In his inaugural speech at the Jackson Hole Economic Symposium, Warsh outlined his forward-looking views on inflation, to which the market reacted. Warsh also made a statement rarely reported by the media: "Trends are what matter most." Indeed, sovereign debt is the most worrying negative trend facing developed economies in the medium term. Another Deeper Implication of Warsh's Speech Last Friday's market reaction focused on the short-term situation. Warsh argued that the persistently high inflation over the past 65 months is entirely the responsibility of central banks, stating, "We still have work to do." He also pointed out that the 12-month average of personal consumption expenditure (PCE) inflation was 3.7%, and the 6-month average reached 4.1%. The market significantly increased the probability of a September rate hike, and the two-year Treasury yield rose by 11 basis points. Warsh also made a statement rarely reported by the media: "Trends are the most important." The market easily interprets this as referring to the current short-term inflation trend. However, there is another possibility—even a high-probability interpretation—that this statement addresses the Federal Reserve's approach to policy-making around sovereign debt in the short, medium, and long term. In fact , the current state and evolution of US sovereign debt is the core reason why US Treasury Secretary Bessant previously proposed anchoring the 10-year Treasury yield, and the current US Treasury repurchase program is consistent with this. The key point lies in the credibility of the fiscal path: in the event of future shocks, the performance of the bond market will affect asset allocation. Worrying Issues: How Investors View Bonds First, when comparing fiscal debt with other assets and investment themes, investors see significant risks and limited opportunities. The end of the 40-year bond bull market and the subsequent four-year sell-off have undoubtedly exacerbated this perception. Second, during periods of economic uncertainty, investors tend to buy stocks rather than bonds. This overturns the textbook relationship between stocks and bonds: investors' tendency to reduce bond holdings is not necessarily irrational. Since 2022, investors have observed that bonds may fall sharply in tandem with stocks. Research on safe-haven assets shows that since 2020, the combination of the six traditional safe-haven assets (gold, US dollar, Swiss franc, Japanese yen, 10-year US Treasury bonds, and German government bonds) has failed more frequently than it has been effective, failing in all four major shock events of the past decade (COVID-19, interest rate hikes, tariffs, and the Iran-related crisis). In the medium to long term, the risk lies in whether investors will continue to view the bond market in this way, given the continued deterioration of sovereign debt in most developed economies. Bonds are meant to be hedging assets—strengthening when other assets fall, preventing investors from being forced to sell at a loss during periods of decline in risky assets. Once bonds lose this property, the entire portfolio is affected. Why is declining bond attractiveness a problem? Continued rise in uncertainty. Since interest rates returned to normal in 2022, the number of monthly VIX spikes has increased by 51% compared to pre-pandemic levels. Following the return to normal interest rates in the 2020s, various long-term trends, since the 2008 financial crisis, have once again become the core forces determining the direction of the economy and markets. In short: more shock events, the unreliability of existing safe-haven asset portfolios in past shocks, and investor sentiment—preferring stocks to bonds during economic turmoil. This portfolio is very vulnerable. The risk of sovereign debt trends lies here: the risk may not manifest as a gradual pricing adjustment, but rather as a sudden sell-off in sovereign bonds, especially under the combined influence of exogenous shocks and investor sentiment. Sovereign debt is the most worrying major trend. A Deutsche Bank mega-trend model tracks six core global forces: technology, sovereign debt and fiscal deficits, geopolitics and globalization, domestic politics and social conflicts, demographic structure, and energy transformation and transition. The model uses nearly 100 data points, generating indicators for each major trend on a quarterly basis; all indicators are standardized for easy horizontal comparison and combined assessment. Of the six trends, sovereign debt is the most concerning. Domestic fiscal deficit indicators have been declining for thirty consecutive years. Demographic structure further exacerbates debt deterioration: the shrinking working-age population in most G20 countries weakens the foundation of fiscal revenue on the one hand, and increases the pressure on fiscal expenditure on the other. Regarding the debt outlook: the Congressional Budget Office (CBO) predicts that the US public debt-to-GDP ratio will rise from approximately 100% currently to 120% in 2036, with the fiscal deficit exceeding 6% of GDP. Most other developed economies face similar problems. In addition to declining population, the deterioration of sovereign debt is intertwined with domestic social conflicts and geopolitical factors. Even in an optimistic scenario, indicators will only return to neutral levels. Regarding the major trend of sovereign debt, we project to 2030, setting baseline, optimistic, and pessimistic scenarios. The optimistic scenario assumes: accelerated AI adoption, significant productivity gains, positive government