelling, but so too are the risks, from stretched valuations to rising debt levels. The Shiller CAPE is edging close to an all-time high.

Warnings of overheating have been sounded for years, yet the market keeps grinding higher. The real danger may not be the next short-lived correction — like those in 2020, 2022 and 2025 — but a more prolonged and damaging downturn.

Is there a way of participating in the upside yet managing the downside risk?

Managing equity risk

Averaging into the market with regular investment is one approach. For regular savers or pension contributors with long time horizons this make sense. If the market rises you gain on existing holdings, if it falls you invest more at lower levels.

Somebody considering a lump sum investment could take a similar approach, spreading the investment over say a year. But that can be risky too. You could scale into a rising market but complete the investment just before the market turns down.

Diversifying across a portfolio of stocks internationally is another suggestion. US exceptionalism has translated into US outperformance in the last decade but there are signs that is changing. However historically when equities fall, they tend to fall in unison.

Historically, the advice was to blend equities with bonds. The 60-40 equity/bond portfolio is the industry standard in this respect. On the surface this seems sensible. Equities for growth, bonds for defence.

Shifting correlations

Between 2000 and 2021, the correlation between the S&P 500 TR and the TLT ETF (long duration US treasuries) was -0.3. The negative correlation translated into a meaningful reduction of volatility when mixing equities with bonds. The 60-40 portfolio realised 8.7% annualised volatility versus 14.5% for the S&P 500 providing a smoother ride for investors.

But 2022 showed they can fall together, especially when inflation rises. Between January and September 2022, the S&P 500 declined by -22% but the TLT ETF declined even more (-30%), producing a -26% fall for the 60-40 portfolio.

Since 2022 the correlation between SPY and TLT has averaged 0.6 and the annualised volatility of the 60-40 portfolio has been over 15%.

What’s changed? Inflation concerns. In an environment of structurally higher inflation central banks cannot ease policy as readily in response to a slowing economy and that can weigh on equities without any offsetting support from bonds.

There are plenty of reasons to suggest inflation could be more of a challenge for investors going forward putting a question mark over how much of a diversifier long duration will be for equity holdings in the years ahead.

The premise of many multi-asset funds is that they are more diversified and provide upside participation with less downside risk. In reality, many multi-asset funds behave just like the 60-40 portfolio. A wide range of assets—from equities to high yields bonds to emerging markets -tend to perform just like equities. They do well when the economy is solid, but in a deep recession, they typically underperform together.

In fact, when you adjust for volatility across asset classes, equities typically account for more 60% of total portfolio risk in a multi asset portfolio.

Equally, many assets—from long-duration bonds to equities—do well when inflation is contained and interest rates are falling. What about a regime of rising inflation or even stagflation (rising inflation when the economy is weak). Most portfolios are still ill-prepared for either a severe downturn or a stagflationary environment.

These concerns have fuelled an interest in more innovative solutions - particularly alternative investments

The promise and reality of alternatives

But what are alternatives, and can they really live up to the promise of offering something genuinely different?

Broadly, they come in two flavours – alternative assets and alternative strategies. Private equity, infrastructure, venture capital and private credit are in the alternative asset side. While there can be a solid case for these, they should be thought of as alternative growth strategies rather than diversifiers. In a severe downturn don’t expect them to provide much of an offset to equities.

That’s where alternative investment strategies come in. These are trading strategies that can go long or short in markets. That gives more flexibility to respond to market moves. They can go short and profit from falling equity prices and they also often trade markets like commodities, typically underrepresented in many portfolios.

One set of alternative investments that deserves attention is systematic or rules-based strategies.

Investors might find systematic strategies intimidating, often lumping them under “quant” investing and assuming they rely on opaque, black-box algorithms. But some systematic strategies provide a disciplined rules-based alternative—removing emotional bias, sidestepping macro speculation, and dynamically adjusting to market shifts.

Systematic trend-following, for example, buys assets that are rising, sell those that are falling. That’s it. It doesn’t try to predict macro events; it simply reacts to price movements.

The really interesting and valuable aspect of alternative strategies is that some, like trend-following, have delivered strong returns during periods of major market stress such as 2022, 2008 and during the dot.com bust, making them a powerful complement to equities.

The benefit of this can be appreciated if we compare a 100% investment in the S&P 500 versus an 80% allocation combined with a 20% allocation to the SG Trend Index, an index or leading trend-following manager performance.

The annualised return of the combined portfolio since 2000 at 7.62% versus 7.8% but the volatility is significantly less (12.2% versus 15.3%). Importantly the allocation to trend-following helped reduce the portfolio drawdown during the major equity drawdowns since 2000.

In particular, in 2022 the drawdown of the combined portfolio was 10 percentage points less than the S&P 500.

Of course, no strategy is perfect. Trend-following struggles in choppy, directionless markets, where false breakouts and sudden reversals can erode returns.

Yes, these strategies are increasingly being seen in multi-asset and asset allocation funds as the need for greater diversification is increasingly recognised.

Allocating 5% or even 10% to an alternative strategy often doesn’t move the needle — especially if it runs at low volatility. In diversification, size matters as much as selection.

Managing Uncertainty, Not Eliminating It

At its core, investing isn’t about eliminating uncertainty—it’s about managing it intelligently.

While equities will likely continue to deliver strong returns over the long term, the path forward will be unpredictable. In 1996 Alan Greenspan famously warned about irrational exuberance only for the market to rise for another three years before the dotcom boom turned to bust.

For investors grappling with the current investing dilemma, diversification makes sense.

The next correction is inevitable — we just don’t know when, how deep or how long. The goal isn’t to avoid risk altogether, but to build a portfolio resilient enough to withstand it. True diversification means looking beyond the traditional mix of equities and bonds to strategies that can adapt when markets change.

With the Trump administration continuing to pressure the Fed to lower rates, “fiscal dominance” has become the buzz word in markets. The idea that monetary policy will be directed at debt sustainability rather than inflation is no longer theoretical; investors are now pricing it in for the US, UK and Japan.

The first-order market implications are already visible: a steeper US yield curve, a higher risk premium in long-term bonds, and a rally in gold. But the deeper significance of a fiscal dominance regime is not just about bonds or bullion, but instead credibility.

Central bank independence and inflation targeting were key to the achievement of the Great Moderation, the era of low inflation and stable growth from the late 1990s to the mid-2000s. The belief in the importance of independence stemmed from the Great Inflation of the 1970s, when it became clear that only central banks free from political pressure could deliver price stability.

If that credibility is now eroded, the risk is a shift from moderation to a new era of macro volatility. For investors, relying on passive beta to equities and bonds, which worked in the era of low inflation and stable growth, may no longer hold. Instead, inflation protection and allocations to dynamic adaptive strategies may now be the order of the day.

The rise and fall of monetary dominance

The Global Financial Crisis thrust central banks into the spotlight. Extraordinary tools were deployed to stabilise markets, and when politicians failed to agree on sustained fiscal measures, monetary policy was called “the only game in town.”

Reinhart and Rogoff’s This Time is Different in 2009 captured the mood of that period: excessive debt often precedes crises, sovereign defaults are more common than imagined, and growth slows once debt-to-GDP passes critical thresholds. Fiscal conservatism and austerity followed, reinforcing reliance on monetary support.

Although central banks cut rates to zero and engaged in large-scale asset purchases, the headwinds of deleveraging meant the result was a decade of secular stagnation and ultra-low interest rates.

By the mid-2010s, the mood was shifting. Populist movements such as Brexit and MAGA reflected the dissatisfaction with weak growth and neoliberal thinking. Economic thought also evolved: Modern Monetary Theory, once fringe, gained surprising traction.

The real catalyst came with COVID and then the war in Ukraine. Governments turned to aggressive fiscal measures to shield households, fund defence, and support economies. Since then, deficits have widened almost everywhere, and the warnings of Reinhart and Rogoff have faded from memory.

