Why Fiscal Dominance Means You Should Buy Stocks

The stock market since 2022 has remained resilient in the face of significantly higher interest rates, stubborn inflation, and geopolitical escalation.

We think the biggest reason for this is: fiscal dominance.  This is the idea that government spending, especially when funded by large deficits, matters more than what central banks are doing with interest rates.  And right now, it’s deficits that are doing the heavy lifting for the global economy and equity markets.

Fiscal dominance is when government spending (fiscal policy) outweighs monetary policy (interest rates and central bank balance sheets) in driving economic and market outcomes.  Traditionally, investors focused heavily on what the Federal Reserve or the European Central Bank was doing.  But today, it’s arguably more important to look at the massive government deficits fuelling the economy, particularly in the US, which in turn is keeping the economy and markets positive.

In simple terms: so long as governments keep spending more than they collect in taxes, that money has to go somewhere.  It usually flows into households, businesses, and markets, supporting consumption, growth and ultimately, stock prices.

This is biggest in the US, where fiscal policy is doing more to stimulate the economy than at any time outside of wartime or deep recession.  This deficit spending acts like an ongoing stimulus.  Despite the Federal Reserve keeping interest rates above 5%, GDP growth in the US remains strong and unemployment remains near historic lows. 

The first Trump administration implemented heavy tax cuts (reducing tax income and increasing the budget deficit).  Then the Biden administration implemented the Inflation Reduction Act, a massive fiscal stimulus to the economy (higher spending, higher deficit).  And now the second Trump administration is again reducing tax and increasing spending.  In the US, it appears fiscal support for the economy will remain in place for the foreseeable future.  

Markets are forward-looking.  Investors care about earnings growth, and sustained deficits mean more money circulating in the real economy.  That boosts corporate revenues, supports profit margins, and justifies higher equity valuations.

And it’s not just the US, this is happening in Europe too.  For years, Europe was synonymous with austerity, especially after the Eurozone crisis.  But that era appears over.  Germany, long the poster child for fiscal discipline, is now embracing deficits, with plans for hundreds of billions of euros in borrowing to fund new investment in infrastructure and defence.

France and the UK are following similar paths: both are running high deficits of close to 5% of GDP, with rising requirements to spend on defence, infrastructure, and healthcare.

That means fiscal stimulus is not just an American phenomenon.  It’s increasingly global, particularly in the developed world, and it’s helping to keep global growth ticking along even as central banks try to fight inflation.

We’re entering an era where budget deficits are no longer just an economic statistic—they’re the driving force of market performance. As long as governments keep spending freely, the macro tailwind for stocks remains in place.

For investors, this means: ‘don’t fight the fiscal flow!’.  Be wary of underweighting stocks just because interest rates are high, or you may have concerns about geopolitics.  Further, investors can look for sectors aligned with government priorities like infrastructure, defence, energy transition, and AI.

In the end, it may not be Jerome Powell or Christine Lagarde who matter most in the next market cycle, but the finance ministers signing the cheques in Washington, Berlin, Paris, and London.