Spiking US yields spook investors as political storm clouds loom on both sides of the Pacific

Markets

Stocks stumbled into late trading, tripped up by disappointing updates from key companies and growing uncertainty over the pace of Federal Reserve rate cuts. Investors are navigating a tangled web of geopolitical tensions in the Middle East, a Federal Reserve turning out less dovish than expected, and the sudden reawakening of the "Trump Trade." The latter has shaken the bond market, forcing some bond traders to pull their heads out of the sand as real jitters emerge about the fiscal landscape post-election.

Benchmark borrowing rates surged, rattling stock market bulls but delivering the dollar its most decisive boost since August. The 10-year Treasury yield soared past 4.20%, though markets steadied somewhat today. Traders seem comfortable with the rate-cut forecast, but they’re starting to hedge their bets, particularly on a December move.

A bigger problem looms: some forward rate cut expectations for 2025 might eventually get downgraded to a coin toss. The issue is that investors could turn even more increasingly attracted to higher yields, and the appeal of riskier stocks may wane, putting pressure on equities. The sharp rise in bond yields signals a deeper issue, as betting markets now overwhelmingly favour Donald Trump as the candidate most likely to exacerbate the fiscal situation. Bookmakers are even raising the odds of a Republican clean sweep of Congress.

But here’s the kicker: it’s not just the absolute yield level spooking stock investors. After all, 2023 and much of 2024 showed us that higher yields don’t necessarily slam stocks, with U.S. indexes hitting record highs despite rising rates. What’s unsettling is the sharp, sudden spike in yields when stocks were already hovering at lofty levels. In addition, long-term inflation expectations are between 2.3% and 2.5%, and the road ahead will start to look a bit foggier, especially if Trump’s policies reignite inflation.

Asia markets: The party crasher

Over in Asia, rising U.S. yields and a stronger dollar are party crashers for local stock markets, particularly when wrapped in the ominous "Trump Tariff Man" package. The concern is that a Trump resurgence could disrupt foreign direct investment (FDI) into the region, where U.S. capital has been a key driver. While this could be a short-term issue, things might recalibrate quickly outside of China.

In the meantime, doubts surrounding China’s economic health and whether Beijing’s flurry of support measures will have any real impact are adding to the gloom. Right now, Asian investors are looking at the glass half-empty.

The immediate problem? If Wall Street feels the heat from spiking yields, Asian markets jump out of the frying pan into the fire. Asian stocks have fallen in five of the last six sessions, with no reprieve in sight.

On Tuesday, the 10-year U.S. Treasury yield smashed through the 4.20% barrier for the first time in three months, and the dollar index surged to levels not seen since early August. Rate and yield differentials drive the dollar’s rise, and the yen is back in the crosshairs. The dollar broke above 151.00 yen, marking a three-month high, and the yen is once again the worst-performing major Asian currency this year.

Even the weaker yen doesn’t support Japanese equities much. The Tokyo market is wrestling with political turbulence, with election uncertainty clouding the horizon. While foreign investors have been dipping their toes in, domestic players seem less convinced, pushing their money overseas as the Nikkei sits at a three-week low. The political storms in Japan and the U.S. are making Asia’s outlook even murkier.

Forex: Positioning for a Trump victory

While USD/JPY often grabs the spotlight when U.S. yields soar, political storm clouds on both sides of the Pacific amplify the broader sell-off. Beyond Japan, the euro feels the heat as traders hedge for a potential tariff barrage under a Trump presidency.

There’s increasing chatter that the euro could fall as much as 10%, potentially dipping below the $1.00 mark. Trump’s return to the White House, combined with widespread tariffs and domestic tax cuts, would almost certainly send the dollar surging across the board, leaving the euro and other major currencies scrambling for cover.

This shift in positioning highlights the bubbling anxiety in the market as traders brace for policy shocks that could drastically reshape global trade dynamics—and drive a fresh wave of volatility.