The allure of financial repression

During COVID, fiscal packages could be financed cheaply with bond yields at historic lows. But the fiscal splurge has not gone unnoticed by bond markets. Today, however, with spending needs rising and global yields climbing, debt sustainability has become a pressing concern.

If all US debt was financed at the current 30-year yield, US debt service costs would be higher than at any time in five decades. That’s why the Treasury has shifted to issuing more T Bills and why the Fed is under such intense pressure to reduce interest rates.

Higher borrowing costs push debt-service burdens up, making fiscal trajectories look less sustainable. Yet demands for spending — on defence, ageing populations, and cost-of-living support — continue to grow. Attempts to impose austerity have been met with swift political backlash.

As a result, policymakers are turning to more subtle tools. Austerity is out; financial repression and debt monetisation are in.

Financial repression works by holding interest rates below the rate of inflation, quietly transferring wealth from savers to the state. Debt monetisation goes a step further: central banks purchase government bonds with newly created money, directly funding deficits. Both approaches avoid immediate spending cuts or tax hikes. But their cost shows up later, in the erosion of purchasing power and the slow bleed of negative real returns for investors.

Historical parallels

We have seen this before. During World War II, military spending pushed up inflation and the US debt/GDP ratio. The Fed suppressed its price stability objective, capping 10-year yields at 2.5% by buying government bonds. By the end of the decade inflation averaged 5.5%, delivering negative real returns for bond investors. Because yields were held down in the 1940s, bondholders suffered four straight decades of negative real returns between 1940 and 1979.

The onset of COVID-19 ushered in a similar sense of wartime. Formal yield-curve control did not happen in the US (though it did in Australia), but the Fed massively expanded its asset purchases to accommodate record Treasury issuance. Although it was presented as quantitative easing, it felt like debt monetisation in everything but name. The ultimate result was a significant rise in inflation and wealth erosion for bond holders.

The broader impact

The focus has now shifted back to interest rate policy. The attacks the Fed has endured from President Trump have been unprecedented. Even Treasury Secretary Bessent appeared to shift the goalposts in a recent WSJ op-ed by adding “stable interest rates” to the Fed’s traditional mandate of maximum employment and price stability.

Much will depend on Trump’s choice of Jerome Powell’s successor as Fed Chair. That appointment could prove decisive in determining whether the Fed continues to resist fiscal dominance or bends fully to it.

The extent to which countries go down the road of repression and monetisation will shape asset markets. FX markets are likely to be increasingly driven by fiscal considerations, as economies differ in the degree to which central banks remain independent. The Maastricht Treaty embedded ECB independence and fiscal constraints for precisely this reason. Switzerland has also maintained strict anti-inflation credentials.

There will also be spill overs. Easier policy in the US, for example, could strengthen the euro, which would be a deflationary force in Europe and create pressure on the ECB to ease policy in response.

Opportunities in EM and equities

Emerging markets are another area to watch. Historically, the yield on EM debt was higher due to perceived credit and inflation risk. But many EM central banks have fought hard to establish inflation-fighting credibility and may be loath to give it up. In a world where US credibility is in doubt, EM assets could paradoxically be seen as more attractive, particularly if the dollar weakens structurally.

For equities, the picture is mixed. A less independent Fed feels negative for US assets. But against that, nominal GDP growth would likely be stronger. In the 1940s, US equities posted disappointing real returns of about 4% per annum. But as inflation averaged 5.5% over the decade, nominal returns of close to 10% looked normal. For investors, being attuned to the difference between nominal and real returns was key.

In practice, this argues for a more flexible approach to allocation — one that blends traditional assets with real assets and diversifying strategies. Static mixes that worked in the Great Moderation may be poorly suited to an era where fiscal considerations drive markets.

A coming era of macro volatility?

The irony is central banks spent decades building the credibility that underpinned ultra-low bond yields of the 2010s. But those same yields encouraged the fiscal expenditure which now threatens to unwind that credibility.

Keeping rates low to ease the debt burden risks squandering that credibility. If investors, employees and employers start to believe inflation has become embedded — if expectations become unanchored, in central bank language — the risks to the economy would be substantial.

If that loss of credibility meets a supply-side shock, such as an oil price surge, the danger is a re-run of the 1970s. The Great Inflation began with excess demand in the late 1960s, was accentuated by oil shocks, and once expectations became embedded, the cost of bringing inflation down rose higher and higher. It took a national crisis and Paul Volcker’s resolve to restore stability.

With all that is happening day to day, it is sometimes easy to forget how much the landscape has shifted since the end of the last decade. We have gone from secular stagnation, low interest rates and low bond yields to a world where fiscal dominance, financial repression and macro volatility are back on the table.

The lesson from the 1970s is not only that real returns, particularly in financial assets, can be eroded, but also that higher macro volatility can translate into huge swings in bonds, equities, currencies and commodities.

Bonds suffered most in real terms in the 1970s but equities also posted negative real returns. That said, equities had a huge rally between mid-1970 and 1972 and again in 1975, either side of the severe bear market of 1973.1974. The USD trended lower, gold rose and there were huge spikes in commodities at times. A return to that kind of volatility would favour divergent strategies like global macro and trend following.

For investors today, preparing for a more volatile inflation prone world means thinking in terms of adaptive allocation — building portfolios that can adjust across regimes, rather than relying on the stability that central bank independence once guaranteed.

The fight to choose the next Federal Reserve Chair could be the most consequential appointment since Paul Volcker took the reins in 1979.

After months of speculation, markets now face the real prospect that the Fed’s independence could be reshaped.

With Treasury Secretary Scott Bessent now seemingly out of contention, attention is fixed on three contenders: Chris Waller, the continuity choice; Kevin Hassett, whose close political ties raise the most independence concerns; and Kevin Warsh, the wildcard who could mark the sharpest break from recent policy.

With equities at record highs and bond markets steady, investors are in “wait-and-see” mode. But the outcome could shape markets for years to come.

A Fed Under Attack

For months, Jerome Powell has endured jibes and barbs from the President as he has swatted away suggestions for lower rates. Although 50 years have passed, the ghost of Arthur Burns still lingers, and markets remember how he was cajoled and manipulated by Nixon into easier policy, contributing to the Great Inflation.

Can the next Chair be as resolute as Powell?

The timing of this appointment raises the stakes. It comes at a time when a rare coalition of ideological opposites — from easy-money advocates to those seeking a fundamental rethink of the Fed’s role — are calling for change.

Unsurprisingly, the easy-money camp (Trump, parts of Wall Street, and the business community) is critical of the Fed for not lowering rates — but that is their typical bias.

At the same time, mainstream economists and former policymakers have joined the chorus of criticism. While remarks from Treasury Secretary Scott Bessent and Council of Economic Advisers Chair Stephen Miran can be dismissed as political, other prominent voices — such as former Fed Governor Larry Lindsey and market economist Jeremy Siegel — have weighed in as well.

The sense of crisis was underscored when former PIMCO CEO Mohamed El-Erian suggested it might be better for the Fed’s independence if Jerome Powell resigned.

The Fed’s Failures

The list of shortcomings against the Fed reads like a failing end-of-term report card.

Chief amongst them is the 2021 policy error, when the Fed was slow to raise rates in response to seemingly “transitory inflation.” In a recent CNBC interview, Warsh described it as the greatest error in macro forecasting in 45 years.

The Fed’s overall policy framework is a second. The Fed believes in a Keynesian labour-market view of inflation — the idea that wages, employment levels, and inflation expectations are the primary drivers of inflation. That framework ignores factors such as government spending and monetary growth, both of which fuelled the 2021 inflation spike.

Quantitative easing is another bone of contention. Yes, it helped stabilise markets during the GFC, but extensive QE in the last decade may have distorted capital markets, fuelled inequality, and created other unforeseen consequences. Unwinding it has also been fiendishly difficult.

