US Dollar In Focus for the Election: Rates, Stocks Set for Volatility

US Dollar Talking Points:

• The US Presidential Election is here and there’s a rather wide variance of expectations across election speculation sites. I looked into equities in the weekend forecasts while associating stocks with US bond rates.
• At Kalshi, which is a partner of StoneX, those odds shifted quickly over the weekend, with Kamala Harris briefly showing as the favorite at 50.1% to Trump’s 49.9%. But those odds have tilted back in Trump’s favor and as of this writing he’s showing at 55% to 45% for Kamala Harris.
• I’ll be looking at several markets ahead of election results in tomorrow’s webinar, and you’re welcome to join: Click here for registration information.

Indices Forecast

Count the US Dollar as yet another market that’s prone to volatility ahead of tomorrow’s US Presidential Election. While I’m normally one to dismiss the impact of politics on markets, especially given both parties’ propensity to spend and continue adding to US debt, the shift has been clear, and this helps to validate the prior month of price action in the US Dollar.

Going back to October 9^th the election was seen roughly as a coin flip. But as October wore on, Trump’s odds shifted higher and Harris lower until, eventually, a peak was seen last week with Trump’s 65% favor compared to 35% for Kamala Harris.

That jump in expectation for a Trump win accompanied a strong run of USD-strength, and given the shift shown at the open this week, where the US Dollar pulled back quickly after the fast move in election odds over the weekend, the theory is further validated that a Trump win seems positive for the US Dollar while a Harris win would serve as a negative.

I realize this may not come as news to many; but having some evidence certainly can help to better bolster expectations as we go into election day tomorrow. And from that observation, we can also walk forward with evidence of how other markets may be impacted, such as US Treasuries or perhaps even equities.

Election Odds Per Kalshi.com

Chart prepared by James Stanley; election odds per Kalshi.com

Testing the Theory

From the above chart, there’s a couple of waypoints that seem important. The first is October 9^th, as that’s when odds for a Trump victory began to shoot higher. And the other is October 29^th when those same odds peaked at 65%. Both values can show on the US Dollar chart, as well, as October 9^th is when a bullish breakout showed in the currency and October 29^th is when DXY peaked, pulling back thereafter to go along with softening odds for a Trump win.

US Dollar Daily Price Chart

What Does Macro Look Like in a Trump Win Scenario

Given the accompanying rise in long-term rates in US Treasuries, the first takeaway would be higher growth expectations, leading to potential for more inflation down-the-road. There’s also probably an element of foreign countries selling US Treasuries in anticipation of stiffer tariffs that has added into that mix, leading to selling in longer-dated US debt ahead of the election. We’ve heard both Stanley Druckenmiller and Paul Tudor Jones talking about their bets for higher long-term rates in the US and that could fit well with the above analysis.

There’s also the role of the US Treasury department to consider:  Despite long-term yields being, at one point, more than 130 basis points below short-term three-month yields, the Treasury department has continued to issue more and more short-term debt.

Normally, a situation of that nature would allow for the Treasury to lower borrowing costs by issuing longer-term debt, and that increase in supply would come with both lower prices and higher rates. This is something that could help to normalize the yield curve that the Fed has said they follow for recession forecasts, and that’s the difference between the 10 year note and 3-month T-bill.

Interestingly, however, longer-term rates have shot-higher after the FOMC cut rates in September, and the 10 year/3-month yield spread is at its least inverted since November of 2022.

US 10-year/3-month Treasury Spread

With a Trump win, one would assume that Yellen would likely be heading back to the private sector and the ability to issue longer-term debt at lower yields than shorter-term debt could help to further normalize the yield curve. Higher longer-term rates would punish current holders of long-term US debt and this can further explain the fast moves that we’ve seen on the long end of the curve, both from market participants like Druckenmiller and PTJ as well as foreign governments.

Higher long-term US rates could have several reverberations across global markets and, eventually, it could make the idea of buying long-term Treasuries attractive again. But there may be some pain along the way as lower long-term rates help to make speculative investments look more attractive (with diminished opportunity cost when compared to 10 or 30 year yields).

