Dollar drops sharply on Democrats' early gains in US midterm election

SHANGHAI/SINGAPORE, Nov 4 (Reuters) - The dollar fell sharply against major currencies on Wednesday as early results from the US midterm elections showed Democrats making strong gains in their attempt to wrest control of Congress from President Donald Trump's Republicans.

The immediate market reaction from investors was to sell stocks, rush out of the US dollar and seek safety in Treasuries.

The euro firmed 0.5% to $1.1249, while the yen strengthened 0.7% to 157.63 per US dollar. The dollar index , which measures the greenback against a basket of six currencies, fell 0.3% to 101.4.

In an indication of the strength of the swing against Trump and his Republican Party, Democrat Annie Andrews won South Carolina's US Senate seat on Tuesday, a stunning victory over Darline Graham in a state that Trump carried by nearly 18 percentage points just two years ago.

Andrews' win, along with Democrat Roy Cooper's win in North Carolina's Senate race, gave the party two of the four seats it needs to net in order to take control of the chamber.

Prediction markets signaled growing expectations of a Democratic sweep of the US Congress.

"The US dollar could sell off further from here, because a Democratic sweep would limit government spending over Trump's term," said Carol Kong, currency strategist at Commonwealth Bank of Australia.

Kong said investors were also watching the risk of an escalation in the Middle East depending on the election outcome.

"If the Republicans do lose control of the House and the Senate, what will the President do? He previously flagged that he will restart a bombing campaign in Iran after the election, so we are watching that very closely," she said.

"If he does ramp up the aggression in the conflict, then we could see oil prices jump sharply higher, and that will support the US dollar."

Oil prices edged down to $103.34 a barrel after easing about 1% on Tuesday to their lowest level in nearly four weeks.

AI RISKS

For some, though, the bigger story for the dollar lies in what a Democratic win could mean for the AI sector.

"The price action is consistent with concerns about greater scrutiny on AI in the event of a Democratic sweep, and that is reflected in the underperformance of the Nasdaq and worries about US growth should AI face greater regulation, " said Moh Siong Sim, currency strategist at OCBC.

But Sim also noted: "Even in the event of a Democratic sweep, it is still difficult to pass legislation at the federal level, given the high hurdle under President Trump," who holds veto power.

Sterling rose 0.4% to $1.3460, with traders eyeing the Bank of England's policy announcement on Thursday. The central bank's Monetary Policy Committee is expected to raise interest rates for the first time since August 2023.

Against the Swiss franc , the dollar weakened 0.9% to 0.8133.

China's offshore yuan eased 0.1%, last trading at 6.6782 per dollar. It extended declines after suffering its biggest one-day drop since May 15 on Tuesday, when the People's Bank of China raised the amount of foreign currency that financial institutions must hold in reserve in a move to slow the yuan's rally.