The merit of shifting from a scarce-reserve to an ample-reserves system and paying interest on bank reserves has also been questioned. The interest payments mean the Fed now operates at a loss, opening another avenue for populist criticism of the institution.

But it’s not just in the technicalities of monetary policy where the Fed faces fire. The 2019 shift to Flexible Average Inflation Targeting, and a focus on “inclusive” employment, arguably delayed the 2022 tightening.

And the list goes on: corporate bond buying during COVID is seen as overreach, the demise of SVB a supervisory lapse, and the rise in yields last year, after the Fed cut rates, a sign of a loss of credibility.

The Case for the Defence

The Fed could reasonably argue that much of the criticism is unfair. Yes, inflation remains above target, but it has fallen sharply from its 2021–2022 peak. The economy is slowing, yet unemployment is still just 4.2%. Before tariffs entered the picture, the Fed appeared to have pulled off the elusive soft landing, something few FOMC’s have managed in the last four decades.

Many mainstream economists see as much success as error in the 2021–2022 episode. Inflation was reduced without a major rise in unemployment — a result they attribute to the Fed’s credibility and its inflation-targeting framework, which helped prevent a wage–price spiral.

Even so, some economists within this sympathetic camp see a central bank that is too reactive, overly reliant on backward-looking data, and too enamoured with communication and forward guidance.

That’s why Powell’s successor matters. This is more than a change of style; there’s an appetite for a deeper, structural rethink of how the Fed operates.

Continuity or Regime Change?

Despite all of this, the current favourite, Chris Waller, hardly reflects a radical departure.

As an academic economist and a Fed governor, he has the right credentials. Yes, he is currently aligned with the President on the need for lower interest rates, but he is by no means a persistent dove. In fact, his selection would help ease a lot of the concern about independence.

He argued for higher rates in late 2021 and for faster, more aggressive tightening in 2022. His broad framework has also been correct: he anticipated that inflation would fall in 2022/2023 without a significant cost in terms of unemployment — a view that put him at odds with the likes of Larry Summers.

He’s a fan of wrestling analogies, which may help him connect with the President, but the big question from Trump’s perspective will be: how loyal will he be? Certainly, there is nothing in his approach to say that he will always lean dovish. That could set up a clash on monetary policy down the line.

Hassett is Trump’s safe bet — and the market’s nightmare pick.

His loyalty to Trump is undeniable. He was Chairman of the Council of Economic Advisors in Trump 1.0 and after that worked for Trump’s son-in-law Jared Kushner in his private equity firm. These days, he appears almost daily on CNBC defending the President’s policies.

His alignment with the administration is partially ideological — he has written extensively on supply-side economics — but the clear suspicion is that policy would be open to the President’s persuasions on rates.

The appointment of Hassett would likely result in an immediate hit to the USD and a rise in long-term bond yields.

Warsh is the dark horse — the candidate who could tear up the policy manual.

Like the others, he shares the President’s public criticism of the Fed and sees a case for rate cuts, citing the disinflationary impact of AI. But beyond the near term, a Warsh-led Fed could break sharply with the past.

He has called for new approaches, fresher ideas, and sharper debate. He opposes the routine use of QE, wants a smaller balance sheet, and accuses the Fed of enabling Washington’s fiscal profligacy through bond buying.

Yet his framework is frustratingly undefined. He warns against money printing but leaves open whether fiscal deficits and monetary targets would be formal guideposts. He rejects data dependence without offering an alternative. He rails against bailouts but still claims credit for the Fed’s crisis moves in 2008.

In tone, he sounds like he could bring Volcker’s inflation-fighting zeal to balance sheet reduction — with unpredictable consequences. If his stance on QE and deficits holds, markets could face a central bank less willing to finance large fiscal gaps and less inclined to backstop markets. That combination would be far less friendly to both bonds and equities.

A Fork in the Road

Some dismiss the appointment as overblown — after all, the Chair is just one vote on the FOMC. But that ignores the Chair’s power to set the agenda, steer debate, and direct the Fed’s research. History shows that, Bill Miller aside, the Chair has always shaped the institution.

Waller may be the favourite but the race is far from settled. A Bloomberg report last week suggested the search has widened to ten candidates. Trump’s choice of market-friendly Scott Bessent as Treasury Secretary will fuel hopes that Waller — the most competent and continuity-minded option in investors’ eyes — could prevail.

Yet the stakes are bigger than one man’s CV. The Fed is already battling a crisis of confidence; more broadly, trust in US institutions is eroding, as shown by April’s rare simultaneous sell-off in stocks, bonds, and the dollar.

If America’s independent central bank is seen as compromised, it won’t just be a blow to the Fed — it will strike at the heart of the US exceptionalism narrative and global faith in the dollar and American assets.

Equities are back at all-time highs. Bond yields are falling. CNBC and the financial media are fixated on whether the Fed will cut rates and engineer a soft landing.

But for long-term investors, the cycle is a distraction. The real driver of returns is the regime—whether it’s a disinflationary boom, a period of stagflation or something else.

The challenge is that, throughout history, each regime tends to sow the seeds of its own destruction. Yet investors are often wrong-footed at the turn—because sentiment is usually at its most extreme just as the shift begins.

Clocks and quadrants

The temptation to time the cycle is understandable. Models like the “investment clock” or investment quadrants suggest a predictable progression from recovery to expansion, overheating, and eventually recession. Each phase has an associated playbook for asset allocation. Buy equities during the recovery and expansion, switch to bonds as the economy cools, and repeat.

The reality is messier. For one, pinpointing the economy in real time is difficult. Although the economy was in recession during COVID and recovery thereafter, identifying where it is in the cycle has been difficult since then.

Markets zig-zag even more. Investors priced stagflation in 2022, then a possible recession after the demise of SVB in March 2023 and again as the Sahm rule was triggered in 2024. This year started with optimism about growth, which was followed by pessimism about stagflation. Now, the hope is for a disinflationary expansion.

One reason for the volatility is that investors are forward-looking. It’s not just where the economy is now that matters—it’s where it is heading that really counts. Famed macro investor Stanley Druckenmiller likes to form his view on markets based on where the economy will be in six months’ time.

And perception matters too. It’s not just about understanding the economic data—it’s about anticipating how others will interpret it. As Keynes observed, it’s like the newspaper beauty contest where readers pick the prettiest face—not based on personal preference, but on what they thought others would choose. Success came not from your own opinion of the prettiest face, but from guessing “what average opinion expects average opinion to be.”

For sure, some traders have successfully used the cycle and quadrants to inform their investments, but for most investors, an appreciation of the market regime rather than the market cycle matters more.

Defining the Regime

Over the past century, decade-long stretches have been shaped by structural forces—what we refer to as regimes—that drive returns across asset classes. Successful investing has often meant aligning with the dominant trend of the prevailing regime.

In the post-WWII era, the use of active fiscal demand management supported economic growth and sustained equity gains, while bonds underperformed amid rising inflation expectations.

The optimism of the 1960s gave way to supply shocks and persistent inflation in the 1970s. From 1966 to 1982, investors who didn’t see the shift in the regime reaped low or negative real returns in equities and bonds. Meanwhile, commodities and gold outperformed.

The Volcker shock in 1979 marked a regime change. His inflation-fighting success, combined with deregulation and the early waves of globalisation, ushered in falling inflation and a multi-decade bull market for equities and bonds. Commodities lagged.

The 2000s were characterised by a reset and two savage bear markets: the dotcom bust and the Global Financial Crisis. Bonds held up well in a disinflationary environment, while gold once again delivered strong returns as investors questioned fiat stability.

The deleveraging and austerity that followed the Global Financial Crisis contributed to the secular stagnation of the 2010s. Monetary policy became the only game in town. Growth was sluggish, but low rates and corporate profit expansion supported strong equity returns. Bonds rallied too, with trillions of dollars in government debt having negative yields, while commodities remained under pressure.

How Regimes Shape Markets—and End

What can we learn from past regimes to inform current investments?

