The US Dollar Index is finding support around 98.00 but is having trouble moving higher. Trade tensions between the US and China are affecting markets and putting pressure on the US Dollar. The Federal Reserve (Fed) has hinted at the possibility of two more rate cuts by year-end, which is shaping market expectations. During the European trading session, the Index managed to reduce some of its losses after a four-day drop of 1.30%. Ongoing concerns over US-China trade issues and anticipation of Fed rate cuts are making it hard for the Index to fully recover.

Escalation of the US-China Trade War

The US-China trade war intensified when President Trump acknowledged it, and Treasury Secretary Scott Bessent criticized China’s trade negotiator. At the same time, the Fed is signaling more monetary easing ahead. Fed Governor Christopher Waller and Board Member Stephen Miran have indicated that more rate cuts may be coming. Despite a US government shutdown, the Fed plans to release the September Industrial Production report, predicting a slight growth of 0.1%. We’re also looking forward to insights on monetary policy from St. Louis Fed President Alberto Mussalen. The trade war, which started in 2018 under Trump, brought tariffs and strained economic ties. With Trump back in the presidency, tensions have flared again, featuring a 60% tariff on Chinese goods. This situation is affecting global economics and driving inflation concerns. Currently, the US Dollar Index is struggling to stay stable, facing significant pressure that has pushed it down from its recent highs. This decline is driven by renewed US-China trade tensions and clear signals from the Fed about potential rate cuts. A similar pattern occurred in 2019 when the Fed cut rates three times amid trade uncertainty, causing the DXY to fall nearly 3% in the latter half of the year.

Market Reaction and Strategic Opportunities

The renewed trade war presents a major source of uncertainty, leading to sharp market movements in the weeks ahead. Historically, during the peak of the 2019 trade conflict, the VIX volatility index surged over 40% on two occasions after tariff announcements. Therefore, buying call options on the VIX or VIX-related ETFs could be a smart way to profit from the anticipated volatility. Given the Fed’s dovish stance and futures markets indicating over an 85% chance of a rate cut at the next meeting, we expect further weakness in the dollar against the Euro. This creates an attractive opportunity to go long on EUR/USD. Utilizing call options on EUR/USD could provide a cost-effective way to benefit from this potential upside while managing risk. Although we may see a brief bounce in USD/JPY, the overall trend suggests a weaker dollar and a stronger safe-haven yen. We witnessed this in August 2019, when trade tensions caused USD/JPY to drop below 105. It seems prudent to sell into these rallies or buy put options on USD/JPY to position ourselves against ongoing risk-off sentiment. Create your live VT Markets account and start trading now.

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