The US dollar's performance in yesterday's session was influenced by dovish Fed speak, as it danced to the tune while disregarding strong macro upside surprises. Despite starting the week on a strong note, it gave up some of its earlier gains. Equity markets also retraced from record highs as investors flocked back to government bonds. The 2-year Treasury yield fell for the sixth time in seven days to 4.15%, reaching its lowest level since early November.

Fed's Dovish Tone Shapes Currency Markets

US Dollar's Dovish Dance

After the comments from Waller and Williams on Monday, Goolsbee and Kugler joined the chorus of slightly dovish Fed officials open to rate cuts in December. This shows that the strong economic backdrop has not deterred policy makers from continuing to ease policy. Easing bets for the next meeting remained somewhat unchanged at 74%. It seems that the macro and policy sides have a complex interaction when it comes to market pricing.In macro land, US job openings picked up again in October, rising from 7.37 to 7.74 million. This reading was well above consensus and the strongest advance in more than a year. It will now draw attention to upcoming labor market data such as the employment sub-index from the ISM services report, the ADP private employment report, and the non-farm payrolls release at the end of the week.

Korean Won's Political Volatility

The Korean won recovered almost all its politically-induced losses yesterday following the imposition and almost immediate recall of martial law by the president. The opposition party is now calling on the head of state to resign. Such risk events highlight that politically-induced idiosyncratic currency volatility is likely to persist. Going into 2025, disputes between countries on the trade front and rising tariffs are expected to keep demand for options hedging elevated.

European Investors' Focus on France

European investors' attention remains solely on France as the government faces a no-confidence vote on Wednesday. President Emmanuel Macron has called on lawmakers to set aside differences to keep the current government in power. However, the demand for hedging short-term euro downside risks suggests that this may not happen. EUR/USD option volatility is the highest since March 2023 as macro hedge funds try to profit from global political uncertainty.Economic data out of Europe is scarce this week, pushing politics and US macro into the spotlight. Yesterday's rise above the important $1.05 mark could give the currency pair impetus for an advance to $1.0560 if Fed Chair Jerome Powell leans into dovish comments from his peers later today. However, moves beyond $1.06 would require either the French government to survive the no-confidence vote or the US jobs report on Friday to disappoint expectations by a large margin. Otherwise, the range between $1.0460 – $1.0560 will likely be sustained.

Sterling's Resilience

The British pound climbed modestly against the US dollar yesterday and has extended its gains towards $1.27 this morning, despite global political risks clouding the broader outlook for currency markets. The risk-sensitive pound usually weakens in such an environment, but its correlation with risk measures has weakened or reversed over the last month.Although GBP/USD has failed to decisively clear the $1.27 handle and is still down slightly month-to-date, it has held up relatively well in the face of recent political upheaval. One bullish factor helping the pound is the monetary policy outlook. The Bank of England remains the least dovish of the G3 central banks, with only a 10% chance of a rate cut this month and only three 25-basis point cuts priced in by this time next year. This is similar to the Fed but half the amount expected by the ECB, which is why GBP/EUR is edging closer to €1.21 – a level it's only been above for 1% of the time since the Brexit vote of 2016.Looking ahead, we expect further gains for GBP/EUR given the relative growth and yield differentials favoring the pound, not to mention the political instability hanging over Europe. For GBP/USD, a breach of the $1.26 support level will expose $1.25, as it did two weeks ago, followed by the year-to-date low of $1.23. Conversely, if buyers successfully reclaim $1.27, they could test the 200-day moving average at $1.2818. The direction will likely be determined by US macro news and Fed speakers.