For one, markets still exhibit cycles—but it’s the regime that drives returns. There were equity rallies during the inflationary 1970s and again in the early 2000s, but they proved fleeting. In both cases, the prevailing macro regime ultimately reasserted itself and reversed those gains.

Second, what works in one regime often reverses when the market transitions into the next regime. But investor sentiment can often be at an extreme just as the regime changes.

In fact, regimes often sow the seeds of their own destruction.

In the mid 1960s, after two decades of strong equity returns, investors were bullish, with the Nifty Fifty—the darlings of the day—pushed to extreme valuations, much like today’s Magnificent Seven.

On 31 December 1965, Keynes featured on the front cover of Time magazine, in recognition of the widespread adoption and perceived success of Keynesianism. But excessive reliance on demand management laid the foundations for the inflation of the 1970s and disappointing returns for the high-flying Nifty Fifty.

The trauma of that inflation and the pessimism it created gave political cover for Volcker’s tightening in the early 1980s. Famously, BusinessWeek magazine heralded the death of equities in 1979, just as a major rally was about to begin.

Two decades of strong returns for equities then led to hubris and excessive optimism at the turn of the century. Stocks like Cisco or Sun Microsystems were seen as cornerstones of any portfolio. But overly optimistic investors were wrong-footed again as a lost decade for equity investors unfolded.

Again, in the 2010s, the regime shifted again with both the secular stagnation and the new equity rally, a by-product of the Global Financial Crisis and the QE that came thereafter.

Investing in a new macro regime

Fast forward to today, and we can see how the current regime is taking shape—again heavily influenced by the past.

The austerity of the 2010s, the belief that QE fuelled inequality, and the perception that globalisation failed to deliver broad-based gains have all contributed to the demise of the neoliberal free-market ideology.

But what is replacing it is still unclear. In the US, it was initially Biden’s progressive agenda, now replaced by a populist, mercantilist agenda under Trump. In Europe, the focus has shifted to industrial policy and defence spending. The common denominator: large fiscal deficits.

The willingness to embrace deficit spending also has its origins in the 2010s. A decade of ultra-low—even negative—bond yields enabled the fiscal lever to be pulled during COVID and again during the cost-of-living crisis.

But old habits die hard, and it will be difficult for governments to wean themselves off the fiscal addiction. The bond market has taken note, and global bond yields are now roughly 3% higher than in the previous decade.

Although yields have fallen in the last two months on growing hopes that the Fed will ease, higher and more volatile bond yields could well become a defining feature of the regime.

The secular stagnation of the 2010s was a headwind for commodities. Falling prices led to reduced investment across the sector. In 2010, commodities featured in many asset allocation plans. But there’s nothing like sustained price weakness to change sentiment. A decade of poor performance has seen allocations steadily decline

Just as higher prices often cure inflation by dampening demand, lower prices tend to sow the seeds of future rallies—by constraining supply growth and delaying investment. Commodities may also see a secular trend change given the past underinvestment and rising defence and infrastructure related demand.

Equities are less clear-cut. With the S&P 500 back at record highs, there is no obvious regime shift—yet. Optimists might argue the regime has turned more positive amid continued AI-driven capital expenditure.

But fifteen years of double-digit US equity gains have left valuations stretched and sentiment bullish. Although central banks have shifted from asset purchases to asset sales, the QE era helped cement the prevailing psychology: buy the dip has been rewarded time and again.

Low borrowing costs, cheap assets, and rising valuations also created ideal conditions for private equity—and the money flowed in, by the trillion. But the landscape has shifted. Higher interest rates and inflated asset prices have stalled deal activity. Less capital is being returned to investors, and less is being recycled into new deals—perhaps an early warning sign for risk assets more broadly.

The equity rally and perception of US exceptionalism were key supports for the dollar in the 2010s, and a strong dollar weighed on gold. But the dynamics are shifting.

Dollar strength in the previous regime has contributed to widening US trade deficits, and the policy stance has quietly turned less dollar-friendly. Gold, previously constrained by dollar strength, is now trending higher—even with real yields still elevated -as concerns around fiat debasement emerge as a by product of QE and rising deficits.

Regime shifts don’t ring a bell. They build quietly—then become obvious in hindsight.

For investors, now is the time to look past the noise of rate cuts and soft landings—and focus instead on what excessive deficits, higher interest rates, and rising macro volatility mean for asset prices in the years ahead.

After a roughly 25% rally from the April lows, equity-heavy investors will feel vindicated that buying the dip was once again the right strategy.

Despite the warnings of a potential sea change for markets, from the end of US exceptionalism or a more fraught global trade environment, the multi-year equity rally remains intact.

There’s been plenty of talk of investors making structural portfolio changes in response to the shifting macro backdrop.

But when I review portfolios across family offices, institutions, and private investors, I keep coming back to the same question:

Are these portfolios built for the last decade—or the next?

The Risks Have Not Gone Away

Of course, there may be merit to the bull case in the short term. Inflation is edging lower, the ECB is cutting rates and there’s still no hard evidence of a downturn. Even if we do see a slowdown, markets expect some easing from the Fed later this year. Equities could grind higher.

But that doesn’t mean the risks have disappeared.

Valuations for US equities remain elevated. The forward P/E ratio on the S&P 500 is about 22, historically associated with lower-than-average future returns.

Even if trade deals are cut, it looks like tariffs are here to stay—likely around 10%—which will be a headwind for the consumer and corporate earnings growth.

Although yields have come off their highs, fiscal concerns continue to lurk in the shadows. The ambitions of DOGE have been scaled back, and Trump’s “Big Beautiful Bill” could add close to $4 trillion to the deficit over the next decade. All roads seem to point to higher yields - but when?

These macro risks don’t guarantee a downturn, but they make it essential for investors to think critically about how their portfolios are built and where the stress points may lie.

In short, this is not a time for complacency. As JFK once said, “the time to mend the roof is when the sun is shining”.

Why Diversification Often Fails

While portfolios appear diversified, with allocations to multiple asset classes, the actual level of resilience is often much weaker.

Multi-asset or diversified growth funds, often marketed as “all-weather”, suffer from the same flaw: a bet on continued sunshine.

Take the typical family office asset allocation from the recent UBS Global Family Office Report. At a high level it looks quite diversified with allocations to distinct categories from equities to antiques.

But when you group them into high-level asset classes and broader categories—growth, defence, and diversification—the portfolio looks far less diversified.

And adjusting the allocations for differences in risk would tilt the overall exposure even more to growth.

A wide range of assets—from equities to private equity, private credit, and real estate—tend to perform well when the economy is solid. But in a deep recession, they typically underperform together.

Equally, many strategies—from long-duration bonds to equities—do well when inflation is contained and interest rates are falling.

What about a regime of rising inflation?

Weak or contracting growth at a time of inflation—stagflation—is the hardest scenario. While stagflationary risks have flared at times in recent years, we haven’t seen a prolonged stagflationary episode since the 1970s.

Most portfolios are still ill-prepared for either a severe downturn or a stagflationary environment.

Why Portfolio Construction Still Matters

Sometimes the problem is an absence of truly diversifying strategies. Other times, the right elements are there—but poorly sized or misaligned.

Take a 50/50 equity/bond portfolio. On the surface, it looks balanced: equities for growth, bonds for defence. Between 1980 and 2020, long-term government bonds consistently rose when equities sharply fell as central banks came to the rescue cutting rates.

That relationship looks less reliable going forward, particularly if inflation proves sticky or investors require higher yields for holding government bonds. As 2022 showed, equities and bonds can fall together.

Reducing the bond duration might lower interest rate risk but turns the bond allocation into something more like cash: low return and limited ability to generate meaningful return or convexity in times of stress.

Adjusting for risk matters as well. You might see a 50% drawdown in equities, but as bonds are less volatile, even if bonds perform well, they may only offset a fraction of the equity losses.

The composition matters, too. Is the equity sleeve dominated by US growth stocks? For euro-based investors, the risk compounds further if growth underperforms and the dollar weakens.

