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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Key Takeaways:
- **US “Indispensable” Status Under Scrutiny:** America’s enduring financial hegemony, traditionally anchored by the US dollar, is increasingly defined by its unparalleled ability to attract global investment capital. However, recent market trends suggest this gravitational pull, fueled by dominant equity markets and robust Treasury demand, may be weakening amidst rising concerns over valuations and fiscal discipline.
- **Interconnected Market Risks:** The health of the US equity market (driving consumer wealth and AI investment) is inextricably linked to the stability of the Treasury market. Rising government borrowing costs directly impact corporate financing for mega-cap tech and increase the discount rate applied to future earnings, creating systemic vulnerability for the broader economy.
- **Global Rebalancing on the Horizon:** While a mass exodus from US assets remains unlikely due to their structural advantages, a discernible shift in global capital flows towards increasingly attractive alternatives in Europe, Japan, and emerging markets could fundamentally alter the equilibrium of the US economy and its financial markets, necessitating a re-evaluation of long-held investment strategies.
When we talk about American financial hegemony, we almost always talk about the US dollar—its undisputed role as the world’s reserve currency, its safe-haven status, and its pervasive use in global trade and finance. The resilience of this dollar-centric system is the subject of continuous speculation, particularly in an increasingly multi-polar world. But there is a better, perhaps more immediate, way to frame the issue: the US’s role as the world’s indispensable investment destination. The world’s prodigious savings, seeking both safety and superior returns, are pulled to the US as if by an economic super-gravity, crowding into American stocks, corporate bonds, and government Treasuries. This persistent capital inflow provides its economy with a critical, yet often underappreciated, support system, enabling lower borrowing costs and fueling growth.
If this powerful financial gravity should weaken, the consequences for both domestic and global markets would be profound and far-reaching. The primary pillars of today’s US economy — robust consumer spending and transformative AI investment — are deeply wired into the health and performance of the US stock market. Consumption is significantly boosted by the “wealth effect” of plump retirement accounts, 401(k)s, and brokerage portfolios heavily allocated to the S&P 500 and Nasdaq. A sustained market downturn could severely dampen this crucial economic engine. Similarly, the data centre boom, driving the current technological revolution, can only rip along while “hyperscaler” stock prices, such as those of Nvidia, Microsoft, Amazon, and Alphabet, maintain their lofty valuations, allowing them to raise vast amounts of capital cheaply. And it hardly needs to be said that weaker global demand for US Treasury bonds, coupled with a corresponding rise in government borrowing costs, could wreck an already wobbly fiscal outlook, impacting everything from federal spending to the cost of mortgages and corporate debt across the economy. The sheer scale of the US national debt, now exceeding $34 trillion, makes this vulnerability particularly acute.
Over the past 20 years or so, US stock markets have consistently crushed the field, delivering unparalleled returns that have made being “overweight America” the default investment posture. Since the depths of the global financial crisis, for instance, US equities have returned almost 17 per cent a year on average, significantly lapping major markets in Europe (e.g., Euro Stoxx 50), Japan (Nikkei 225), the emerging world (MSCI EM), and China. This outperformance has been a key driver of US wealth accumulation. But lately things are changing. In the past two years, global stock returns have been comparable to the US, or even better, especially when measured in local currencies, signaling a potential shift in momentum. Meanwhile, US Treasuries have come under increasing pressure this summer, with yields on longer maturities, particularly the benchmark 10-year note, pressing against or even passing the top end of the trading range that has held since the 2021–2022 inflation surge, reflecting a tangible unease among fixed-income investors.
What’s happening beneath these market shifts? For stocks, there is growing discomfort with the concentration risk inherent in the “Magnificent Seven” AI trade that, just a year or two ago, seemed to raise all boats. While investors can’t afford to skip the AI theme altogether, neither is there enough new money to push the broader US market decisively out of the trading range it’s been in all summer. High US valuations, measured by metrics like the Shiller CAPE ratio or forward P/E multiples, are also starting to pinch, making international alternatives appear relatively cheaper. For Treasuries, the ugliness of the fiscal situation — characterized by persistent large deficits, ballooning national debt, and the indifference of Congress and recent administrations (other than some often-pointless window dressing by the Treasury secretary) — seems to have finally focused debt investors’ minds. Concerns are mounting that whether in the form of sustained inflation, a debased dollar, or some other painful economic adjustment, the deficit chickens will inevitably come home to roost, demanding higher compensation for holding US government debt.
