Middle East and midterms driving the dollar

USD

For most of Tuesday, the dollar did what we expected, holding its ground as traders weighed mixed Middle East signals against the midterms. A strong JOLTS report, with September job openings rising to 7.52m against a 7.16m consensus, and a 1.8% jump in factory orders helped the DXY close marginally higher at 101.8, with December Fed hike odds holding above 70%. Meanwhile, oil was volatile after the White House confirmed limited strikes on Iran’s Qeshm Island, though Brent still settled near $104 as Qatar-mediated talks continued. Those modest dollar gains have reversed overnight as mid-term results filter through. The Democrats are projected to take both the House and the Senate, and the dollar index has fallen around 0.4% to land near 101.4, with 10-year Treasury yields also nudging lower. For now, markets read a Democratic sweep as negative for fiscal stimulus and the AI trade, though we would caution against extrapolating too far given the presidential veto. The bigger risk today is whether the administration, now past the election, resumes large-scale strikes on Iran, with reports that Central Command has options ready as soon as today. ISM services and ADP are secondary to that.

EUR

EURUSD failed to hold the 1.12 handle on Tuesday as the greenback firmed on solid US data. Overnight, however, dollar selling has lifted the pair back into the mid-1.12s, though we see the euro as a passive beneficiary rather than a story in its own right. Attention this morning turns to the October flash CPI print at 10:00 GMT. National data were mixed: German inflation eased to 2.8% thanks to a temporary fuel tax cut, but France rose to 3.4%, and Italy jumped to 5.4% as the energy shock from the Middle East conflict continues to feed through. Consensus looks for headline inflation to tick up to 4.0% from 3.8%, with core at 2.5%. Markets already price in roughly an 80% chance of a December ECB hike after last Thursday’s hold, so an in-line print should be well absorbed. With the OAT-Bund spread still elevated on French fiscal worries, we continue to see modest downside risks for EURUSD, particularly if Middle East hostilities escalate and oil retraces this week’s losses.

GBP

Sterling closed little changed near 1.34 yesterday as traders stayed sidelined ahead of the midterms and tomorrow’s Bank of England decision. The dollar’s overnight slide has since pushed cable a little higher, though again, that is mostly a US story. Looking ahead, today’s final services PMI at 09:30 is unlikely to move the needle, with attention now turning to Thursday’s BoE decision. A 25bp hike to 4.00%, the first since August 2023, is now around 95% priced, and we agree the MPC will deliver given the tone of recent commentary. The more important question, we think, is guidance. Markets price in close to 100bp of tightening over the next twelve months, which we think is too much given a still soft underlying economy. As such, we expect tomorrow’s hike to come paired with dovish forward guidance, and so continue to see cable holding near current levels into the decision before drifting lower afterwards, leaving any pre-meeting gains vulnerable to reversal.

CAD

USDCAD was again quiet on Tuesday, continuing to trade around 1.40. Governor Macklem’s appearance before the Commons finance committee offered little new, reiterating that last week’s hike to 2.50% was aimed at limiting the spread of energy-driven price pressures, and that further increases remain possible. For now, that means oil remains the swing factor in loonie fortunes, alongside risk conditions. On that score, Brent’s slide on hopes of a US-Iran deal, interrupted by the Qeshm Island strikes and further attacks on tankers off Oman, has helped cap loonie gains. Still, we continue to think the BoC’s October hike was premature and see the roughly 55% priced for December as too high. We therefore expect USDCAD to drift higher into Friday, when US and Canadian payrolls could diverge in the greenback’s favour.

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