Insights 
VT 
The US Dollar Index is finding some support around the 98.00 level, but its ability to move higher is constrained. Trade tensions between the US and China are impacting markets and weighing on the US Dollar. Fed policymakers have suggested the potential for two more rate cuts by year-end, influencing market expectations.
The Index has trimmed some losses during the European trading session after a four-day sell-off of 1.30%. Concerns about US-China trade tensions and expectations of Fed rate cuts are hindering a full recovery.
Escalation of the Us China Trade War
The US-China trade war escalated when President Trump acknowledged it and Treasury Secretary Scott Bessent made remarks against China’s trade negotiator. Meanwhile, the Fed signals more monetary easing. Fed Governor Christopher Waller and Board Member Stephen Miran point to further rate cuts.
The Fed, amidst a US government shutdown, will release September’s Industrial Production report, expecting a modest 0.1% growth. Further insights on monetary policy are awaited from St. Louis Fed President Alberto Mussalen.
The US-China trade war, initiated in 2018 by President Trump, introduced tariffs and strained economic relations. The return of Trump as US President has reignited tensions as he implements 60% tariffs on Chinese goods. This impacts global economic dynamics, contributing to inflation challenges.
We are seeing the US Dollar Index struggle to hold its ground, with significant pressure pushing it down from its recent highs. This weakness stems from a combination of renewed US-China trade tensions and clear signals from the Fed for more rate cuts this year. Looking back, we saw a similar pattern in 2019 when the Fed cut rates three times amid trade uncertainty, causing the DXY to drop nearly 3% in the latter half of that year.
Market Reaction and Strategic Opportunities
The renewed trade war is the biggest source of uncertainty, and we should expect sharp market swings in the weeks ahead. Historically, during the peak of the 2019 trade conflict, the VIX volatility index spiked over 40% on two separate occasions following tariff announcements. Therefore, buying call options on the VIX or VIX-related ETFs could be a prudent way to profit from this expected turbulence.
Given the dovish Fed, with futures markets now pricing in an over 85% probability of a rate cut at the next meeting, we anticipate further dollar weakness against the Euro. This makes going long on EUR/USD an attractive position. Using call options on EUR/USD could be a capital-efficient way to gain exposure to this potential upside while limiting risk.
While we see a temporary bounce in USD/JPY, the bigger picture points to a weaker dollar and a stronger safe-haven yen. We saw this in August 2019, when trade tensions flared and USD/JPY fell below 105. A strategy of selling into these rallies or buying put options on USD/JPY seems appropriate for positioning against the ongoing risk-off sentiment.
