The US dollar stayed supported after the September FOMC minutes indicated policymakers still saw scope for another increase in the federal funds target range by year-end, following discussion of stubborn inflation and surprise at the pace and scale of the AI build-out. Money markets have already priced a 25bp move in December, taking rates to 4.25%, and they also imply a further 50bp of tightening next year, while positioning still extends to additional tightening priced into 2027.
Dollar support was also underpinned by elevated Treasury yields and rising volatility, alongside solid demand at the latest US 10-year auction, which saw a strong bid-to-cover ratio and robust indirect bidding. Those conditions have drawn funds away from the carry trade, leaving many Latam currencies under pressure, and the US Dollar Index (DXY) was described as edging higher towards 102.85 over the coming months.
Derivative Trading Strategies for a Stronger US Dollar
We believe derivative traders should position for continued US Dollar strength in the coming weeks as the Federal Reserve maintains a hawkish outlook. With the US Dollar Index (DXY) grinding toward the 102.85 mark, buying pressure remains firmly intact. This upward trajectory is supported by money markets pricing in a 25-basis-point rate hike by December, a trend we do not expect to be challenged anytime soon.
Our view is reinforced by recent Treasury auction data, where a strong bid-to-cover ratio of over 2.5 demonstrated robust demand for high US yields. Historically, when the spread between US and European 10-year bonds widens past 150 basis points, the greenback experiences sustained upward momentum. This yield cushion makes the dollar a highly attractive safe haven as autumn volatility begins to rise.
Options and Futures Recommendations
In the options market, we suggest focusing on USD call options against weaker G10 and emerging market currencies. Rising volatility has already triggered an unwind of popular carry trades, causing Latin American currencies to shed over 3% in recent weeks. Derivative traders can exploit this by purchasing out-of-the-money put options on high-beta currencies to hedge against further downside.
Additionally, we recommend using short-term interest rate futures to position for a flatter yield curve. Current market pricing expects another 50 basis points of tightening next year, which we believe is overly aggressive but unlikely to shift before year-end. Traders can capture premium by selling premium on interest rate options, taking advantage of elevated implied volatility.
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