On US midterm election day, the dollar strengthened; rising Treasury yields provided support; US-Iran tensions may dominate the market's subsequent direction.

The dollar strengthened on Tuesday during voting in the US midterm elections, supported by rising US Treasury yields and solid economic data. However, with positive signs emerging in diplomatic negotiations between the US and Iran, volatility in international oil prices is becoming an important factor affecting the dollar's short-term trajectory. Analysts believe that, compared with the midterm election results, the subsequent development of the US-Iran conflict and the Trump administration's policy stance may have a more significant impact on the dollar. The Bloomberg Dollar Spot Index rose 0.2% on Tuesday, hovering near its high for the year. The index hit its year-to-date high last month, when persistently elevated US inflation data drove the market to raise expectations for further Federal Reserve rate hikes, providing strong support for the dollar. Meanwhile, recent US economic data have also shown considerable resilience. Data released by the Institute for Supply Management (ISM) on Monday showed that the manufacturing purchasing managers' index (PMI) rose to 55.5 in October, the second-highest level in more than four years, with manufacturing production growth reaching its fastest pace since 2021. Strong economic activity data, combined with a rebound in US Treasury yields, further enhanced the dollar's appeal. However, this week's market moves show that international oil prices and changes in US-Iran relations may become the key factors driving the dollar's performance in the coming days. On Monday, as both the US and Iran signaled willingness to resolve the conflict through negotiations, international oil prices fell sharply and the dollar weakened accordingly. During Tuesday's session, as signs of progress in the negotiations increased and reports emerged that Trump wanted to give diplomatic talks more time, the dollar once again followed oil prices lower. This price action highlights that, against the backdrop of the ongoing Middle East conflict pushing up energy prices and US inflation, the dollar's sensitivity to oil price changes is increasing. Sarah Ying, head of FX strategy at CIBC, noted in a report that for the dollar, oil prices remain the most closely watched short-term driver. "For the dollar, oil prices remain the most important short-term indicator to watch, and any sharp move is likely to overshadow the impact of the US midterm elections," she said. Ying believes that, given the Trump administration's more moderate rhetoric on Iran in recent days, investors could consider positioning for a weaker dollar. However, she also cautioned that the US government's stance could change after the midterm elections. Indeed, as the midterm elections approached, bets in the FX options market on further dollar gains also weakened. According to the one-week risk reversal for the Bloomberg Dollar Index, the premium traders pay for bullish dollar options has fallen to its lowest level since September, indicating reduced confidence in the dollar's short-term upside. Risk reversals are typically used to gauge the market's relative pricing of upside and downside exchange-rate risk. A narrowing premium on call options means investors' willingness to pay extra to hedge against dollar gains is weakening. CIBC's analysis also shows that, based on implied volatility in the FX market, traders are currently assigning roughly the same risk weight to the US midterm elections as to a regular US consumer price index (CPI) report. This means that although the midterm elections may influence the future direction of US policy, the FX market does not regard them as a major risk event capable of single-handedly triggering sharp dollar swings. By contrast, investors are more focused on what policy Trump will pursue after the elections, especially the US military and diplomatic stance toward Iran, as well as the progress of future trade negotiations. "What is more noteworthy is Trump's policy agenda after the midterm elections, especially the Iran issue and trade negotiations," Ying said.