LONDON: Foreign exchange markets moved on Tuesday towards pricing a victory for US Democratic candidate Joe Biden against President Donald Trump despite warnings that possible post-election disputes could unleash weeks of dollar volatility.
The dollar was down 0.44% against a basket of currencies at 93.618 after hitting a month high on Monday.
Analysts believe a Biden win would weaken the dollar as the former vice president is expected to spend big on stimulus and to take a freer approach to trade, boosting other currencies at the dollar's expense.
They cautioned, however, that uncertainty was very high about the election outcome and that taking positions might prove premature.
"I'm more nervous than European markets are today," said Berenberg chief economist Holger Schmieding, warning some investors may be jumping the gun on the issue, particularly if no clear winner emerges swiftly from the polls.
The euro extended gains and rose 0.58% against the dollar, crossing the $1.17 bar, while sterling also rose slightly to just below $1.30.
Meanwhile, European stock markets were making strong gains while euro zone government yields rose and oil prices extended their rally, exposing how investors were gradually switching from a cautious mood and getting ready to bet on a clear victory for the Democratic candidate.
"The markets tempted fate on Tuesday morning, forgetting the lessons of 2016 as they pre-emptively celebrated a Joe Biden victory," warned Connor Campbell, an analyst at Spreadex.
Republican Trump, who is trailing Biden in national opinion polls, has criticised mail-in ballots and suggested he would deploy lawyers if states are still counting votes after election day on Tuesday.
Overnight gauges of volatility for major currency pairs jumped to multi-month highs ahead of the outcome of the election.
Euro/dollar implied volatility surged over 19%, its highest level since the depths of the market mayhem in March, compared with less than 7% on Monday. Other indicators like dollar/yen volatility also jumped.
Investors had taken a more cautious approach as the election neared. Rather than outright bets on a particular outcome, many traders had flocked to the safety of dollars so that they were well positioned to take advantage of volatility when results arrive.
"Those who haven't hedged yet, but who would feel the pain in case of strong moves, should hedge themselves as soon as possible, as it is getting increasingly expensive," Commerzbank strategist Antje Praefcke wrote to her clients in a morning note prior to the dollar losing ground.
"There is only one thing we can do: fasten seatbelts, put the helmets on and await what happens in EUR-USD over the coming days," she said, adding that: "Even riots in the US cannot be excluded, which may cause the market to sell the dollar."
It is not unusual in the United States for states to take several days or even weeks to count their votes, and a record surge in mail ballots due to the COVID-19 pandemic could draw out the process further this year.
"Under no scenario will Donald Trump be declared a victor on election night," Biden campaign manager Jennifer O'Malley Dillon told reporters.
Among other currencies making gains against the dollar, the Aussie rose 0.15% after an initial dip which followed the Reserve Bank of Australia lowering its policy interest rate by 15 basis points to 0.1% and announcing a bond-buying programme.
The safe-harbour yen was also slightly higher, up 0.03% at 104.69 per dollar.