Bell Curve
July 29, 2025

Forward Guidance: Threat to Fed Independence is Un-Anchoring Inflation Expectations | Jens Nordvig

Jens Nordvig, founder of Exante Data and former head of currency strategy at Goldman Sachs and Nomura, breaks down a monumental regime shift in markets. This episode unpacks the erosion of Fed independence, the structural weakening of the US dollar, and the new calculus for global investors in a world of tariffs and AI booms.

The Powell Paradox: Fed Under Pressure

  • “It's tempting to say we have this incredible pressure on the Fed now, and we're going to have more inflation in the next year or two as a function of the Fed overdoing it. But what's the Fed actually going to do?”
  • “You can have an ironic situation where all the name-calling and the 'Powell is late' narrative actually makes him late itself, because he can't be seen to give in to it.”
  • The constant political pressure on the Federal Reserve is actively un-anchoring long-term inflation expectations, as seen in the recent rise in 5-year break-evens, which is detached from moves in oil prices.
  • The market is grappling with a paradox: Powell may delay necessary rate cuts to avoid appearing to cave to political demands, ironically creating the very economic softness he’s being pressured to prevent.
  • While Trump has limited appointments to the Fed board, the persistent questioning of the central bank’s independence introduces a long-term risk of fiscal dominance that investors are starting to price in.

The Great Re-Allocation: A Weaker Dollar Regime

  • “We've had the worst start to a year—the worst first half for the dollar in many decades. If you're an investor outside the United States who had success running open dollar exposure, it makes sense to at least revisit if the framework you're using is the correct one.”
  • The US dollar’s persistent weakness signals a structural shift in global asset allocation. For the first time in years, international equities are seeing significantly more inflows, breaking the multi-year dominance of US-centric investments.
  • This capital shift is unfolding in four phases: first, fast-moving hedge funds; second, professional hedgers like pension funds; third, institutions that are new to hedging; and finally, a slow-moving shift by US domestic investors diversifying abroad.
  • Central banks are also diversifying away from total reliance on the dollar, increasing gold reserves as a hedge against geopolitical tension and unpredictable US trade policy.

The Long Bond's Identity Crisis

  • “The long end is supposed to work as a hedge against equity weakness when something bad is happening, and it didn't work. That really left a lot of portfolio managers around the world with new questions about the Treasury market.”
  • The Treasury market’s failure to rally during the April growth scare shattered its reputation as a reliable portfolio hedge, forcing a major rethink among global asset allocators.
  • A flat yield curve offers little incentive for investors to take on duration risk. Combined with upward pressure from massive bond issuance in Europe and Japan, US long-end yields are likely to remain elevated.
  • While the US faces cyclical drags from tariffs, a powerful AI-driven capex boom is providing a significant, deflationary offset, creating a tug-of-war between growth headwinds and a productivity boom that complicates the outlook for rates.

Key Takeaways:

  • Fed Independence is No Longer Guaranteed: The market is now pricing in a future where political pressure and high debt levels could force the Fed to tolerate higher inflation, fundamentally changing the risk profile of US assets.
  • The Dollar's Decade-Long Bull Run is Over: A structural shift in global capital flows is underway. Investors are moving beyond a "US-only" mindset, a trend that has more room to run as different types of allocators slowly adjust their strategies.
  • The Treasury Hedge is Broken: The traditional 60/40 portfolio is under threat. Investors can no longer blindly rely on long-term government bonds to protect them during equity downturns, demanding a new approach to portfolio construction.

For further insights and detailed discussions, watch the full update: Link

This episode dissects the precarious balance between waning Fed independence and shifting global capital flows, revealing how political pressure and fiscal realities are reshaping the investment landscape for the US dollar and beyond.

Introduction to a New Macro Regime

Jens Nordvig, founder of Exante Data and a former executive at Goldman Sachs and Bridgewater, opens the discussion by outlining his firm's analytical framework. He explains that while their approach is heavily data-centric—focusing on granular capital flow analysis—the current environment requires a conceptual understanding of events that are difficult to quantify, such as the erosion of central bank independence.

  • Jens's Perspective: He emphasizes a dual approach. Hard data, especially on capital flows, provides a clear signal on market positioning and asset allocation shifts. However, for unprecedented issues like political pressure on the Fed, one must think conceptually and draw parallels from other contexts, like emerging markets.
  • Strategic Insight: For investors, this highlights the need to combine quantitative models with qualitative assessments of political and structural shifts, as historical data alone may not capture the current regime's unique risks.