On the bond side, is the exposure to government debt or to credit?

Investment grade, high yield, or emerging market bonds can offer income in calm markets. However, in periods of acute stress or rising rates (such as March 2020 or 2022), concerns about creditworthiness increase and these assets behave much more like equities—just when you want them to be doing the opposite.

Some investors have embraced alternatives. But calling something “private equity” rather than “public equity” doesn’t fundamentally change its behaviour in a downturn. The fact that you pay more for the private versions – only to get the same downside - adds insult to injury.

Even those who include truly diversifying strategies—like hedge funds—might not see much impact. The nature of the allocation matters.

1. If the hedge fund strategy has an inherent equity beta it might not perform well in a more stressed period. Strategies like global macro and trend following have historically fared better in more prolonged equity bear markets.

2. An allocation of 4% is unlikely to move the needle of the overall portfolio.

3. If the volatility of the hedge funds is low, the impact on the portfolio may be even less than expected, even for a low allocation like 4%. Paradoxically, higher volatility diversifying strategies can be more risk mitigating for the overall portfolio than lower volatility versions.

It is not just a matter of allocating to hedge funds. It’s about selecting the ones with a reasonable prospect of performing in more stressed conditions and allocating a meaningful amount of the risk budget.

For those looking to build a global macro hedge fund allocation that diversifies, our recent white paper lays out a few key considerations.

The Total Portfolio Approach

Among large institutions there is a growing trend to shift from traditional asset allocation models toward what’s called a “total portfolio approach.” The essence is simple: focus less on asset class names and more on the overall portfolio’s risk exposures.

It sounds like common sense, and it is.

The challenge for large institutions is that historically, because of their size, they tended to organise themselves according to the asset class exposure and allow teams to operate independently without really thinking about whether it made sense to allocate the marginal dollar to private equity or hedge funds. That’s now changing.

While the operational challenges are unique to large institutions, the principle—allocating capital to where it adds the most value per unit of risk—applies just as well to private investors: understand what assets you own, how they behave in stress periods, and what role each part plays.

There are ways to construct portfolios that don’t rely on predicting the next crisis—yet can survive when one inevitably comes.

It starts with better diversification, more thoughtful sizing, and a clearer understanding of what drives portfolio risk.

That typically translates into more meaningful allocations to truly diversifying assets and strategies, like gold, commodities, global macro and trend following.

The use of futures for beta, capital efficiency and greater flexibility can also be helpful, but that’s a story for another post.

Most portfolios I see still reflect the last decade more than the next—but the next is unlikely to resemble the last.

With the Big Beautiful Bill now steadily making its way through Congress — and DOGE disappearing from the front pages — the US fiscal deficit is back as a key market driver.

Moody’s downgrade of US debt wasn’t seismic on its own. But it did refocus investor attention on the budget arithmetic. And the numbers are getting harder to ignore.

Whether we’re on the cusp of a debt crisis is hard to call. But the broader outlook is becoming clearer — and more worrying.

Trump 2.0 is shaping up just like Trump 1.0: ever-widening deficits and rising debt. The goal of hitting a 3% deficit under Scott Bessent’s 3/3/3 plan now looks far-fetched.

The CBO estimates the new bill will add $3.8 trillion to the deficit over the next decade. Even before this, they projected debt-to-GDP rising from 100% to 118% — and that assumed 10-year yields stay under 4%. That already looks optimistic.

Some in the market are starting to ask: could the US face its own “Liz Truss moment” — a disorderly bond market sell-off?

The comparison is only partial. In the UK, it was forced selling of Gilts to meet pension LDI liquidity needs that really accelerated the Gilt sell-off.

But the bigger question is this: are we nearing the tipping point of fiscal dominance — where bond markets, not policymakers, start setting the agenda? And will it take a meltdown to force Washington into making the hard fiscal choices it’s been avoiding?

Back to 1993

The year was 1993, when James Carville, political advisor to Bill Clinton uttered his oft-repeated remark

“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

US 10-year yields were just over 6% and with inflation running at about 3%, real yields at over 3% were seen as an impediment to growth. The economy was recovering from the 1990-1991 recession, but recovery was slow. It was called the jobless recovery. The unemployment rate was still above 7.0%, having peaked at 7.8% in July 1992.

The fiscal deficit was close to 4.5% of GDP, perhaps not unsurprising given the weakness of the economy, but touching the highest levels in about a decade. Clinton understood that to stimulate growth he needed to get interest rates down. Encouraged by Fed Chair Alan Greenspan, he knew a fiscal adjustment would make it easier for the Fed to pursue easier monetary policy.

He raised the top rate of income tax from 31% to just under 40% in the Tax Reform Act of 1993. Although the Fed raised interest rates in 1994, they cut in 1995, and long-term yields trended lower through much of the mid-late 1990s, contributing to the virtuous cycle of rising asset prices and strong economic growth.

Of course, Greenspan’s new paradigm economy was also a factor, as was the global disinflationary trend underway after the fall of the Berlin wall in 1989. But the change in the fiscal picture was real. In fact, by 2000 the US posted a fiscal surplus and the chat in the Treasury market was whether the government should stop issuing long bonds.

Modern Monetary Madness

But that was the turning point. The post dotcom bust saw the deficit rise as the economy went into recession and the George W. Bush tax cuts further increased it. After the Global Financial Crisis, the American Recovery and Reinvestment Act of 2009, combined with the TARP, saw the deficit rise to almost 10% in 2009. But the Zeitgeist still called for austerity and in the subsequent years the deficit fell back to more normal levels by the mid-2010s.

While 2000 may have been the turning point, 2017 was the tipping point of legitimising large deficits. Despite the unemployment rate being only 4%, a significant tax cut was deemed necessary. By the end of 2019, the deficit had grown to 4.5%, about the same level facing Clinton in 1993, but this time for an economy at full employment.

COVID cemented the structural shift providing a justification for an eye-watering deficit of 15% in 2020. But unlike the post-GFC era, when the virus departed, there was no appetite for fiscal consolidation. Instead, Modern Monetary Theory was the new dogma.

In the aftermath of COVID and Russia’s advance on Ukraine, Bidenomics brought the justification of national security threats, potential supply chain disruptions and the need to rebuild flailing US infrastructure to the Chips Act and Inflation Reduction Acts. It was the end of the neoliberal era of free markets and conservative fiscal policy.

The inverse relationship between unemployment and the deficit was still in place, but the curve had shifted — deficits were now significantly larger at every level of unemployment than they were in the past.

The Trend Change in Bond Yields

While the initial impulse of COVID was deflationary, with bond yields falling to historic lows in March 2020, the bond market eventually took note of the radical shift in policy that was underway.

The underlying driver of bond yields is the balance between savings and investment, and that balance was tilting to higher investment spending.

The era of secular stagnation of the 2010s saw excess savings and weak investment demand forcing yields down, but that changed with the large fiscal deficits of the COVID years and the growing need for investment in defence and other projects in subsequent years.

It’s no coincidence that after the Democrats won the runoff elections in Georgia in January 2021, giving them effective control of the Senate, bond yields started to rise in anticipation of higher spending. Yields have trended higher ever since.

Other factors have accentuated the move. Inflation has shifted into a higher range meaning investors require a higher yield in nominal bonds and central banks have ceased asset purchase programs and have turned net sellers of bonds.

Some Unpleasant Fiscal Arithmetic

The trouble with a structural rise in yields is simple: higher yields raise the cost of issuing new debt, and old debt gets refinanced at higher rates.

In theory, a country that borrows in its own currency can't default. But if investors lose faith in the fiscal trajectory, they’ll demand a much higher risk premium to hold Treasuries. That’s when debt sustainability becomes a real concern.

That’s where the U.S. finds itself today — caught between rising costs and fading confidence.

At the heart of any debt sustainability analysis is the relationship between interest rates and growth: R – G.

