Insights 
VT 
Concerns linger over the US regional banks’ health and the broader credit quality, affecting foreign exchange markets. A minor recovery in market sentiment on Friday allowed the dollar to rebound, but further evidence is needed to put pressure on it again.
Risks for the dollar remain on the downside, especially if lending issues persist beyond Zions Bancorp and Western Alliance. Signs of broader contagion could result in the Dollar Index (DXY) dropping by over 1% soon.
Consumer Price Index Release
The Bureau of Labor Statistics will release the delayed Consumer Price Index (CPI) figures for September on Friday. The expected 0.3% monthly increase in core inflation supports a potential 25 basis points cut by the Federal Reserve next week.
This inflation data is not anticipated to have significant foreign exchange impacts unless it deviates notably from expectations. Nevertheless, employment figures might influence rate expectations more prominently.
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We see significant downside risks for the US dollar in the weeks ahead, centered on concerns about the health of regional banks and the quality of credit. The KBW Regional Banking Index (KRX) has already slipped 4% this month, showing trader anxiety ahead of key earnings reports. Any fresh evidence of stress could trigger a sharp sell-off in the dollar.
Concerns Over Regional Lenders Earnings
The upcoming earnings releases from regional lenders are the primary catalyst we are watching. Evidence that credit issues are spreading could easily send the DXY falling more than 1% in a few days. Derivative traders might consider buying short-dated put options on the Dollar Index (DXY) or a related ETF like UUP to position for such a move.
This situation is reminiscent of the banking turmoil back in March 2023, which saw the DXY drop sharply from over 105 to below 102 in just a matter of weeks. We believe a similar rapid repricing could occur if earnings reports disappoint investors. History shows that credit events often have an outsized impact on currency markets.
The delayed September CPI data, set for release this Friday, is a secondary factor. The consensus expectation for a 0.3% core monthly reading should reinforce the case for a 25 basis point Federal Reserve rate cut next week. With Fed funds futures already pricing in an 85% probability of a cut, this inflation print is unlikely to be a major market mover unless it misses expectations widely.
Given the binary risk from the bank earnings, we anticipate a rise in short-term implied volatility on major currency pairs. Traders could use strategies like straddles on EUR/USD to profit from a large price move, regardless of direction. However, the dominant risk remains tilted towards dollar weakness heading into these key events.
