In the US, March Madness is synonymous with the annual knockout college basketball tournament, known for its unpredictable results and stunning turnarounds.
But the country has seemingly exported this concept to its foreign policy in the past month, with shifting tariff threats, territorial disputes and abortive peace talks with Russia putting foreign exchange on the front line of market reaction (cue the Make FX Great Again slogans…).
All this has come much to the delight of foreign exchange options dealers, where for the first time in a long while clients all have a different idea of where they think the US dollar will go. But US president Donald Trump’s continued flip-flopping over when and by how much to impose trade tariffs has made it extremely difficult for people to take a clear view.
There are those that assume Trump’s policies are artificially weakening the currency – for instance, Treasury secretary Scott Bessant recently said the dollar’s decline is a “natural adjustment” after years of strengthening.
Everyone seems to have a different view, which is music to the ears of market-makers
Meanwhile, Germany’s landmark plans to increase defence spending have reawakened euro volatility, flipping market sentiment to euro/US dollar call trades, with some now putting on positions of EUR/USD grinding higher.
Additionally, traders have also flocked to historical safe-haven currencies like the yen and Swiss franc. Dealers suggest US dollar/yen has undergone one of the biggest adjustments to date, with the consensus trade amongst hedge funds being to place short-dated topside USD/JPY calls as a hedge against falling equity markets.
Others, perhaps, are positioning for a dollar rebound – as the underlying factors that drove the dollar higher and threats of tariffs on Europe remain – and are now taking advantage of a more favourable entry point. Even with the sharp rise in EUR/USD in recent weeks, for example, some traders still have parity bets on.
Leveraged structures such as European knockouts and put spreads have also seen demand to cheapen these positions.
Meanwhile, a pause by the Bank of Japan on further rate rises has led to a rise in USD/JPY, and traders are also positioning for a weakening of the Swiss franc in anticipation of expected rate cuts.
Everyone seems to have a different view, which is music to the ears of market-makers, even if they’ve had to adjust to a new focus on Asia hours trading. Volumes are good, but when those volumes are multi-directional, it makes it even easier to match speculative bets with corporate and private bank supply. Those with a large enough franchise will be able to capture even more flow and provide tighter liquidity.
It’s also been bringing new hedgers into the market. Real money firms holding US equities are said to be considering hedging downside dollar risk, given typical “markets down, dollar up” correlations have not been holding as they once did.
And it’s not just in the G10. Emerging markets have also felt some excitement, with prospects of a truce in the Ukraine-Russia war seeing the ruble gain a lot of strength this year, and yet more political turmoil in Turkey causing USD/TRY to take off once again.
But it hasn’t been smooth sailing for everyone. Some clients have been hurt, most notably Brevan Howard, which reported its worst start to the year as a result of wrong-way bets, via FX options, on US dollar strengthening. If clients lose money, that often means a decline in volumes.
Furthermore, corporates and pension funds that had moved to lock-in strong USD hedges in January and February are not as nimble when reassessing these positions – they often must go through several layers of board approvals first.
Nevertheless, high vols and a high-vol surface, coupled with a liquid market, do suggest a healthier FX options market for dealers. And the likely continuation of Trump-related headline risk and central bank event risk means dealers are even more optimistic that this buoyant volatility market will continue.
Editing by Lukas Becker