If nominal GDP growth exceeds nominal bond yields (G>R), growth is sufficient to generate the tax revenues to service interest rate costs. But, if R>G the arithmetic changes and an increasing amount of tax revenues goes on servicing debt.

Let’s say inflation settles at 2% or even 2.5% and real GDP growth is a respectable 2%, nominal GDP growth is 4-4.5%. But US 10-year yields are already at about 4.5%. That’s why a move above 5% would be so worrisome.

As every emerging market knows, once investor confidence goes, yields jump. The result: a vicious cycle of rising interest costs, wider deficits, and even greater risk premiums.

Can Growth or Inflation Save Us?

Of course there are solutions to the problem. Stronger economic growth would generate higher tax revenues and arithmetically would reduce the debt as a percentage of GDP.

Optimists point to AI as a potential saviour in that regard. Couldn’t an AI fuelled productivity boost, just like in Greenspan’s New Paradigm Economy propel the economy to a higher growth rate, keeping the deficit in check?

It’s possible, but the potential impact of AI on the economy is fiendishly difficult to assess never mind quantify. And even if AI transforms the economy, the experience of the internet would suggest a large lag between the development of the technology and the realisation of productivity gains.

And what about higher inflation? Can’t we just inflate our way out of the debt?

Yes, higher inflation does erode the real value of debt, and the US got the benefit of this with the inflationary surge of 2021. But the problem with this is market expectations quickly adjust and if inflation is seen as endemic, investors require compensation in the form of a higher inflation risk premium in bond yields.

Making some tough choices on spending and cutting the deficit is a third solution. But such changes were politically challenging even when there was a semblance of bipartisanship in Congress. It is hard to envisage agreement on major spending cuts at the current juncture.

The Coming Era of Fiscal Dominance and Financial Repression

The warning sound now is that we may now be approaching the point of fiscal dominance. It’s the moment where monetary policy is directed at managing the sustainability of fiscal policy.

It could mean the Fed keeping interest rates lower than otherwise to keep down debt servicing costs, or it could mean a return to QE and outright purchases of treasuries to keep long-term yields under control. In either case monetary policy is directed at debt sustainability in the first instance rather than price stability.

Could that really happen in the US?

Going back in history it has. The Fed engaged in yield curve control in the 1940s to keep borrowing costs under control during World War II. That only ended in 1951 after the Fed and the Treasury had a standoff and the Fed eventually reasserted its independence via the Treasury-Fed Accord.

But it could come in another variant, via moral suasion or arm twisting the Fed. In the 1970s, Nixon bullied Fed Chair Arthur Burns and planted stories in the press about him seeking a pay rise to discredit him and force him into easier policy. The result was a decade characterised by a trend drift higher in inflation.

Back to the Future

In 1993, the debt/GDP level was only 47% and the deficit was only 4.4%, yet Clinton saw the need for a fiscal adjustment — and had the political capital and congressional alignment to deliver it. The result was a win-win of fiscal adjustment, lower yields and stronger growth.

Today, the US debt/GDP is more than double what it was then, and the deficit is 50% higher, yet the ideological and political consensus does not exist to address them. The era of low interest rates has allowed a complacency with respect to deficit spending to take hold just as the challenge of addressing entitlement spending looms large.

Now, not only are debt and deficit levels higher but the debt sustainability dynamics of R versus G are deteriorating as well. Only a market-induced crisis will force action.

How things play out from here is anybody’s guess but here are three possible scenarios:

(1) Bond yields remain elevated, but assuming a 10% baseline tariff is eventually pushed through (with higher tariff on certain target industries) the impact on growth will become more apparent as we go through the year, pushing the US economy into recession and allowing the Fed to ease. That would take the heat out of longer-term yields even allowing for a likely steepening of the yield curve. In the short-term a crisis would be avoided but the deficit would likely grow even bigger in the downturn and the trend higher in rates would resume next year when the economy recovers.

(2) Growth remains resilient while inflation responds to the impact of tariffs forcing the Fed to shock the market with higher, not lower, rates this year. Bond yields spike and strains between the White House and the Fed ramp up. Yields might accelerate as a sustained break of 5.0% on the 10-year yield could force unforeseen consequences such as on bank balance sheets or unearth other vulnerabilities in the system. We could see a quick move to 6% and a significant sell-off in equities. The equity sell-off and higher yields would probably cause a recession and ultimately see yields peak for the cycle, but the underlying vulnerability would remain.

(3) The economy slows and the bond markets stays in a broad range. The Fed doesn’t hike but it is slow to ease. By next year, it will be time for Trump to replace Powell and he does so with a more sympathetic Fed Chair. Although the other voting members of the FOMC still exert restraint, having a Fed leadership with more dovish leanings produces a Fed inclined to tolerate higher inflation. The market sees this and demands a higher inflation premium, particularly as the US dollar weakens in response to a perception of reduced credibility. Growth holds up but bond yields trend higher and we enter the era of financial repression whereby the government is forced to use moral suasion and other measures to force domestic investors to buy Treasuries.

As Paul Tudor Jones remarked last year, “all roads lead to inflation” and that has obvious implications for the bond market.

When I started working in the markets in the mid-1990s, traders used to remark about the JGB market that it was the sell of the century. The question was which century!

As Rudi Dornbusch once quipped, “a crisis takes longer to develop than you think, and then evolves more quickly than you thought possible.”

Fiscal risks are mounting in the Treasury market. Whether it’s this year, next year, or beyond — all roads lead to higher yields.

Although equities have bounced back and reclaimed their post–Liberation Day losses, the volatility in April has left its mark.

While many saw the sell-off as just another buyable dip, institutional investors are asking a deeper question: Was it a temporary shock — or a sign that a structural shift is under way?

When I speak to investors around the world, two questions keep coming up: Are we entering a new regime for investing — and what does that mean for asset allocation?

From Secular Stagnation to Macro Volatility

With over 100 days of Trump 2.0 behind us, it now seems clear that a new market paradigm is taking shape. U.S. policy is focused on an "America First" mercantilist agenda aimed at boosting domestic manufacturing. In response, Europe has been compelled to adapt to a changing global order, increasing both defence and infrastructure spending.

Even before Trump won the presidency last year, structural trends — high government debt, ageing populations, deglobalisation, and accelerating AI adoption — were already pointing to a new macro regime.

Whereas the 2010s were defined by secular stagnation, low inflation, low interest rates and quantitative easing, we are moving to a regime of greater macro volatility, more erratic policymaking, and a reshaping of global trade and capital flows.

The stable macro environment and accommodative monetary policy of the 2010s were a boon for equity markets — but that playbook may now be obsolete. We appear to be entering an era of more volatile interest rates and currencies, creating headwinds for equities but opportunities for active strategies.

Here are three areas where investors need to rethink their approach to asset allocation.

What Is a Safe Asset?

First and foremost, the definition of a "safe haven" is being re-evaluated. The U.S. dollar has historically been seen as a safe haven, given its reserve currency status and deep, liquid markets.

But with more erratic policymaking, reduced confidence in the U.S., and a growing suspicion that the administration favours a weaker dollar, we have to question whether the dollar will continue to offer the same protection during future stress periods.

This is particularly relevant for international reserve holders and non-U.S. investors. Historically, the dollar has tended to appreciate during periods of market stress, providing a natural hedge on U.S. assets. Today, gold and the Swiss franc are re-emerging as more reliable haven assets.

What Diversifies Equities?

The role of government bonds in portfolios has to be reconsidered. U.S. Treasuries fell in April even as equities sold off. The four decades between 1980 and 2020 were a golden age for fixed income.

A global disinflationary trend produced a bond bull market and a reliable negative correlation between bonds and equities. Bonds not only generated solid returns but also acted as a hedge during equity market drawdowns.

That dynamic is now in question.