The Specter of Waning Fed Independence

The conversation frames the current pressure on the Federal Reserve as a pivotal moment, with limited historical parallels in the US outside of the post-WWII era. Jens contextualizes this by drawing on experiences from emerging markets like Brazil, where political interference in central banking is more common.

  • The Core Problem: Jens argues the root issue is the high level of US debt. This makes the financial system highly sensitive to shocks, whether from tariff announcements, foreign demand shifts, or political attacks on the Fed's credibility.
  • Historical Context: The discussion references the Treasury-Fed Accord of 1951, a landmark agreement that established the Federal Reserve's independence from the Treasury Department's financing needs after years of being forced to cap interest rates to fund war debt. The current situation raises concerns about a potential reversal of this long-standing principle, a concept known as fiscal dominance, where a government's debt obligations dictate monetary policy.
  • Jens on the Real Issue: "The reason why these shocks are relevant is that we have a lot of supply of bonds, we have doubt about whether the market will continue to absorb it. So it all comes down to the debt."

The April Treasury Market Anomaly

A key event that signaled a potential regime shift occurred in April, when the Treasury market behaved in a highly unusual and alarming way. During a negative growth shock that sent equities lower, long-term Treasury bonds—which typically act as a safe-haven hedge—also sold off.

  • Broken Correlations: This breakdown in the traditional risk-off relationship left global portfolio managers questioning the reliability of US Treasurys as a portfolio hedge.
  • Actionable Insight: Crypto AI investors should note this event, as a failure of traditional safe-haven assets could accelerate the search for alternative, non-sovereign stores of value. The reliability of Treasurys as a risk-free benchmark is now being questioned at a fundamental level.

A Persistently Weak Dollar and Shifting Equity Flows

Despite a normalization in some market correlations since April, Jens points out that the US dollar has failed to recover, indicating a deeper, more structural shift is underway. This is not about a temporary risk-off move but a persistent change in global capital allocation.

  • The Data Signal: Exante Data's analysis reveals a multi-month trend of global equity flows moving away from their extreme US-centric positioning. For the first time in years, international equities are attracting significantly more subscriptions.
  • Key Trend: This is not about investors aggressively selling US assets, but rather a persistent, multi-month pattern of diversifying away from them. This shift began before the major tariff escalations, suggesting it's a more fundamental reallocation.

The Great Hedging Reassessment

Jens describes a multi-stage process of how different investors are reacting to the dollar's weakness, creating a long-tailed trend that could last for years.

  • The Four Stages of Hedging:
    1. Hedge Funds: Fast-moving players who changed their dollar posture within days.
    2. Professional Hedgers: Large pension funds with dedicated FX teams who adjusted in April and May.
    3. Non-Traditional Hedgers: Large institutions that are now, in August and September, beginning to review and change their long-standing currency hedging policies.
    4. US Investors: The final, and slowest, group to move. US investors have an extreme "home bias," with less than 1% of the $2 trillion in US fixed-income ETFs holding any foreign currency risk.
  • Strategic Implication: The slow-moving nature of US institutional and retail investors means the trend of diversifying away from the dollar could have a very long runway. A shift in this massive pool of capital would have profound, multi-year effects on global markets.

Tariffs, Balance of Payments, and Capital Controls

The discussion explores the complex effects of tariffs on the US economy and investor sentiment. While intended to narrow the trade deficit, their primary effects are a drag on domestic income and a source of significant policy uncertainty.

  • Economic Impact: Tariffs act as a tax on US consumers and companies, reducing disposable income and dragging on consumption. While the revenue is a positive for the US budget, it comes at a cost to the private sector.
  • Investor Uncertainty: Jens highlights a critical moment when the "Big Beautiful Bill" nearly included a tax on certain foreign capital inflows. Though removed, its initial inclusion sent a shockwave through the international investment community.
  • Actionable Insight: The unpredictable use of tariffs and the threat of capital controls are actively pushing global investors to diversify. For Crypto AI researchers, this environment underscores the value proposition of decentralized, censorship-resistant networks that are immune to such nation-state-level policy risks.