It’s important to acknowledge that there cannot be a mass abandonment of US assets, just as there cannot be a mass departure from the dollar’s central role. They are simply too big, too liquid, and structurally superior to the available alternatives for a sudden, dramatic shift. On the equity side, the US has a unique combination of advantages nowhere else can fully touch: world-class universities fostering innovation; a reliable legal system protecting property rights; relatively lower regulatory hurdles compared to some peers; abundant energy resources; a huge, dynamic domestic market; and relatively attractive demographics. These fundamental strengths will persist even if the current AI boom should fizzle and stock markets face a severe correction. Moreover, paradoxically, when US public assets — Treasuries — become less appealing due to fiscal concerns, demand for US private assets (stocks and corporate bonds) may increase as global capital still seeks a home within the perceived safety and innovation of the US economy.
So, should investors simply cut Treasury exposure and double down on US stocks? Not so fast. Public and private assets are conjoined in several critical ways. Most basically, as Treasury prices fall and both nominal and real (inflation-adjusted) yields increase, the discount rate applied to stocks’ future cash flows rises. This directly strikes at the heart of the value proposition of the expensive, long-duration tech stocks that hold up much of the US market. Higher discount rates diminish the present value of future earnings, making growth stocks appear less attractive. Furthermore, many of the “hyperscalers” from Alphabet to Oracle are moving to increasingly capital-intensive business models, investing heavily in data centers, chips, and AI infrastructure, and they finance a significant portion of this with corporate debt. Therefore, because Treasury yields serve as a benchmark for corporate borrowing costs, there is now more connective tissue joining the biggest companies in the stock market to volatility in the Treasury market, creating a feedback loop.
Paradoxically, there is even a risk for stock markets if government deficits are eventually brought under control. Government deficits tend to appear on the other side of the national ledger as corporate surpluses — that is, profits. This accounting identity suggests that closing the deficit will very likely be accompanied by a painful drop in corporate earnings and therefore share prices in the short to medium term, as the government’s reduced spending or increased taxation siphons demand or capital from the private sector. And the longer these deficits are allowed to proliferate, creating an ever-larger fiscal hole, the harder and more abrupt this adjustment will be, potentially triggering a more severe market correction.
Meanwhile, alternatives to the US are looking increasingly attractive. Profits at European companies, particularly in certain cyclical sectors, are accelerating, and their valuations often appear more compelling compared to their US counterparts. In Japan, corporate governance reform has significant momentum, with the Tokyo Stock Exchange actively pushing companies to improve capital efficiency and shareholder returns, alongside a more sustained inflationary environment supporting nominal growth. Emerging market countries’ own fiscal situations have, in many cases, improved, with some boasting stronger current account balances and reduced external debt, making them potentially more resilient to global shocks and offering diversification benefits. As these regions strengthen their economic fundamentals and market structures, being overweight America could look less and less like the default, risk-free option, and this growing shift in global capital allocation could fundamentally upset the country’s long-standing economic equilibrium.
When despairing about America’s public finances, it is easy to be comforted by its dynamic private economy, the world-beating markets that economy supports, and the global capital it attracts. But poor fiscal mismanagement doesn’t just threaten the Treasury market; it puts the entire package at risk, from the consumer wealth effect to the future of AI investment, challenging the very notion of US financial indispensability.
Market Impact:
For investors, these dynamics necessitate a critical re-evaluation of traditional portfolio allocations. The era of blindly favoring US equities for unparalleled returns may be giving way to a more nuanced, diversified approach. Rising Treasury yields will continue to put pressure on high-valuation growth stocks, favoring companies with stronger current cash flows and more reasonable multiples. Fixed-income investors must contend with persistent inflation risk and the increasing likelihood of higher-for-longer government borrowing costs. Global capital flows could begin to diversify more aggressively, channeling funds towards regions like Europe and Japan where valuations are more attractive and structural reforms are gaining traction. Policymakers face an urgent imperative to address the national debt, as continued fiscal profligacy threatens not only the government’s borrowing capacity but also the broader economic stability by raising the cost of capital for all sectors and potentially dampening the vital wealth effect that fuels consumer spending. The interconnectedness of US public and private markets means that fiscal health is no longer a peripheral concern but a central determinant of market performance and global financial leadership.
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