FX.co ★ Elections instead of bombing

Demand for the dollar fell immediately after Donald Trump's statement that the US will not attack Iran before the midterm elections in November; in turn, risk assets rallied. Additional pressure on the dollar came from a sharp drop in US bond yields, which, as of yesterday, were around 5.31%, near their highest level since 2002. Stock and currency buyers who were trading the dip have won, while those who held the dollar as a defensive asset lost out. I believe the market reacted to the simplest fact: while there is no strike, one of the week's main fears has eased.

The statement was a response to reports earlier in the week. At the start of the week, it was reported the White House had asked the Pentagon to prepare strike options against Iran before the elections, and senior officials discussed plans that included an intensive three-day campaign. Those reports on Wednesday pushed Brent back above $102 and sent markets down. Now the market has received the opposite signal, and the speed of the repricing shows how much prices depend on political headlines rather than on the oil balance.

However, there is little reason for full relief. Trump revealed no details of the talks, which remain deadlocked on several issues, including control of the Strait of Hormuz. In September, he rejected an Iranian offer after intermediary talks at the UN. The president has previously spoken of "productive" talks without results and has repeatedly threatened escalation. Less than a month ago, he said he would not let elections influence decisions about Iran. He also said in a Time interview that strikes after the elections were possible, and the Pentagon late last month moved another carrier strike group and 10,000 sailors and Marines to the Gulf — there are now three carriers in the area. A naval blockade of Iranian exports, Trump stressed, remains in place.

The reality at sea has not changed. The UK Maritime Trade Operations service (UKMTO) reported nine attacks in the Strait of Hormuz since the start of October, and they threaten to interrupt the recent increase in oil flows that US forces have been helping to restore toward prewar levels.

What does this mean for the dollar? It had been sitting at the year's highs on three pillars: high US yields, expectations of Fed tightening, and safe-haven demand amid war and European problems. The September minutes showed that all 19 participants supported the hike; the market now expects little in October and prices in roughly an 80% chance of a December move. One of the dollar's supports has now weakened: geopolitical demand has eased, and the sharp fall in yields hit the currency's appeal. The euro, which this week fell to a 17-month low, is getting a small reprieve, although the ECB — judging by Lane — is not rushing to pause on October 29 and to hike to 2.75% in December. Gold, trading around $4,140, usually benefits from lower yields and a weaker dollar.

In my view, the market is celebrating too early. The statement covers only strikes before November 3, the blockade remains, tankers are still being attacked, and Trump left the door open for action after the election. So any dollar weakness is likely to be small and short-lived unless yields continue to fall; the dollar can return to its highs at the first renewed spike in tensions or on strong US inflation data.

As for the current technical picture of EUR/USD, buyers now need to think about reclaiming 1.1240. Only that would allow a test of 1.1275. From there, a climb to 1.1310 is possible, but doing so without support from large players would be difficult. On the downside, I expect significant buying only around 1.1200. If nobody appears there, it would be prudent to wait for a new low at 1.1165 or open longs from 1.1130.

Regarding the technical picture for GBP/USD, pound buyers need to take the nearest resistance at 1.3250. Only that would allow a target of 1.3280, above which further progress would be difficult. The farthest objective is the 1.3310 area. On a downside move, the bears will try to seize control of 1.3215. If they succeed, breaking that range would deliver a serious blow to bulls and push GBP/USD down to 1.3180 with a prospect of reaching 1.3155.