Central Bank Diversification Beyond the Dollar

At the sovereign level, central banks are also rethinking their reserve strategies. While not engaging in large-scale, outright selling of US dollars, their behavior signals a clear desire to diversify.

  • The Gold Bid: Central banks have been steadily increasing their allocation to gold, a trend that accelerated after Russia's foreign reserves were frozen in 2022. This is a direct response to the weaponization of the dollar-based financial system.
  • The Euro's Rise: European officials are now more actively promoting the euro as a reserve currency. With their own significant debt issuance needs, they have a direct incentive to attract foreign buyers by positioning the euro as a viable alternative to the dollar.

The Dollar's Next Move and the Fed's Dilemma

Jens outlines his dollar forecasting framework, which now includes a third, structural factor alongside traditional drivers.

  • Three Key Variables:
    1. Global Growth: A strong global economy is typically dollar-negative.
    2. Fed Policy: Dovish Fed policy weakens the dollar.
    3. Structural Asset Allocation: The ongoing diversification away from US assets is a new, persistent headwind for the dollar.
  • The September Fed Meeting: Jens identifies the upcoming meeting as "crunch time." The Fed must decide whether to focus on lagging inflation data or respond to weakening consumption. A dovish pivot, combined with signs of improving global growth, could trigger the next major leg down in the dollar.

Unanchoring Inflation Expectations

The conversation turns to the market's pricing of future inflation, using breakeven rates—the spread between nominal Treasury yields and Treasury Inflation-Protected Securities (TIPS), which serves as a market-based measure of inflation expectations.

  • The "Fed Independence Effect": Recent charts show 5-year breakeven rates rising even as oil prices fall. Jens attributes this divergence directly to the market pricing in higher future inflation due to political pressure on the Fed.
  • Jens's Contrarian View: He argues the market may be overpricing the immediate inflation risk (as Powell is unlikely to fold quickly) but underpricing the long-term risk. "I actually think the market is potentially overdoing it in the very short end and not doing it enough in the long end." This suggests a steepening of the breakeven curve is a likely outcome.

The Outlook for the Long Bond

The discussion concludes with an analysis of the forces weighing on long-term US Treasury yields. Jens is skeptical of a major rally in the long bond, citing several persistent headwinds.

  • Global Pressures: Rising yields in Japan and heavy bond issuance in Europe are creating a global environment of higher rates, putting upward pressure on US yields.
  • Domestic Fiscal Issues: A lack of political will for budget consolidation in the US means supply will remain high.
  • The Hedging Problem: After the April shock, investors are less confident in the long bond's ability to act as a reliable hedge, reducing demand. This points toward a continued trend of yield curve steepening.

US Debt Issuance and the Demand for Bills

The supply side of the equation is also critical. The Treasury is expected to be cautious about issuing long-term debt, given the market's clear preference for short-term bills.

  • Issuance Strategy: Despite past critiques of focusing on short-term debt, the Treasury under potential leadership from Scott Bessent is likely to continue tilting issuance toward bills to meet market demand and avoid disrupting the fragile long end.
  • Investor Incentive: With a relatively flat yield curve, there is little financial incentive for investors to take on the duration risk of long-term bonds, especially given the heightened uncertainty.

The Tug-of-War: AI Productivity vs. Tariff Drag

Jens highlights the central tension defining the current macro landscape: a powerful, deflationary productivity boom driven by AI clashing with inflationary pressures from tariffs and fiscal policy.

  • The AI Capex Boom: An "incredible investment" push is happening in AI, exemplified by massive projects from companies like xAI. This is complemented by a push for foreign direct investment, with over $3 trillion in "soft commitments" announced. This is a powerful deflationary force.
  • The Tariff Drag: Simultaneously, tariffs are creating a cyclical drag on consumption and real incomes.
  • Strategic Consideration: For Crypto AI investors, this divergence is the key dynamic to watch. The deflationary power of AI could offset some inflationary pressures, but the battle between these two forces will determine the ultimate path for growth, inflation, and Fed policy.

Conclusion

The US economy is caught between inflationary fiscal pressures that threaten Fed credibility and a powerful, deflationary AI-driven productivity wave. Investors and researchers must monitor global capital flows and Fed policy signals closely, as the resolution of this conflict will define asset performance and market leadership for years to come.

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