First, inflation remains sticky and may require higher interest rates — a scenario that, as in 2022, could be negative for both bonds and equities. Second, as we saw in April, erratic policymaking can erode confidence in U.S. assets more broadly, triggering a “Sell America” trend that could reappear. Third, if the U.S. fiscal trajectory continues to deteriorate, we could see a vicious cycle of reduced demand for Treasuries and rising bond yields, further pressuring equities.

Meanwhile, trend-following strategies — another core risk mitigation tool — also struggled in April, with the SG Trend Index down nearly 5%. Managers were broadly long equities coming into March and were hit as the decline accelerated. But it was the simultaneous reversals in the U.S. dollar and commodities like copper that compounded losses. Anyone looking to trend for “crisis alpha” last month came away disappointed.

That said, the initial stages of an equity drawdown are often challenging for the strategy. Investors should remember that trend following doesn’t always perform during sharp, short-term pullbacks. The longer and more persistent the decline, the more favourable the historical outcomes. Allocating to trend can test the resolve of even the most disciplined investors, but it remains one of the few strategies with a track record of strong performance during major equity market declines.

Although the HFRI Macro Index was -2.2% in April that was partially driven losses in quant macro (including trend following). Across discretionary macro managers what seems clear is that the dispersion of returns was unusually high. The current environment offers rich opportunities for tactical managers, but not all will successfully catch the turns. Global macro remains a compelling diversifier for equity risk, but manager selection and diversification within the strategy are critical.

Rethinking Growth Allocations

On the growth side, two dominant themes of the past decade — U.S. equity outperformance and the surge in private markets — are also being reassessed.

While the market may be premature in calling an end to U.S. exceptionalism — especially if the upcoming “Big Beautiful Bill” delivers market-friendly deregulation and tax reforms — the erratic policymaking of April and the periodic attacks on the Fed may unnerve investors.

Even before Liberation Day, high valuations, tariff concerns, and the Deep Seek developments in January had already begun to shift investor sentiment on U.S. equities. At the same time, Germany’s decision to unwind its "debt brake" prompted many to reconsider eurozone exposures.

In private markets, a persistent influx of capital into private equity has coincided with a slowdown in distributions. Higher rates have made leveraged buyouts less attractive, and many managers are reluctant to realise losses on assets still marked at optimistic valuations.

With less capital being returned — and many institutions already overweight private markets — some have turned to the secondary market, often selling at steep discounts. Private credit stakes, for example, have reportedly been trading at 70 cents on the dollar.

Meanwhile, prominent endowments such as Harvard have faced funding pressures exacerbated by U.S. political decisions, reinforcing the importance of liquidity. Geopolitical tensions have also prompted major Canadian pension funds and Chinese sovereign wealth funds — historically large U.S. allocators — to pause new commitments.

Implications for Investors

In this shifting macro regime, three portfolio adjustments stand out:

1. Diversify safe assets. A mix of currencies and gold may now be more reliable than sole dependence on the dollar.

2. Reassess diversification. Bonds may offer income again, but their role as a hedge is no longer assured. Global macro — including trend following — remains a strong candidate for diversifying equity risk.

3. Prioritise liquidity and balance equity exposures. With uncertainty high, a more globally balanced equity allocation and greater attention to liquidity are both warranted.

How this regime shift ultimately plays out remains to be seen.

Equity markets have again shown resilience, but as we saw during the Global Financial Crisis, relief rallies can be fleeting.

The investing landscape is being reshaped — but amid the uncertainty, time-tested principles remain: diversification, robustness, and maintaining liquidity are more important than ever in guiding long-term asset allocation.

Just weeks ago, markets were fixated on a coordinated effort to weaken the U.S. dollar—the so-called "Mar-a-Lago accord." Echoing the 1985 Plaza Accord and drawing on ideas from Steve Miran, the aim was to engineer a weaker dollar to boost trade and rebalance global flows.

The recent movements of the dollar highlights how in FX markets it’s a case of “careful what you wish for.” In openly considering discouraging capital inflows into the U.S., the U.S. may have contributed to capital flight.

Emerging market literature often warns of “sudden stops” in capital flows that lead to currency and bond crises. That thinking is now being applied to the U.S.

In the immediate aftermath of Liberation Day, U.S. equities, bonds, and the dollar all sold off, sparking fears of a structural shift in capital away from the U.S. Equities have since rebounded, but the dollar’s recovery has lagged. Sentiment remains fragile.

It seems that as soon as the dollar begins to fall—particularly when it does so abruptly—concerns emerge that a structural change is underway that could erode the dollar’s reserve status. While important, even for long-term allocators, it misses the central issue.

Source: Measuring Worth

If you look at the experience of sterling, it began to lose its reserve currency status in the 1920s but GBP/USD remained quite stable until World War II, and its long-term decline accelerated in the post-war era.

In the case of the U.S. dollar, it has already experienced structural bull and bear markets (including major declines) whilst maintaining its reserve currency status.

The relevant question is whether the demand for U.S. assets will diminish—and is the dollar on the verge of a structural bear market?

The Bearish Case for the Dollar

On that question, the odds of a structural bear market have certainly increased.

First, there’s growing suspicion that U.S. policymakers—either implicitly or explicitly—prefer a weaker dollar to support domestic manufacturing and reduce external imbalances.

Second, there is the question of policy credibility, which appears increasingly strained—whether due to unanchored fiscal trajectories, erratic tariff announcements, or threats to undermine Fed independence.

Third, the narrative of U.S. exceptionalism, which underpinned the prior cycle of dollar strength, appears to be weakening.

And history tells us that prior periods of sustained dollar appreciation were accompanied by high-quality, credible policy responses—from Volcker’s aggressive hikes in the early 1980s, to Clinton-era fiscal consolidation in the 1990s, to the Fed’s crisis stewardship under Bernanke and Powell. That credibility now looks more fragile.

Against that, in the short term, sentiment may have gone a bit extreme. The Economist magazine has run front-page stories warning of a structural decline in the dollar. Their front pages have a history of being contrary indicators.

Also, as Alan Greenspan once remarked, “I’ve never been able to forecast the dollar. I can’t do it and nobody else can either.” That humility is worth remembering. FX markets are driven as much by narrative and perception as by fundamentals. And narratives can shift with little warning.

Is there a case that this is just a cyclical correction in the dollar bull market?

It looks unlikely right now, but investors must remain open-minded. Themes in FX markets change quickly. If sentiment shifts again—for instance, if U.S. growth proves more resilient or institutional credibility is restored—short positioning could reverse just as abruptly as it built up.

One possibility is that the Fed proves more resistant to easing policy and stays on hold, disappointing market expectations of rate cuts. While in theory that should support the dollar in the current environment, such a move may antagonize the already fraught relations between the Fed and the White House.

So while we have to remain open-minded about this being just a cyclical decline, the negatives are accumulating for the dollar.

The Dollar Trilemma

At the heart of U.S. dollar policy lies a trilemma. The U.S. faces three conflicting goals:

1. A desire for a weaker, more competitive dollar to support manufacturing.

2. Maintaining the dollar's reserve currency status.

3. Attracting sustained capital inflows to fund large fiscal deficits.

The U.S. has long enjoyed the "exorbitant privilege" of borrowing in its own currency. But the flip side of persistent trade deficits is a growing foreign ownership of U.S. assets. Each year, the current account deficit is matched by a capital account surplus.

This dynamic—known as the Triffin dilemma—remained academic in normal times. But when confidence in U.S. policy weakens, the risks become more tangible. That’s especially concerning when the U.S. is running fiscal deficits of 6–7% of GDP. Just weeks ago, proposals were floated to tax holders of Treasuries. But now it’s the expression “relying on the kindness of strangers” that comes to mind.

The current pessimism is even more remarkable when considering that, only a few years ago during COVID, the U.S. dollar surged. At that time, investors were preoccupied with the idea that the world is structurally short dollars.

Making Sense of the Great Dollar Mismatch

How can the world be overweight U.S. assets but structurally short U.S. dollars?

