US elections, the energy shock and central banks are reshaping currency markets
The foreign exchange market is being driven by two forces: expectations for interest rates and bond yields on one side, and political and geopolitical uncertainty on the other. The US midterm elections have boosted global markets and weakened the dollar, while the prospect of further monetary tightening in Japan and the eurozone is providing tentative support for the yen and the euro.
In trading on November 5, the dollar index fell to 101.25, EUR/USD rose to 1.1261 and USD/JPY slipped to 157.95. The 10-year Treasury yield fell to 4.847%. These moves also reflect the market’s immediate reaction to the election results; whether they hold will depend on upcoming economic data and central bank decisions.
The dollar: less of a political risk premium, but the Fed remains central
The Democrats’ victory in both chambers of Congress has, for now, reduced election-related uncertainty and expectations of an escalation in US policy toward Iran. Markets responded positively, with stocks and Treasuries gaining; lower yields have taken some support away from the dollar.
That does not mean the currency has lost its underlying sources of support. Markets continue to watch the Federal Reserve and inflation signals. According to Reuters pricing data, investors were assigning roughly an 81% probability to a rate increase of at least 25 basis points in December. US private payrolls rose by 86,000 in October, above expectations of 69,000. Friday’s official employment report will be a more important test of labour-market resilience and the Fed’s next steps.
The outlook therefore remains mixed: falling yields and reduced political uncertainty could weigh on the greenback, but strong data or persistent inflation could keep the Fed on a restrictive path and renew demand for the dollar.
The yen: the Bank of Japan’s message is gaining weight
The yen strengthened after minutes from the Bank of Japan’s September meeting reinforced expectations of further rate increases. The central bank left rates at 1.25% on October 30, but raised its inflation forecasts and described a monetary policy phase more focused on normalisation. Governor Kazuo Ueda said decisions would be assessed at each meeting, leaving open the possibility of a move as early as December.
The interest-rate gap between Japan and the United States remains wide, limiting the yen’s potential to appreciate for now. But the prospect of further BoJ hikes could gradually narrow that gap. Geopolitics also matters: if easing tensions around Iran reduce demand for safe-haven assets, the yen could lose some of its support from risk aversion. Conversely, a new market shock or a decline in global yields could benefit the currency.
The euro: rates may rise as growth comes under pressure
The euro has recovered against the dollar, but the eurozone outlook is complicated by rising energy prices. On October 29, the European Central Bank left rates unchanged, warning that higher oil and gas prices were increasing inflation risks and weighing on growth prospects. According to sources cited by Reuters, several ECB policymakers consider a December rate increase likely unless energy prices fall sharply.
Higher interest rates can support the currency, but they do not guarantee a stronger euro if energy-driven inflation weakens consumption and economic activity. French politics and concerns about debt sustainability also remain in focus: fiscal pressures can affect yields and confidence in the eurozone. Christine Lagarde’s announced early departure as ECB president adds another institutional uncertainty.
What to watch
In the near term, EUR/USD may remain sensitive to the contrast between US data and ECB signals. A resilient US labour market could support the dollar; further signs of energy-driven inflation in Europe could strengthen expectations of an ECB rate hike, without necessarily improving the growth outlook.
For USD/JPY, the key factor is how quickly the interest-rate gap narrows. A more decisive BoJ and falling US yields could support the yen; a more restrictive Fed or a fresh bout of risk aversion could hinder its recovery.
The outlook remains exposed to geopolitical developments, particularly the trajectory of the conflict involving Iran and its impact on energy prices. Markets have welcomed the US election result, but confirmation from economic data and monetary policy decisions will be needed before the currency moves develop into a more durable trend.
Disclaimer: This article is for informational purposes only and does not constitute financial advice, a solicitation to invest, or an investment recommendation. Forex trading involves significant risk, including the possible loss of capital. The assessments and scenarios described may change rapidly.
© 4FT Invest LTD. All rights reserved
