The US Dollar eased on Friday as risk appetite improved, with the US Dollar Index (DXY) hovering around 99.60, a few pips above one-week lows, and heading for a 0.35% weekly fall. The move followed reports of a potential US-Iran peace deal after President Donald Trump said he called off plans for a third day of strikes. The proposed agreement, still awaiting Tehran’s approval, would bar Iran from developing a nuclear weapon and could reopen the Strait of Hormuz, which carries about 20% of global crude supply.
Iran said no final decision has been taken, though Foreign Ministry spokesperson Esmail Baghaei said the document is under review and “closer to being approved than ever before.” DXY had jumped about 3% after the US-Israel attack on Iran, reflecting safe-haven demand. On the data front, US producer prices sent mixed signals: headline PPI rose to 6.5% year on year in May versus 6.4% expected, while core PPI held at 4.9% against a 5.4% forecast, tempering expectations for Federal Reserve rate rises. Meanwhile, the dollar remains dominant in FX, accounting for over 88% of turnover, or about $6.6 trillion a day in 2022.
US Dollar Outlook and Trading Strategies
Given the shift in market sentiment, we see the US Dollar’s safe-haven premium quickly eroding. With a potential US-Iran deal on the horizon, the primary reason for the Dollar’s recent strength is disappearing. We should anticipate the US Dollar Index (DXY) to continue its slide from the current 99.60 level towards the 97.50 area seen before the conflict escalated.
To capitalize on this expected decline, we are looking at buying put options on dollar-tracking exchange-traded funds like the Invesco DB USD Bullish ETF (UUP). This strategy provides direct exposure to a weakening dollar with a clearly defined risk. The timeline for this move could be swift as geopolitical news continues to drive sentiment.
Furthermore, we’ve observed that implied volatility in currency markets has started to decrease sharply from its recent highs. The Cboe Volatility Index (VIX), a measure of market fear, has already fallen below 18 from highs above 25 during the peak tensions. We believe selling out-of-the-money call spreads on the DXY is an attractive way to profit from both a falling dollar and decreasing volatility.
Federal Reserve Outlook and Cross-Asset Opportunities
The recent Producer Price Index data reinforces our bearish dollar view by reducing the odds of a Federal Reserve rate hike. Futures markets now show traders are pricing in less than a 15% probability of a rate increase at the Fed’s next meeting, a significant drop from over 60% just three weeks ago. This monetary policy outlook removes a key pillar of support for the dollar.
Consequently, we are positioning for strength in currencies that benefit from a risk-on environment and a weaker dollar, especially the Euro. We are initiating long positions through call options on the EUR/USD currency pair. A drop in the DXY to 97.50 has historically corresponded with the EUR/USD rising several cents, offering significant upside.
The normalization of oil transit through the Strait of Hormuz should also stabilize energy prices, further validating the Fed’s patient stance on interest rates. This environment is historically favorable for commodity-linked currencies. We see an opportunity in the Australian Dollar and are considering AUD/USD call options to gain exposure to this secondary effect.
