FX Market on the Brink: How the U.S. Election Could Shake Up Currencies

🏛️ The Calm Before the (Election) Storm

The dollar’s been somewhat subdued this week, hovering in a range as we wait for the outcome of the big macro event: the U.S. election. 📅 While some expected strong moves in the dollar, the currency took a breather. The big picture is that USD is steady—until it isn’t.

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📉 October’s Jobs Report Twist: Surprise USD Drop

On Friday, things got interesting. A weak U.S. jobs report threw the dollar off balance, with only 12,000 jobs added in October instead of the anticipated 100,000. This softer-than-expected data caused a dip in U.S. short-term yields as investors began to reconsider the Fed’s rate path.

Add to that some known obstacles—strikes, hurricanes—that hindered job growth last month, but still, the takeaway was clear: economic momentum is slowing, and USD reflected that with a slight retreat.

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🎭 Election Scenarios & the FX Reaction Function

With every potential election outcome, there’s a unique FX reaction waiting in the wings. Let’s break it down:

1. Republican Sweep (aka “Trump 2.0”) 🚀

   • USD Moves: We could see the dollar rocket higher, with long-term U.S. yields following suit. A Republican sweep signals potential tax cuts and deregulation, which the markets interpret as risk-on for the U.S. and pro-USD.

   • Most Sensitive Pairs: USDJPY, USDCNH, and USDMXN could see the biggest moves as traders lean into this risk-on playbook.

   • The Twist? It’s already partly priced in, so the reaction may not be as explosive as some might think.

2. Trump Gridlock 🏛️

   • USD Moves: A divided government throws water on the likelihood of further tax cuts but still poses volatility risks, especially for the Mexican peso (MXN) due to potential trade tensions.

   • Most Sensitive Pairs: USDJPY might soften here if yields edge lower, while USDCNH could stabilize somewhat.

3. Harris Gridlock ⚖️

   • USD Moves: This would keep the current divided landscape, with markets quickly moving on to economic concerns and stock earnings.

   • Most Sensitive Pairs: Likely favorable for JPY (USDJPY might weaken), as this could allow U.S. yields to ease up.

4. Democratic Sweep 🔵

   • USD Moves: This scenario could jolt the dollar lower as markets price in the likelihood of higher taxes and heavier regulation.

   • Most Sensitive Pairs: Expect relief for USDCNH and USDMXN as trade frictions ease, and USDJPY could fall as a result of lower yields.

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🇬🇧 UK’s Autumn Budget Shocker: A Stagflationary Worry for Sterling

While all eyes are on the U.S., let’s not forget the big budget news out of the UK. Rachel Reeves’ autumn budget, touted as growth-boosting, actually triggered some serious market concerns over the UK’s economic future.

The budget leaned stagflationary (a mix of stagnant growth and inflation), raising fears that UK yields may rise alongside national debt concerns. This pushed UK gilt yields higher and knocked sterling, drawing eerie comparisons to last year’s budget fiasco.

With UK and U.S. yields strongly correlated, sterling now stands vulnerable to shifts in U.S. rates. Sterling will also be in the FX spotlight post-election, especially if U.S. long yields spike or plummet.

🔥 Sterling vs. EUR: EURGBP Reaches a Key Pivot Level

In the wake of the UK budget, EURGBP surged past the 0.8400 level, a crucial line that traders are watching. This level is now in play as a potential “reversal” signal if the pair holds above it.

Europe’s economy is no picture of health either, with France and Germany facing major economic hurdles. This leaves both sterling and the euro under pressure in their own unique ways.

🎬 The Election Night Drama: What to Expect on Tuesday

Implied volatility is high across the board as traders prepare for the election results. Here’s how it might unfold:

1. Early Hints 📉: Markets will start reacting as soon as polls close in key states like Florida, and the FX market will be primed to “read the tea leaves” by midnight GMT.

2. The Wait ⏳: If it’s a close race, buckle up—counting could drag into Wednesday or beyond, with Pennsylvania potentially being the deciding factor.

3. Market Overreaction Potential: High volatility can sometimes trigger overreactions, especially if a Republican win stirs up immediate concern over deficit spending. Expect knee-jerk USD moves, with some retracement as reality sets in.

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🎯 Key Takeaways

1. USD Holds the Power: The dollar’s reaction to the election outcome will shape global FX trends, with USDJPY, USDCNH, and USDMXN the most sensitive pairs.

2. Sterling on Shaky Ground: UK markets are sensitive to U.S. yields now, making sterling especially vulnerable to volatility across the Atlantic.

3. Election Night Could Bring Whiplash: Get ready for big swings—and maybe a few surprises—as the election shakes up risk appetite and market sentiment.