Fiscal Dominance

Summary

Lisa Shalett, Morgan Stanley Wealth Management CIO, discusses the coming fiscal dominance regime as the Fed's easing cycle ends and a new Fed chair is expected. She argues this regime will feature Fed balance sheet expansion, a dovish policy framework, and potentially a higher inflation target, leading to run-it-hot growth with rising inflation risks. Market implications include US equity gains near 10%, a steeper Treasury curve with 10-year yields above 4%, a weaker US dollar, and positive stock-bond correlations. She recommends rebalancing away from speculative small/micro caps into large-cap quality, quality fixed income, international equities, and real assets like gold and real estate.

• Fed easing cycle expected to end at a 3% neutral rate.
• New fiscal dominance regime shifts Fed focus to managing US debt and deficits.
• Fed may grow its balance sheet by mid-2026 and reinvest MBS paydowns into T-bills.
• A dovish run-it-hot framework could include a shift in the inflation target from 2% to 3%.
• US equity gains are seen closer to 10% with higher earnings but multiple compression.
• The 10-year Treasury yield is expected above 4% with a steeper curve and weaker US dollar.
• Positive stock-bond correlations suggest rebalancing for diversification.
• She prefers large-cap quality over speculative small/micro caps, and suggests adding international equities and real assets.