The answer lies in two different sides of the global balance sheet. Long-term investors such as pension funds, sovereign wealth funds, and family offices are fully funded and have surplus capital to invest. Over time, increasing flows from these investors have gone into U.S. assets, leaving the world structurally long dollars on the asset side.

At the same time, global banks and shadow banks, both inside and outside the U.S., have issued massive volumes of dollar-denominated liabilities. In times of funding stress, liquidity becomes scarce, and these issuers scramble to source dollar funding. That’s why the dollar surged during the Global Financial Crisis and during COVID, and why the Fed activated swap lines with other central banks to meet global dollar demand.

From Strength to Stress

It’s the asset side of the equation where the risks to the dollar are now mounting.

With over $60 trillion in U.S. assets held by foreign investors—more than $20 trillion of it in liquid instruments—even modest selling could trigger persistent pressure. U.S. investors may also diversify overseas if confidence erodes or valuations shift, raising the risk of structural outflows even without outright panic.

Cyclical variations in the dollar are often driven by relative interest rate movements and relative economic growth. The strength of the U.S. dollar since the Financial Crisis owes much to stronger economic growth and higher interest rates. Notwithstanding the large trade and fiscal deficits, the dollar has been the “cleanest dirty shirt.”

But even those factors are either eroding or not providing support. U.S. 10-year yields have been rising relative to foreign yields, and the ECB has been cutting rates while the Fed has been on hold. Both should have supported the dollar, yet the dollar has fallen—suggesting something more structural may be at work.

FX markets are also highly thematic and sentiment-driven. Over the past year, the dominant narrative was one of U.S. exceptionalism, reinforcing dollar strength. But that has quickly shifted. Investors are now focused on institutional fragilities, fiscal excesses, and foreign policy uncertainty—each undermining the credibility of U.S. stewardship of the global monetary system.

Importantly, the dollar now appears sensitive not just to macroeconomic variables like growth and interest rates, but to structural supports such as the credibility of the Fed, the stability of governance, and geopolitical trust.

The freezing of Russian reserves post-Ukraine, rising gold purchases by central banks, and an increase in non-dollar trade settlements all hint at subtle shifts underway. The strong and persistent rally in gold, seemingly driven at least in part by central bank reserve buyers, points to a slow-moving structural transition.

Barry Eichengreen has pointed out how individuals as much as institutions influence when currencies rise and fall. Although Scott Bessent has reiterated that the U.S. has a strong dollar policy, in the aftermath of Steve Miran’s “Mar-a-Lago paper” and Trump’s previous comments, there is a suspicion that the U.S. is happy to see the dollar slide.

Implications for Long-Term Allocators

With all the negativity around the dollar and debates over its reserve status, a few truths are worth keeping in mind:

• If the U.S. dollar is to lose its reserve status, it won’t happen overnight. In fact, a steady decline in dollar holdings has already been under way even through the Dollar rally of the last decade.

Global Reserve Manager Currency Holdings

• Some commentators point out that the dollar’s importance in the global system has increased as the Fed has agreed swap lines with even more foreign central banks. But even if the dollar remains structurally important, that doesn’t preclude a significant decline in value—we’ve seen 30–40% drawdowns multiple times since the breakdown of Bretton Woods.

• Although many asset holders are long dollars, international borrowers remain structurally short dollars. This means the dollar can still experience sharp rallies during episodes of funding stress.

• A weaker dollar typically supports global liquidity and growth, but a disorderly collapse in the dollar is in nobody’s interest—as captured by former Treasury Secretary John Connally’s famous line: “Our dollar, your problem.”

Conclusion: Demand, Not Dominance

The dollar’s role as a reserve currency is not binary—it can persist while the dollar weakens, and it can be challenged even while the dollar rallies. Today, the debate is less about global “de-dollarization” and more about whether foreign and domestic investors still want to hold U.S. assets at scale. On that score, the risks to the dollar now appear structurally tilted to the downside.

The Liberation Day announcement of broad-based tariffs has triggered an unprecedented economic confrontation for the US - with both allies and trading competitors. But a potentially more significant battle may be brewing at home—not just with Democrats, but with the Federal Reserve.

What’s at risk isn’t just a spat between the President and the Fed Chair. Fed independence—long seen as a cornerstone of financial and price stability—could come under pressure, with far-reaching consequences for US markets.

A looming policy dilemma for the Fed

Even before the election, concerns were growing about what Trump 2.0 might mean for the Fed. The worry stemmed from Trump’s first term when he frequently criticised the central bank for not cutting rates. In 2019, Trump tweeted: “My only question is, who is our bigger enemy, Jay Powell or Chairman Xi”.

In the aftermath of the Liberation Day equity sell-off, it hasn’t taken long for the President to turn his attention back to the Fed. In a tweet, he argued that falling oil prices justified a rate cut. This week Trump ratcheted up the pressure another notch saying Powell’s termination “cannot come quick enough”.

But even with the announcement of a 90-day pause on reciprocal tariffs, the outstanding tariffs still put the Fed in a bind. They’re likely to weaken growth while pushing up inflation—challenging both sides of the Fed’s dual mandate of maximum employment and price stability.

For now, the US labour market remains solid, with unemployment stable at 4.2%, giving the Fed room to focus on inflation. Indeed, in his comments following the tariffs, Chair Powell has struck a hawkish tone, noting that the larger-than-expected measures would likely worsen inflation.

Meanwhile, markets are still pricing in around a 0.75% cut in rates this year—betting that the Fed will respond once growth weakens materially.

But even if the pause on reciprocal tariffs helps the US avoid recession, it could set the stage for moderately weak growth combined with higher inflation—a mix that might see the Fed stay on hold, further straining relations with the White House.

Making sense of Trump’s trade policy

In the wake of the tariff announcement, investors and commentators have scrambled to rationalise the move. Many were shocked at the scale, believing that moderate voices like Treasury Secretary Scott Bessent may have persuaded the President to take a softer line.

An alternative explanation is that the announcement should not have come as a surprise. After all, Trump had threatened tariffs of 60% on China during the presidential campaign. The President should be taken literally, the logic goes.

If so, the implications for Fed independence could be stark.

Trump has previously expressed a view that he should have a say in monetary policy. He also said he wouldn’t immediately fire Powell, “as long as he was doing a good job”—a clear signal that might change if policy is not to his liking. He has also been open to the idea of naming a shadow Fed Chair - a move that would directly undermine the central bank.

While it’s not clear whether Trump has the authority to remove Powell, he seems likely to nominate a more administration-friendly pick when Powell’s term ends next year.

Central bank independence under fire

We’ve come to see central bank independence as normal—critical for maintaining price stability and preventing political interference in monetary decisions.

But it hasn’t always been that way. The push for independent central banks only really gained momentum in the 1980s and 1990s, following the inflation surge of the 1970s. For example, in the UK, the Chancellor still set interest rates as late as the mid-1990s.

Before that, Arthur Burns—Fed Chair for much of the 1970s—was widely seen as having bowed to pressure from President Nixon for looser policy. At the end of his term, Burns lamented that the Fed lacked the political backing for low inflation. Paul Volcker’s success in bringing down inflation in the early 1980s depended heavily on support from Reagan, in the face of congressional pushback.

The concern now is that a weakened Fed

(1) may be more inclined to keep policy easy to stimulate growth at the expense of higher inflation;

(2) could face political pressure in its supervision of the banking and financial system; and

(3) might be called upon to use its balance sheet to buy Treasuries should US debt levels spiral.

Up until recently, the idea that policymakers might meddle with central bank independence has seemed fanciful. During and after the Global Financial Crisis, central bankers were treated almost like rock stars—credited with staving off disaster while politicians clung to austerity. Monetary policy was “the only game in town”.

But we’re now in uncharted territory. The old rules of economic policy no longer seem to apply, and everything is up for grabs. If the impact of the tariffs proves to be as negative as most mainstream economists expect, the tension between the administration and the Fed looks set to ratchet even higher.