Political uncertainty: Does it matter?

For traders, being politically agnostic is often a good thing. It’s not that elections don’t matter—they do—but when it comes to the stock market, growth and inflation trends tend to carry more weight than who’s in the White House. Historical data suggests that the correlation between the president and the stock market is pretty weak, implying who wins doesn’t matter.

Take the S&P 500, for example; it often dips before an election and rallies once the uncertainty clears. Ahead of Biden’s 2020 victory, the index dropped for two months before roaring back with a 10% rally in November, helped by promising vaccine developments. In 2016, the S&P 500 nudged lower in the three months leading up to Trump’s win, only to bounce back by over 3% post-election. Ultimately, it’s not about the candidate—hedging bets is about removing uncertainty. That’s why volatility matters. It’s the pulse of risk, directly impacting market liquidity and the ability to exit positions cleanly. When your exit price feels like you’re playing Pin the Tail on the Donkey, it’s a game no one wants to play.

Looking ahead, if there’s a "red wave" that hands Republicans control of both the White House and Congress, expect inflationary policies like tax cuts to swell the deficit, pushing government borrowing costs higher. But those policies might coincide with Fed rate cuts, muddying the waters and making the market direction even more complicated to predict.

A Trump win is primarily seen as inflationary, likely making it more of a bond and currency trade (think: short rates, long dollars) rather than an equity play. However, the relationship between higher rates and stocks in 2023-24 isn’t as linear as in 2016, and higher rates won’t necessarily mean a bear market—primarily if they’re driven by strong economic growth.

The trade: Betting on a Trump victory

Earnings season may be making headlines, but with the U.S. election just two weeks away, political winds are starting to shape investor sentiment. While polls show a tight race, savvy hedge funds and institutional players push the betting odds and position for a Trump win.

The "Trump Trade" is alive and well, with assets poised to benefit from Republican policies gaining momentum. Others are doubling down on the dollar, betting on a steeper U.S. yield curve—anticipating that long-term rates will rise faster than short-term ones under a Trump administration. U.S. Treasury yields surged, with the 10-year yield breaking through 4.2% for the first time since July, signalling growing anticipation that Trump could reclaim the White House.

I’m not so sure this is simply a lark, either. Sure, it’s still a razor-thin race when it comes to the “Blue Wall”—Wisconsin, Michigan, and Pennsylvania. But if I’m picking up the right signals, those in the know on the Democrat side are hitting the panic button. Their internal polling must be flashing red, which means the battleground could be slipping away faster than they or the Democratic pollsters care to admit.

There is no fiscal crisis in the US—Not yet

Despite the noise, talk of an imminent U.S. fiscal crisis under Trump is more bark than bite. Some pessimists are whispering about a "Liz Truss Moment" for the U.S., warning that the swelling fiscal deficit and rising public debt levels are pushing the country toward a fiscal cliff.

Sure, Trump will inherit a mountain of debt and hefty interest payments. But unless the economy suddenly goes into overdrive, or his tariff strategies turn into a windfall to fund tax cuts, it’s unlikely that Republican fiscal hawks will let him off the leash beyond the first honeymoon year.

Let’s keep it in perspective. The U.S. debt-to-GDP ratio has ballooned to 120%, compared to just 35% in 1980—a shift that would raise an eyebrow for any seasoned investor. And yet, bond yields have done the opposite: they’ve fallen, not risen. It’s puzzling for many, but far from panic mode. Japan, for instance, has a debt-to-GDP ratio of 220%, and their 10-year yields still struggle to hit 1%.

The correlation between debt levels and interest rates is negative. As long as a country isn’t borrowing in foreign currency, the so-called “fiscal risk premium” is practically non-existent because the central bank can always step in as the buyer of last resort. Sure, currency or inflation crises are always lurking, but a sovereign debt blow-up? Not so much. Think of it like a safety net—you might bounce, but you won't crash through..