Stefano Rebaudo

(Reuters) – The U.S. dollar hit a 2 1/2-month high on Tuesday on expectations that the Federal Reserve would take a measured approach to easing its policy, while an underemphasized U.S. election campaign continued investors at a constant edge level.

The strength of the dollar, boosted by rising Treasury yields, has kept pressure on the yen, euro and sterling, a theme that has intensified over the past few weeks as investors scale back their bets on quick cuts in U.S. interest rates.

The benchmark 10-year Treasury yield rose 3 basis points in London trading to a 12-week high as investors priced in a more tough U.S. economy.

Some analysts argued that the publication of the Beige Book delayed Wednesday could pose the biggest risk to the dollar this week, with the previous summary of economic conditions considered by some to be the main reason for the 50 basis point (bp) enhance in interest rates in September, which initiated the cycle of easing monetary policy by the Fed.

Markets are pricing in an 87% chance the Fed will cut interest rates by 25 basis points next month, down from a 50% chance a month earlier, when investors saw an equal chance of a larger 50 basis point cut, CME’s FedWatch tool showed.

Traders expect a broad easing of monetary policy by another 40 basis points for the rest of the year.

“The US dollar has risen recently on a hawkish reassessment of Fed monetary policy expectations and because US election uncertainty has reduced risk appetite, supporting safe havens,” said Nick Andrews, strategist at HSBC.

However, the main topic is still the US elections.

Markets expect the strongest dollar response from Republicans, which should pave the way for larger increases in trade tariffs combined with fiscal stimulus.

A smaller dollar gain could be seen in response to a divided Republican government, whereas a Democratic coup or divided Democratic government would likely result in an initial downturn.

The index, which measures the U.S. currency against six others, was last at 103.91 after hitting 104.02 on Monday, the highest since Aug. 1. The index is up more than 3% so far this month.

The euro recently traded at $1.0827, near its lowest level since August 2, while sterling settled at $1.3006, near its lowest level since August 20.

Thursday’s PMI data for the euro zone could provide an additional downward push for the common currency if they highlight the feeble economic situation in the euro zone and enhance expectations of future interest rate cuts by the European Central Bank.

ECB speakers will also be in the spotlight after President Christine Lagarde delivered a dovish message last week.

“The key question is: do hawks agree with Lagarde’s optimistic vision of disinflation, a gradual shift in emphasis on growth and dovish market valuations?” said Francesco Pesole, forex strategist at ING.

“Given the persistent pockets of persistent inflation in the services sector, the answer is probably no.”

ELECTIONS IN THE CENTER

With the U.S. election just two weeks away, former President Donald Trump’s rising odds of victory are strengthening the dollar as it is believed that his proposed tariff and tax policies are likely to keep U.S. interest rates high.

“Even small changes in tight polls can trigger seemingly erratic swings in market sentiment,” said Antti Ilvonen, forex analyst at Danske Bank.

The yield on the benchmark 10-year U.S. Treasury note rose to its highest level since July 26 at 4.22%.

This had an impact on the yen, which remained roughly unchanged at 150.88, after hitting a nearly three-month low of 151.10 per dollar.

The Bank of Japan is closely watching growth risks from rising import prices as the yen weakens, executive director Takeshi Kato said on Tuesday, according to Jiji Press.

The yen’s weakness is linked to Japan’s scheduled general election on October 27. While polls differ on how many seats the ruling Liberal Democratic Party will win, markets are sanguine that the LDP and junior coalition partner Komeito will win.

Barclays expects price-setting suppression from BOJ interest rate increases and increased fiscal concerns, leading to a rise in the yen if the LDP/Komeito coalition has to form a government with additional coalition partners.

It also forecast that in the unlikely event (tail risk scenario) in which the LDP and its coalition partner Komeito are unable to form a government, de-risking moves could cause the dollar-yen exchange rate to drop suddenly by 2%.