USD: Trump Trades Unwinding Amid Poll Shifts

The week kicks off with the US dollar weakening across markets. Investors are digesting Friday’s soft payroll numbers, impacted by severe weather, while recent polls hint at a Democratic rebound in some swing states, potentially reversing certain “Trump trades.” Notably, Kamala Harris is now leading in Iowa, previously considered a Republican-leaning state.

According to ABC’s FiveThirtyEight, Trump has a slight lead in nearly all swing states, with narrow margins in Nevada and Pennsylvania, except for Michigan and Wisconsin, where Harris holds an edge. If Harris secures key blue states, along with Michigan, Wisconsin, and Pennsylvania, she would narrowly reach the 270 electoral votes needed. Although a Democratic win in Iowa would be symbolically significant, its six electoral votes may not heavily influence the outcome compared to Pennsylvania’s 19.

Polling stations open tomorrow, with vote counting and market reactions expected to begin promptly. However, delays in mail-in ballot counts may postpone the final election results, reminiscent of 2020 when Biden’s win wasn’t declared until the following Saturday.

The dollar could see further weakness if Harris prevails, while a Trump win may only boost the dollar if Republicans control Congress. In a split outcome, market impact on the dollar may be limited.

The Federal Reserve’s upcoming rate announcement on Wednesday could be overshadowed by the election outcome, as a 25bp cut is anticipated regardless of results. Although under typical conditions this would weaken the dollar, the Fed’s effect on FX will be clearer post-election.

USD volatility is likely over the next few days as FX liquidity adjusts and traders reassess positions. While current momentum leans towards a weaker dollar, markets remain sensitive to rapid shifts in sentiment.

EUR: Gaining on Dollar Weakness

EUR/USD is climbing again after a volatile reaction to US payrolls data last Friday. With the US election dominating focus this week, eurozone economic updates will likely play a secondary role.

The dollar’s reaction to the election is crucial for the euro, but ECB policy remains a factor as well. Market sentiment has slightly cooled on ECB rate cuts due to positive growth and inflation data from the eurozone. However, should Trump win, protectionist concerns could prompt the ECB to front-load easing measures, keeping the chance of a December rate cut alive.

This morning, EUR/USD briefly rose above 1.0900, driven by dollar weakness. Election-related volatility is prominent, though wide rate differentials suggest EUR/USD may be overvalued at current levels.

Elsewhere in Europe, EUR/NOK is approaching near-term highs, likely a result of pre-election liquidity constraints. The krone’s recent decline should support Norges Bank’s hawkish stance on Thursday. Meanwhile, the Riksbank is also expected to cut rates by 50bp this week, with a smaller cut potentially on the table if a post-election SEK selloff is significant.

GBP: Stability Returns Amid Gilt Market Calm

Last Friday brought a sense of calm to UK gilt markets, pulling EUR/GBP below 0.8400. Currently, EUR/GBP carries a slight 0.6% risk premium, indicating reduced volatility compared to last year’s mini-budget crisis. However, gradual yield increases amid rising borrowing expectations may pressure the pound.

The Bank of England’s meeting on Thursday is widely expected to result in a 25bp rate hike, but the market will focus on the Monetary Policy Committee’s take on recent fiscal measures. The Office for Budget Responsibility regards the new budget as growth-positive, though not enough to sway the BoE’s view substantially.

Governor Andrew Bailey may shift focus to recent data, specifically the drop in services inflation, hinting at a dovish stance on rates. This could lower expectations for rate hikes, weighing on the pound. Yet if this is coupled with easing long-end gilt yields, sterling markets may see supportive inflows, offsetting any downward pressure on GBP.