Dollar Weakens Amid Election Optimism and Anticipated Fed Rate Cut

The U.S. dollar experienced broad declines on Tuesday as risk sentiment improved in anticipation of the U.S. election results and a Federal Reserve rate cut scheduled for Thursday. U.S. Treasury 2-year yields rose alongside equities, buoyed by a stronger-than-expected ISM non-manufacturing index for October. However, the U.S. trade deficit widened significantly to $84.4 billion in September, its largest since April 2022. Despite the favorable economic indicators, uncertainty surrounding the presidential election contributed to elevated FX volatility, with implied volatility on USD/CNH and USD/MXN surging while longer-term implied volatility declined in anticipation of post-election stability.

Euro and Pound Strengthen as Eurozone Optimism and U.K. Data Boost Sentiment

The euro climbed as Germany’s ruling coalition showed signs of unity on economic stimulus proposals, raising optimism about the eurozone’s growth outlook. In the U.K., the pound advanced and 10-year gilt yields reached year-to-date highs, fueled by robust S&P Global PMI data for October. Expectations of a 25 basis point rate cut from the Bank of England on Thursday remain, but market participants await further guidance on the central bank’s outlook.

Commodity-Linked Currencies Rise on Stronger Risk Sentiment and Commodity Demand

The Australian dollar led G-10 gains, supported by favorable risk sentiment and rising metal prices. The Reserve Bank of Australia held rates steady but emphasized a cautious, restrictive approach. The Canadian dollar also strengthened after positive services sector data suggested economic resilience, while oil prices gained 0.4% amid production concerns in the Gulf of Mexico and dollar weakness.

Market Outlook: U.S. Election and Fed Policy Decision Key Drivers

Looking ahead, the dollar may continue to face pressure if the Fed’s rate cut meets market expectations and election results spark further risk-on sentiment. The euro could see additional support if Germany’s coalition finalizes stimulus measures, enhancing the eurozone’s growth prospects. The pound remains in focus ahead of the Bank of England’s policy decision; dovish guidance could weigh on the currency, while optimism around U.K. growth could provide upside. Commodities, particularly oil and metals, may continue to benefit from a weaker dollar and supply concerns, while equities could see continued strength, especially in tech, as lower yields and improved sentiment create a supportive environment. FX markets may experience reduced volatility as political uncertainty around the election subsides.

Currency Movements: Dollar Falls Broadly, Euro and Pound Gain on Optimistic Data

In currency markets, EUR/USD rose by 0.54%, bolstered by hopes of economic cooperation within Germany’s coalition government and a weaker dollar. USD/JPY declined 0.46% as the yen strengthened with reduced demand for safe-haven assets amid improved risk sentiment. GBP/USD gained 0.59% on positive U.K. PMI data and expectations of Bank of England easing. AUD/USD advanced by 0.77%, buoyed by stronger metal prices and risk appetite, while AUD/JPY rose 0.33% as the Australian dollar outperformed the yen. EUR/JPY and GBP/JPY saw modest gains of 0.08% and 0.12%, respectively, as the euro and pound strengthened. The Canadian dollar also showed resilience, benefiting from a weaker dollar and favorable domestic economic data.

Outlook: Dollar Faces Pressure as Risk Appetite Increases, Euro and Pound Poised for Further Gains

The dollar may encounter further challenges if risk-on sentiment strengthens after the U.S. election. The euro stands to gain if Germany’s coalition advances its stimulus agenda, providing support for eurozone growth. The pound’s direction will hinge on the Bank of England’s decision; dovish signals may weigh on sterling, while optimistic guidance could lend support. The yen’s outlook is likely to depend on market sentiment, with safe-haven demand softening if election-driven risk aversion eases. The Australian dollar appears poised for continued gains if commodity prices remain stable and China offers more clarity on economic stimulus. In sum, currency markets are set for an active week, with political and economic developments driving sentiment and the potential for post-election stability influencing FX volatility.