Market Brief: Apparent easing in geopolitical tensions delivers currency market relief

Long-term yields are slipping, oil prices are edging lower and the dollar is retreating after US president Donald Trump said the US would not attack Iran before next month's midterm elections, easing market fears of another major disruption in global energy supplies. Ten-year Treasury yields are down to 5.24% after reaching 5.35% earlier in the week, front-month Brent futures are trading for $102 a barrel while the West Texas benchmark goes for $90, and the trade-weighted dollar is down roughly 0.25% from yesterday’s high.

The move could be short-lived. Oil markets will stay on edge as long as Iran keeps attacking shipping and Hurricane Isaias churns through the Gulf of Mexico. The Canadian dollar has little room to rally on today’s jobs report, given that a Bank of Canada hike is already priced in for December. The yen is once again coming under sustained selling pressure as hopes for a reversal in Japanese capital flows fade. Sovereign risk premia in the euro area are showing no signs of falling back to levels seen a few months ago. And next week’s US inflation numbers could keep the dollar well supported: headline measures of consumer and producer prices are likely to stay elevated amid a broadening in underlying cost pressures.

We also expect turbulence to build ahead of the mid-term elections, even if they prove less consequential for currency markets than many now believe.

The power transition could be dramatic. History is unkind to incumbents: the sitting president's allies have lost congressional seats in nearly every midterm of the past century as supporters grow complacent, opponents turn out in force and swing voters register their discontent. Prediction markets are giving the Democrats a 90% chance of taking the House and a 60% chance of winning the Senate, up sharply from 70% and 18% earlier this year.

Punters may be getting ahead of themselves, however. President Trump’s approval ratings are near historic lows after a series of self-inflicted economic shocks, but prediction markets are notoriously prone to overstating extreme outcomes, a fractious Democratic Party is hardly polling strongly, and Republican support has been underestimated in several recent presidential elections. A split Congress remains the likeliest outcome, and even a clean sweep would leave Democrats well short of the two-thirds majorities in both chambers needed to override a presidential veto.

Fiscal priorities will change, but a sharp tightening looks fairly improbable. True, policies that are now stimulative could turn more restrictive as spending cuts kick in and subsidies expire. In theory, Democrats could tie the administration’s hands with government shutdowns and another stand-off over the debt ceiling, and congressional Republicans might rediscover their taste for fiscal conservatism as attention turns to the 2028 presidential race. But history would suggest there is also room for bipartisan bargaining, under which the administration postpones planned cuts to social programmes in exchange for more defence spending. Deficits are likely to remain vast, helping support growth in other areas of the economy.

Foreign policy will continue to be made largely by executive fiat. A hostile Congress will almost certainly try to rein the president in, perhaps by attaching conditions to defence appropriations or withholding them, but he will keep vast war-making powers, and with the mid-terms behind him, may no longer feel obliged to placate the isolationist wing of his own party. That could leave him emboldened to end the conflict with Iran, either by escalating militarily or by negotiating a settlement that involves significant American concessions.

Trade policy, too, is likely to stay on its current track. In principle, Congress could reassert its constitutional powers over taxation and revoke the authorities it has delegated to the president to set tariffs. But any such legislation would need a two-thirds majority in both chambers to survive a veto, and there is little sign of the Democrats—for decades the more protectionist party—mustering the votes or the unity. The administration’s Section 232 “national security” tariffs and Section 301 “unfair trade practice” tariffs are therefore unlikely to be reversed except through the courts, and average effective tariff rates should stay in the 10-15% range.

In our view, this backdrop is likely to translate into a widening in trading ranges rather than a sustained directional move in any major currency. The president’s rhetorical broadsides against geopolitical adversaries and trading partners will continue, but epochal shifts in underlying US policy will become increasingly unlikely.

The prospect of deeper political gridlock could initially lift risk appetite, but optimism will be capped by persistent policy uncertainty, leaving markets swinging between competing narratives before and after election day. Energy prices may stay high and volatile as the situation in the Middle East muddles along, keeping the euro, pound, and yen under pressure. The Canadian dollar will remain vulnerable in the run-up to January’s threatened levies on cars and car parts, but the Mexican peso will also face headwinds as a Democratic Congress and individual Republicans take aim at the country’s low-wage labour force and Chinese transshipment flows. And the dollar itself will remain hostage to shifting views on the sustainability of the AI boom and the Fed’s policy trajectory.

With no clear currency winner likely to emerge, hedgers should seek to exploit tactical opportunities rather than bet on a particular outcome.

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