According to recent research by Morgan Stanley, extreme "resonance" among the S&P 500, U.S. Treasury yields, and the Dollar Index often signals an impending reversal in the strong dollar cycle. On October 20, reports from the trading desk indicate that Morgan Stanley's latest study reveals a predictable trend for the dollar over the next six months when extreme resonance is observed among the S&P 500 Index, the Dollar Index, and the yields on 10-year U.S. Treasuries.

The firm's strategists, including Molly Nickolin, analyzed trading days over the past 25 years when the S&P 500 Index, 10-year Treasury yields, and the Dollar Index experienced extreme fluctuations (exceeding 1.25 standard deviations) and identified two strong signals indicating a weakening dollar in the following six months.

Historical data shows that in the "Goldilocks" scenario (the stock market rising by more than 1.25 standard deviations while the dollar and Treasury yields drop by more than 1.25 standard deviations) and the "Broad Upswing" scenario (where the S&P 500 Index, Dollar Index, and 10-year Treasury yields all rise by more than 1.25 standard deviations), shorting the dollar leads to significantly positive returns.

Morgan Stanley emphasizes that in the "Goldilocks" scenario, the strong performance of the pound may reflect expectations of a soft landing. In contrast, the leading performance of the Australian dollar following a "Broad Upswing" scenario may indicate a diminishing "U.S. exceptionalism" with a global economic recovery.

It is noteworthy that 2025 has seen multiple trading days aligning with these signals, accounting for about 7% of historical totals, indicating that current market volatility is at historically high levels.

"Goldilocks" Scenario: The Most Reliable Signal to Short the Dollar

Morgan Stanley defines a "super-large" fluctuation as standard deviations exceeding ±1.25 and applies a 10-year rolling window for calculations. Among the eight possible combinations of the three indicators (S&P 500, Dollar Index, and 10-year Treasury yields), the "Goldilocks" scenario stands out.

The specific characteristics of this combination are as follows: S&P 500 Index standard deviation ≥ +1.25, Dollar Index standard deviation ≤ -1.25, and 10-year Treasury yields standard deviation ≤ -1.25. This combination has appeared 12 times in the past 25 years, on average leading to a 3.3% decline in the Dollar Index within six months.

Statistical tests reveal a t-statistic of -2.8 and a p-value of about 0.02, indicating a strong causal relationship between this combination and dollar weakness. The hit rate shows that in 83% of cases following the 12 occurrences, the dollar weakens within six months, significantly higher than other combinations.

Morgan Stanley states that historical data indicates that after a "Goldilocks" scenario emerges, going long on the pound against the dollar yields the best returns, likely because this signal suggests a "soft landing" scenario—where rising U.S. stocks indicate economic resilience while declining dollar and Treasury yields hint at increasing expectations for Fed policy easing, benefiting currencies like the pound in developed markets.

"Broad Upswing" Scenario: The Second Most Reliable Signal to Short the Dollar

In the "Broad Upswing" scenario, the S&P 500 Index, Dollar Index, and 10-year Treasury yields all rise by more than 1.25 standard deviations. This combination has occurred 26 times over the past 25 years, roughly double the frequency of the "Goldilocks" scenario.

Although this scenario is more frequent, its reliability is slightly less. Data shows that within six months after a "Broad Upswing," the Dollar Index averages a decline of 2.7%, with a t-statistic of -2.0 (p-value around 0.06), indicating moderate evidence supporting subsequent dollar weakness.

The success rate of this strategy is 73%—with the dollar declining in 19 of the 26 occurrences within the subsequent six months. From a currency pair perspective, the Australian dollar performs best following a "Broad Upswing" scenario.

The research suggests that this may reflect a global economic recovery phase following "U.S. exceptionalism": significant rises in the three indicators usually signal extreme strength in the U.S. economy and markets, followed by a recovery in other regions of the economy, narrowing the gap with the U.S., and leading to a pullback in the dollar's gains.

Morgan Stanley notes that the Australian dollar, as a typical risk and commodity currency, often performs exceptionally well during a synchronized global economic recovery phase.