Last week saw FX volatility reach levels similar to a crisis, sparking concerns of deeper market stress. Traditional correlations between US yields and the dollar broke down, raising speculation about a coordinated dollar devaluation.
EUR/USD and USD/JPY experienced one-week implied volatility trading at 20%. Such extreme levels are rare outside of a global financial crisis, and fortunately, the financial system seems stable for now.
Us Treasury And Dollar Divergence
The rare divergence between US Treasury yields and the dollar is usually observed during periods of extreme stress. Last week, heavy deleveraging in the US Treasury market indicated that the basis trade was likely unwinding.
Speculation arose around a ‘Mar-a-Lago accord’, suggesting Washington might rewire the global trading system. US Treasury Secretary Scott Bessent has been tasked with leading trade talks with Japan and South Korea.
We saw implied vols spike across G10, a clear signal that options desks and macro traders alike were hedging—or outright expressing—concerns about dislocations in spot markets. For EUR/USD and USD/JPY, one-week vol spiking to 20% is not something that happens without broader stress signals brewing beneath. That level of price risk points not to routine repricing, but to forced selling, liquidation flows, or central bank policy misinterpretation. Dealers have been caught short gamma, scrambling to cover into thin liquidity.
Let’s be more direct. The dislocation between Treasury yields and the dollar tells us positioning ran too far, too fast. With Treasury futures under pressure from intense basis unwinds, it’s no surprise that USD correlation finally snapped. That unpinning reflects a transition from carry-seeking flows to cash preservation. This, in practical terms, has forced many short-end traders to unwind duration hedges, even before Fed direction was fully priced in. That tends to create air pockets.
Impact On Market Movements
When names like Bessent step in, with overt bilateral trade intentions, markets sniff policy intent. Whether or not the so-called ‘Mar-a-Lago accord’ has factual basis, directional FX bets have already started absorbing it as a non-zero scenario. The dollar weakness across Asia crosses wasn’t technical—real money and macro funds were putting capital behind the theory. Even if it’s speculative, we’ve seen this movie before: where there’s smoke of coordination, there’s some front-running.
From a pricing standpoint, implied vols are still inflated compared to historicals, but OTM risk reversals have flattened considerably after an initial rush for downside hedges. Sellers returned quickly on any spike, suggesting that a lot of near-term panic has been monetised. That said, curve skews remain asymmetric and concentrated around data days. Trading options purely on premium decay is now higher risk, particularly with Japan and Korea being flagged as participants in renegotiated trade setups.
For futures or swaps traders, the carry-adjusted yield is no longer the dominant driver. Flow sensitivity around macro event days, especially Powell testimonies or BoJ moves, is triggering far greater convexity than usual. It’s essential that we’re mapping liquidity stress alongside policy risk. The absence of arbitrage in basis trades last week shows us how fragile that pricing channel has become.
Vol desks should remain aware of gamma trap scenarios late in the NY session, particularly with rising volumes in short-dated tenors. With margin needs spiking in cross-asset desks, we expect more positioning resets over the next fortnight. Watch for cheapening in downside puts, especially in select JPY and EUR pairs, not as a valuation signal but as reflection of improved risk tolerance. That repricing could be illusory.
Looking forward, we anticipate algo-driven stops to remain sensitive to dollar reversals, especially around midweek auctions. Dislocation in USD correlation needs to be treated as a risk signal, not a trading edge. De-risking flows may not be done.