As a case in point, it was 10-year yields topping in both 2022 and 2023 that helped to establish reversals in equities each of the past two years. If we do see long-term yields running higher that could eventually re-frame valuations for equities, particularly tech stocks.

More recently, as we’ve seen that shift towards higher long-term US rates after the FOMC’s rate cut, stocks have started to show a bit of softness which is probably the opposite, on both rates and equities account, that the Fed would’ve thought to happen. Interestingly, longer-term rates have jumped since that rate cut and the continued move there is what’s started to bring impact to stocks.

But on an important note: One should be careful with the immediate reactions around tomorrow’s election, however, as that can be an environment ripe for noise. What I’m referring to here is something that I expect to be a longer-term theme.

US 10 Year Rates and S&P 500 Futures

Short-Term Pain, Long-Term Gain

There hasn’t really been a recession in the United States in 15 years, ever since the Financial Collapse. There was a brief two-month episode in 2020 but that was quickly offset by the stimulus triggered for the Covid pandemic, which simply propelled markets to stratospheric new highs even as the global economy remained shut down.

One likely factor is the continually expanding US debt load, particularly in the wake of the GFC. The Fed hiked rates just once until Trump was elected in 2016 and that helped to keep the US Dollar weak as equities came back to life after the Financial Collapse.

The Fed’s preferred inflation indicator is the same 10-year/3-month Treasury spread looked at above and, from the Fed’s own research, this has shown a tendency to predict recessions. And if you think about it, it makes sense:  Why else would 10 years of debt carry a lower yield than 3 months of debt? The common reason is that investors are expecting pain ahead which will come with rate cuts, and buying a 10-year bond not only locks in a higher rate today, but the principal on that bond stands to appreciate in a falling rate backdrop.

But there’s another element at play here as it’s the US Treasury Department that control supply along the Treasury curve. So if the Treasury auctions off more long-term debt, and there’s greater supply, then there’s lower prices and higher yields.

These are the types of shifts we’ve seen in the Quarterly Refunding Announcement each of the past two years to help 10-year yields pullback, and stock prices shoot back up.

But the real challenge with the 10-year/3-month spread isn’t when its inverted – it’s after it normalizes, and again this is drawn from the Fed’s own research and you’re welcome to read it. It’s all at a page entitled ‘The Yield Curve as a Leading Indicator,’ and the research goes back decades.

Per the Fed’s own research, there remains a greater than 50% probability of a recession in the next 12 months given inversion of that yield spread. And if we look at the fast move in 10 year rates going higher as 3-month rates have taken a dive leading into and after the FOMC’s rate cut, the Treasury spread looked at above is at its closest to normal in two years.

So if we do see that continued run-higher in yields and a greater push towards normalization in the 10-year/3-month spread, there could be a recession in the not-too-distant future and this would be the first since the Financial Collapse, not including the two-month-period around Covid.

And while recessions certainly come with a host of negative connotations, especially given the political stimuli around the current episode, the fact of the matter is that it may not be as negative and terrible as many would expect from a long-term perspective. Similar to what showed in the early 1980’s, Paul Volcker had to engineer a recession (two, actually) in order to finally tame inflation. And the period that followed was a golden age in modern markets. Because like most healthy trends, it’s the one step back that allows the next two steps forward to take place in a somewhat sustainable manner.

I’m not going to cheer for a recession, nor will I ensure that one is one the way. I will merely share the Fed’s own research below while trying to look at the optimistic side of what could become in such a scenario. As of their last update in early-October, the data suggested a 57.05% probability of a recession in the next 12 months.

And, notably, this chart remains the same regardless of who wins tomorrow. So, regardless of who wins tomorrow a recession may follow. But it’s the response to that which will shape the US and, in-turn, the global economy for years to come.

US Treasury Spread (10-year/3-month) and Probability of Recession

--- written by James Stanley, Senior Strategist