In times of uncertainty, when screens are whipsawing between red and green, pockets of opportunity can be hard to come by, and quickly wiped out.
A month after the US and Israel began their military action in Iran, conflicting political messages mean clear trends have been few and far between. Markets have been at the mercy of Donald Trump’s social media posts and flip-flopping news headlines, leaving traders with rock-bottom conviction and struggling to catch a break.
In foreign exchange, the start of the conflict marked a US dollar strengthening trend, initially triggering a mass unwind of consensus emerging market FX carry trades. President Trump’s claims – just a week into the conflict – that military action could be short-lived sparked some cautious bets on high-beta currencies like the Australian dollar and emerging markets. Traders hoped to enter into previously profitable trades at improved levels to benefit from a revival of dollar weakening.
Yet continued high oil prices and further dollar strengthening forced many of these bets to be stopped out. The US dollar index, DXY, which measures the dollar’s value against a basket of currencies, gained almost 5% in February and March.
A seemingly one-way trade like shorting the yen is now clouded by doubt
Talks of a possible ceasefire earlier today (April 1), have again shifted sentiment, pushing crude oil back under $100 and causing a 0.5% pullback in DXY.
On March 23, a Trump social media post claiming “productive conversations” with Iran on a complete resolution of the conflict caused oil prices to tumble by 10% and equities to gain 5% in just five minutes. It’s the kind of move where traders can exit from a short meeting only to find they’ve been stopped out of a trade.
This backdrop has caused some to ask whether markets have become untradable.
FX options have become costly on higher implied volatility. One-month euro/US dollar risk-reversals – an indicator of market preference for puts or calls, which is also known as skew – have been trading at extreme levels for USD calls in recent weeks.
Since March, the measure dipped into negative territory, indicating higher demand for 25-delta EUR/USD puts versus 25-delta calls and signalling a higher cost for dollar-strengthening positioning. On March 13, EUR/USD skew hit -1.45 – the most negative level since August 2024. It has since risen to 0.95 as of April 1.
But options volumes data suggest the market is anything but untradable.
Volumes for all currency pairs averaged $128.6 billion-a-day in March, up almost 10% from the previous month, according to the DTCC’s swaps data repository. EUR/USD options volumes had the biggest jump in ADV from $30 billion in February to $43.7 billion, up by around 46%.
Still, investors are facing a crisis of confidence.
Some hedge funds were badly burned by crowded rates steepener positions in US and euro markets after violent moves in front-end yields, swap spread and short volatility positions. Macro managers like Brevan Howard, Caxton Associates and Taula Capital have reportedly recorded significant losses in March.
While FX traders have fared somewhat better than many interest rate counterparts, they too remain wary of being stopped out on a wrong-way bet and may be facing tighter risk limits in response to carnage elsewhere.
A seemingly one-way trade like shorting the yen is now clouded by doubt with the Bank of Japan threatening intervention when spot hit 160. The currency has since strengthened almost 1% against the dollar.
Real money asset managers and pension funds typically sit on the bench and avoid any knee-jerk reactions during volatile times.
Prior to the conflict, many of Europe’s largest real money accounts, such as Swedish and Dutch pension funds, had been increasing hedges against dollar weakness in January, according to Bank of America research. Australia’s superannuation funds were also taking the same view.
They may see current spot levels in as a unique entry point to increase their USD hedges. Or they may see things differently.
Trump’s latest signal that the US involvement in the Middle East will be over within weeks – with or without a deal with Iran – came as 2,500 additional US marines were deployed to the region. This move prompted unwinds of long dollar positioning in both cash and FX options.
At this stage, a feeling of lethargy has crept in for both clients and dealers. Many will be using a welcome Easter break to seek out new relative trading opportunities following the recent clean-out in carry trades. Some are eyeing long exposure to the Korean won or the Brazilian real, where interest rates are still a whopping 14.75%.
Yet until meaningful actions are taken to de-escalate the war, few are going to be placing their bets with any conviction.
Editing by Helen Bartholomew