U.S. Midterms Become the First Test for a Dollar Backed by Strong Data

Currency markets rarely get a cleaner test of politics against fundamentals than a U.S. midterm election landing on a dollar that is already in good shape. The U.S. midterms are the first major test for a U.S. dollar that heads into the vote on a relatively firm footing, with a clean sweep of the House and Senate seen as a potential dollar negative if it raises the risk of political gridlock. Betting markets give that clean sweep a probability of around 70 to 75%, yet the dollar has gained ground against the euro, the yen and the Australian dollar. So which force wins out, the political noise in the near term or the economic data underneath it?

Fawad Razaqzada, StoneX Media Market Analyst, covers currencies, indices, commodities and cryptocurrencies, combining macroeconomics with technical analysis. That coverage gives insight into what is driving the U.S. dollar, from U.S. economic data and Federal Reserve policy to the political risk surrounding the midterms.

Key Themes

• Betting markets give a clean sweep of the House and Senate around a 70 to 75% probability.
• Stronger-than-expected GDP, ISM manufacturing, JOLTS and factory orders data keep the U.S. dollar on firm footing.
• The Federal Reserve leans toward tighter policy, so only a particularly weak jobs report may derail the dollar.

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U.S. Midterm Clean Sweep Odds Put Gridlock Risk on the Dollar's Radar

A clean sweep of the House and Senate in the U.S. midterm elections is seen as a potential negative for the U.S. dollar if it increases the risk of political gridlock. Razaqzada says such a result "could potentially be dollar negative if it increases the risks of a political gridlock", which is why currency markets treat the election results as the first event on a crowded calendar. With betting markets already putting the odds of a clean sweep at around 70 to 75%, the more useful question for traders is how much of that outcome the dollar already reflects. "But it remains to be seen how much of that is priced into the markets," he adds. Consequently, the dollar's reaction hinges on how far the result lines up with what betting markets already expect, and how far it catches currency markets off guard.

U.S. Dollar Support Rests on Resilient Data and Above-Target Inflation

The U.S. dollar draws its longer-term support from a U.S. economy that is holding up and inflation that remains well above the Federal Reserve's target. Third-quarter GDP came in stronger than expected at 3.4% annualized, and the ISM manufacturing PMI, JOLTS job openings and factory orders have all followed with upside surprises of their own. According to Razaqzada, "the Federal Reserve is still leaning towards tighter policy" despite its decision to hold policy unchanged at its most recent meeting. Conversely, political pressure from the midterms works on a shorter clock, which means a run of firm data can keep cushioning the dollar even while election headlines weigh on sentiment. For currency traders, that leaves the dollar with a floor built on economic fundamentals rather than on politics.

U.S. Dollar Signals Surface in Payrolls, ISM Services and Election Odds

The U.S. nonfarm payrolls report is the clearest signal of the labor market's strength, which shapes how far the Federal Reserve keeps leaning toward tighter policy. The ISM services PMI adds a read on the services side of the U.S. economy, alongside the manufacturing data that has already surprised to the upside. Inflation relative to the Federal Reserve's target shows how much room policymakers have to stay tight, while betting market odds show how much of a clean sweep is already priced. In Razaqzada's words, short of a particularly weak jobs report, "it may not be enough to derail the U.S. dollar".

--- Written by Gus Farrow, Senior Manager, StoneX Media

--- Expert: Fawad Razaqzada, StoneX Media Market Analyst