Dollar stabilizes after midterm election turbulence: strategists say core support remains, options market signals bullish outlook

FX strategists say that while the U.S. midterm election results briefly weighed on the dollar, the factors that have driven the dollar's strength in recent months remain largely unchanged. The Bloomberg Dollar Spot Index fell on Wednesday as traders weighed the impact of policy gridlock in Washington after Democrats won control of Congress. However, the index held steady on Thursday even as U.S. stocks fell; it is currently less than 1% below the nearly 18-month intraday high touched in October. In addition, the options market shows that traders expect the dollar to rise before the end of the year. Growth and Rate-Hike Expectations Form Core Support Institutions including Bank of America, STANCHART, and hedging advisory firm Chatham Financial believe the key point is that this major global reserve currency will continue to be supported by at least two key sourcesthe resilience of the U.S. economy and market expectations for Federal Reserve rate hikes over the coming year. Although large technology stocks plunged after the U.S. midterm elections and the outlook for foreign demand for such stocks is increasingly uncertain, some traders still regard the dollar as the standout among major currencies. "I still think the dollar is king," said Thomas Kikis, head of U.S. and Americas markets at Standard Chartered Bank. Kikis said supporting this view is the likelihood that the U.S. economy outperforms Europe, while Europe will need to rely on U.S. energy supplies. However, what worries him is the possibility that Washington's political landscape could turn into a negative factor and thus alter the economic outlook. The dollar was little changed this week. On Thursday, as technology stocks plunged, the dollar edged higher on concerns that a Democrat-controlled Congress could propose stricter regulation of U.S. data centers. U.S. markets are now awaiting Friday's monthly nonfarm payrolls data and next week's new inflation data. The employment report is expected to show faster job growth, while economists expect next week's data to show easing consumer price pressures. These data are crucial for setting Fed expectations after traders scaled back bets on a rate hike as early as next month. The market currently prices in at least one and possibly two rate hikes by mid-2027; earlier this week, the market expected two hikes by then. Tech Stocks and Oil Prices Disturb, Institutional Views Diverge Dom Bunning, head of G-10 FX strategy at Nomura, pointed to a potential feedback loop that could weigh on the dollar: reduced flows into U.S. equities and lower Treasury yields would transmit into a weaker dollar. "As the Nasdaq continues to fall, we are increasingly seeing that the dollar is not entirely the historical 'safe-haven asset,'" Bunning said. Their positioning is a bet on the yen rising against the dollar, which he called "the best FX trade in a falling stock market/falling yield environment." In early Asian trading on Friday, the dollar was little changed. Sarah Ying, head of FX strategy at CIBC, expects the dollar to weaken, one reason being growing pressure on the AI trade. She is also closely watching whether factors such as falling oil prices after the election will eliminate the so-called "Trump premium." Brent crude fell sharply this week on speculation that Middle East tensions could ease, trimming its year-to-date gains. Rising energy prices during the Iran war fueled inflation concerns and boosted bets on Fed rate hikes. Options Signals Lean Bullish, but Upside Limited In the options market, traders are sending a strong signal of confidence in the dollar's outlook before the end of the year. The one-year risk reversal, a barometer of market positioning and sentiment, shows investors near their most bullish level since early 2025. Bank of America strategist Alex Cohen said this week that he expects the Democrats' strong showing in the midterm elections to be slightly negative for the dollar. Given the U.S. inflation situation, he expects dollar weakness to be short-lived. Data show forecasters expect U.S. inflation-adjusted GDP to grow at an annualized 2.3% this year, compared with 1% in the euro area and 0.8% in Japan. Amol Dhargalkar, chairman of Chatham Financial, said: "Stepping back, the U.S. economic picture is quite strong, and that is not hard to paint." He said that when it comes to the dollar, of course it must be viewed relative to others; compared with other major economies, the U.S. is the most attractive in this context. However, with investors watching the impact of political gridlock on policy and the economy, the dollar's upside now appears limited. He said: "So, the dollar will roughly stall."