The Federal Reserve kept interest rates unchanged, while Chair Warsh spoke for about 45 minutes without setting out a clear rationale for the FOMC decision. That uncertainty coincided with a sell-off at the long end of the US Treasury market, pushing the yield curve steeper and the US dollar lower. The 2s10s spread recorded its biggest jump since August last year, reinforcing a move that the market read as negative for the dollar.
Discussion also turned to the degree of stimulus coming from the Fed’s balance sheet, raising the prospect that any adjustment to its size could come sooner than previously discounted. President Trump added to the backdrop by saying, as the press conference ended, that “Warsh would love to see lower rates”, feeding concerns about political influence and a split within the FOMC between the Board of Governors and the Presidents. Inflation expectations rose sharply, and the episode left Fed credibility under scrutiny, increasing the risk of further dollar depreciation.
Shorting the Dollar and Yield Curve Trades
We suggest derivative traders heavily short the US Dollar Index (DXY) using options and futures over the coming weeks. With the DXY recently slipping toward the 100.50 level and domestic inflation expectations ticking back up toward 3%, put options on the dollar against the Euro and Japanese Yen are highly attractive. We expect the greenback to face sustained downward pressure as the market actively questions the central bank’s commitment to tackling inflation.
In the fixed-income options space, we recommend positioning for a further steepening of the Treasury yield curve. Traders should look at 2s10s spread options or calendar spreads on Treasury futures to capitalize on this widening gap, which just experienced its sharpest jump since August of last year. Historically, when the market suspects the Fed is falling behind the curve, long-term yields surge much faster than short-term rates, making bear-steepener strategies highly profitable.
Gold Strategies Amid Inflation and Political Risk
We also see a prime opportunity in gold futures and call options to hedge against currency debasement and perceived political interference in monetary policy. Gold has consistently consolidated above the $2,400 per ounce threshold this year, and this sudden blow to Fed credibility provides the perfect catalyst for a breakout. Buying near-the-money call options on gold will allow traders to capture the upside of rising inflation expectations while keeping risk strictly defined.