spending on GDP, and resilient global demand for US Treasury bonds. In this scenario, sovereign debt indicators shift from significantly dragging down the market and economy to being roughly neutral. In all scenarios, sovereign debt indicators are unlikely to enter positive territory. This asymmetry will determine medium-term risk allocation strategies. The most realistic optimistic outcome for sovereign debt over the next five years: debt will no longer be a drag. Can technology alleviate debt pressure? A key question raised by Warsh. Technology is currently the only major trend making a clear positive contribution to the global economy and markets. Analysis shows that the impact of AI will be significantly greater than that of the internet in the 1990s. Historical patterns show that whenever technology indicators surge, productivity subsequently rises sharply; the 1990s saw sustained productivity growth of 3%–4%. In the baseline scenario, our technology indicators will surpass the highs of the 1990s by 2030, meaning productivity growth is expected to exceed the aforementioned range. This is precisely the breakthrough path to escape the heavy debt burden, a logic repeatedly mentioned by Warsh in his speech. He raised the following questions: 1. Can the implementation of AI drive a sustained and significant increase in productivity across the entire economy? 2. Is AI a complementary factor to labor or a competitive substitute? 3. Will next-generation AI models require higher capital intensity, or can the models themselves foster capital-light solutions? The issue of capital intensity is particularly noteworthy, as it is directly related to sovereign debt. In the future, the high-capital-investment AI construction cycle may compete with the state for savings resources during periods of increased government financing demand. Therefore, the same technology may either exacerbate sovereign debt problems or alleviate debt pressure in the short term, depending on the final evolution. Warsh stated that he will await the conclusions of the special working group before making a judgment; and clarified that the working group's subsequent recommendations will not affect policy decisions in the current cycle. Historical experience: There are precedents for resolving high sovereign debt pressure. This report is not a prediction of a crisis; historical experience is often more optimistic than current market sentiment. The most direct comparable case is the "Long Depression" in the United States in the mid-1870s: Prior to this, a financial crisis erupted, and the market worried about excessive railroad construction—railroads, as a capital-intensive general-purpose technology, saw a massive influx of capital initially, followed by a collapse in confidence. At the time, government intervention was limited, and the unemployment rate was likely to exceed double digits. However, by the late 1970s, the benefits of railroad technology gradually spread to the overall economy, with multiple trends, including sovereign debt, improving simultaneously, ultimately leading to remarkable economic growth. The second case is the United States after World War II: at the end of the war, US debt exceeded 100% of GDP, and it subsequently deleveraged for 35 years while maintaining strong economic growth. Both historical periods share the common insight that high debt pressure can be mitigated when other major trends combine. After World War II, rapid globalization, relatively stable domestic politics, lower social conflicts, and positive contributions from energy technology all contributed to absorbing the debt pressure. The current environment is drastically different: technology supports the medium-term prospects of the global economy, with energy factors providing a slight boost; the other four major trends—sovereign debt, demographic structure, domestic politics, and geopolitics—all bring negative drags. Therefore, technology needs to play a significant driving role. Four Implications for Portfolio Management Four conclusions can be drawn regarding medium-term asset allocation: 1. Last Friday, the market focused on the Fed's policy trade, but the core long-term issue is: how much risk compensation does the market need when the debt-to-GDP ratio approaches 120%? Especially when ordinary investors still prefer stocks to bonds even in a downturn. 2. Bonds and safe-haven currencies can become risk assets at certain stages: safe-haven assets can potentially transform into risk assets; if the fiscal deficit trend worsens further, the volatility of US Treasuries and the US dollar will increase significantly. Data on the correlation of safe-haven assets since 2020 demonstrates that when hedging tools are exposed to the risk trends they seek to hedge, the difficulty of hedging increases significantly. 3. Sovereign credit pricing increasingly incorporates demographic structure and fiscal credibility: countries with aging populations and no credible fiscal solutions to address rising dependency ratios will experience greater volatility in government bond yields. 4. If AI delivers its growth dividends, sovereign debt pressure will be manageable, and the stock market will benefit; if AI falls short of expectations, there will be a lack of effective hedging tools. This means that, on the one hand, it's necessary to allocate assets to capture the benefits of productivity gains; on the other hand, it's crucial to remain cautious about business models that continuously increase capital intensity. The "light capital" problem proposed by Walsh has both advantages and disadvantages.