It seems that Democrats are doing slightly better than expected in the midterm elections, and the head-to-head race points to the possibility they may be able to retain control of the upper house. The broad market shows a relatively tepid reaction to the incoming elections news: short-term FX and equity markets volatility remains relatively low, the downside in European equities doesn’t exceed 1%, the S&P 500 futures are drifting towards 3800 points. Consolidation mode prevails ahead of the release of the critical US CPI report tomorrow.

The dollar index (DXY) dropped to 109.50 (lowest since mid-September) and is showing a technical rebound today. Earlier I wrote that now there is a struggle for the key trend line that has paved the upside path for greenback since the beginning of this year:

The breakdown of the key line is likely to be accompanied by a technical rebound, which will take the price up to 110.50. A new wave of decline and a repeated breakdown of 110 will allow us to say that the price is trying to consolidate below the key trend line; after holding at least a week in the 109.50-110 range, the price may seek to explore more aggressively new lows within the short-term downtrend (108.50 zone).

Returning to the elections, a scenario in which the Republicans gain control of the lower house, and the Democrats retain control of the Senate could turn out to be moderately positive for the dollar, as the hamstrung Biden administration will be forced to focus on presidential executive orders, and foreign policy may re-target the trade confrontation with China. In addition, if the Republicans gain control of the lower house, they will have a debt ceiling at their disposal as leverage and limit the Democrats' ability to push through a new fiscal stimulus package. Confrontation over this issue next year could reduce investor appetite for US assets and thus weaken the dollar, with the market starting to price this risk now.

In the short term, the New Year's rally scenario is based on rather weak assumptions (including a favorable election outcome) and therefore it is still worth focusing on a tight monetary policy as the main driver of the market. Tomorrow's CPI report will play a big role here, given that the Fed has hinted about the pause in tightening. The consensus forecast for the report is a 0.5% monthly change in CPI (core inflation). If the report lives up to forecasts, speculation about the Fed's pivot in policy will have to be postponed again, which will undoubtedly support the dollar, and make the Treasury market again vulnerable to a sell-off wave.