Understanding Risk Sentiment
The terms “risk-on” and “risk-off” describe investor sentiment, with “risk-on” indicating optimism and increased appetite for risky assets, while “risk-off” suggests caution and preference for safer assets. In risk-on periods, the Australian Dollar, Canadian Dollar, and New Zealand Dollar tend to strengthen. During risk-off times, major currencies like the US Dollar, Japanese Yen, and Swiss Franc usually see an increase due to their perceived safety.
With the US government shutdown likely ending, we are seeing a classic “risk-on” shift in the market. Stock futures are climbing, which removes the immediate need for safe-haven assets. This improved mood explains the US Dollar’s current weakness against most major currencies.
This situation presents a clear opportunity to trade volatility. Historically, as we saw during the shutdown resolutions in 2018 and 2019, the CBOE Volatility Index (VIX) tends to fall sharply once political certainty returns. We should consider selling VIX futures or buying puts on volatility products, anticipating a drop from any elevated levels seen in recent weeks.
The US Dollar Index, hovering at 99.60, is noticeably weaker than the 104-106 range it occupied for much of 2024, suggesting a broader bearish trend. An end to the shutdown removes a key pillar of support for the dollar, so we can expect pairs like EUR/USD to test higher ground. Buying call options on the Euro could be a way to capitalize on this expected dollar weakness.
Capitalizing on Gold Trends
Gold’s surge to near $4,075 is the most telling signal, as it is rallying strongly despite the risk-on sentiment. This indicates that underlying fears, likely related to the persistent inflation we’ve battled since the early 2020s, have not disappeared. We should therefore hold onto some long gold positions, perhaps through futures, as a hedge against these deeper economic concerns.
In Japan, the signal that the Bank of Japan may delay a rate hike until 2026 keeps the Yen weak. This policy divergence is reminiscent of what pushed the USD/JPY toward 160 back in 2024. Therefore, buying call options on USD/JPY looks like a sensible strategy to profit from the ongoing interest rate gap.
