The laundry basket trade: Finding the dirtiest shirt to short against the Yen

What a week in FX. USDJPY led the charge lower in one of the most hyper trading weeks we’ve seen in a while, as dollar bulls watched their gains slip away in the final stretch. The catalyst? A wave of doubt creeping into the US exceptionalism trade, triggered by softer-than-expected data, Walmart’s disappointing earnings, and a US yield curve that flattened under the weight of stagflation fears.

The cracks are starting to show for a market that had been betting on US outperformance. The consumer—the backbone of the American economy—isn’t looking as invincible as it once did. And with Trump suddenly hinting at a possible US-China trade deal, traders took that as a signal to unwind long dollar positions, fearing that tariff tailwinds might not be as powerful as previously thought.

The challenge right now? Finding conviction. I still like the dollar—if nothing else, because I expect the return of the tariff war story to overshadow optimism around a Russia-Ukraine peace deal and any near-term re-rating of US growth. Fortunately, I’ve avoided taking any serious hits in this whipsaw environment, but let’s be honest—this is a market where hesitation can cost you just as much as aggression.

The Euro’s moment of truth—Political jitters and a brewing debt storm

Over in Europe, the euro is tiptoeing toward a critical weekend, with Germany’s election looming large. CDU/CSU is still in the lead at 30%, but AfD has cemented itself as the clear second force at 20%, while the SPD looks like an afterthought at 15%. Markets haven’t priced in much election risk, given the mainstream parties’ hard stance on keeping the far-right out of a coalition—but if AfD overperforms, expect EURUSD to react.

But the bigger headache for the ECB? It’s not politics—it’s the bond market.

Debt issuance is about to explode, no matter how the EU reconfigures the Stability and Growth Pact. And without a coordinated European borrowing plan, sovereign debt concerns are primed to resurface. If spreads between member states start widening, the ECB will be left with no choice but to step in with asset purchases—a move that would send shockwaves across fixed income and FX markets.

What’s the trade?

The setup is as murky as it gets. But here’s what I’m watching:

• The US Dollar—Do we buy the dip, or does the unwinding continue if traders keep betting on a Trump-China détente?
• The Euro—Does political uncertainty or the ECB’s bond-buying dilemma deliver the next big move lower?
• The Yen—It’s back in demand as a safe haven, but does it have another leg higher?

Right now, FX markets are a minefield, and traders need to be sharp, nimble, and prepared for more volatility ahead. This isn’t the time to trade on autopilot.

Let’s start with the ever-chaotic USDJPY—because right now, it’s hard not to like the yen in this environment. Weak US data? Check. BOJ rate hike bias? Check. Safe-haven demand? Check. It’s been a ripping week for the JPY, with the combined forces of a softer dollar, safe-haven flows, and hotter Japanese inflation data reinforcing the hawkish tilt at the Bank of Japan.

But while yen bulls are feeling optimistic, there’s still one potential concern: the Ministry of Finance’s worries about increasing debt servicing costs. If JGB yields continue to rise, the BoJ may be compelled to buy bonds, which could effectively stifle the yen rally. That’s a wildcard worth noting.

The Bigger Picture: Where’s the USDJPY Floor?

I’m more hawkish on the dollar than most, which is why I don’t anticipate a move to 148 unless a US-China trade deal actually gains traction. That said, I’m not naïve enough to overlook the safe-haven appeal of the JPY, particularly on the crosses. This is a laundry basket trade—and it’s all about finding the dirtiest shirt to short against the yen.

The real short play: EUR/JPY looks ripe

While USDJPY is a mixed bag, yen remains broadly attractive on the crosses—and to me, EUR/JPY is shaping up as the more convincing bearish trade.

Here’s why:

• As US-China trade hype cools, the next big trade war battleground could be Europe.
• The ECB has a bond market crisis brewing, with debt issuance ramping up and spreads widening.
• If risk sentiment turns south, the euro will have a much harder time than the dollar in holding ground.

Bottom line: USD/JPY is messy, but EUR/JPY looks like a cleaner bearish setup. In a world where risk-off sentiment is creeping in and the BOJ is getting more hawkish, the yen has more room to flex its muscles—and the euro might just be the weakest link.

Flattening the curve: Stagflation risks and the market reaction

The biggest challenge for the dollar right now—beyond fading inflows due to waning US exceptionalism—is deciphering the yield curve and the Fed’s next move. If the US enters “stagflation lite,” it’s game over for the rest of the world, as a stagnating US economy drags global growth down with it.

In a slowing growth environment, the best way to trade the dollar is through the 2s Why? Because 2s are the purest expression of what the market believes the Fed will do next.

The latest Bank of America global fund manager survey reveals a growing sense of unease, with nearly 60% of respondents now expecting stagflation to define the global economy over the next 12 months—the highest reading in seven months. This aligns with BNP Paribas strategists, who argue that U.S. markets are vastly underpricing stagflation risks.

Since Trump’s inauguration a month ago, the S&P 500 has continued its grind higher, but beneath the surface, the market is showing signs of discomfort. Nominal and real Treasury yields have drifted lower, and most notably, the yield curve has steadily flattened. This is the market’s way of sounding the alarm—a warning that growth expectations are slipping, even as inflation remains sticky.

For now, traders are still watching and waiting, but if the perception solidifies that growth is stagnating while inflation remains stubbornly high, expect markets to act swiftly and aggressively. That could trigger a broad-based selloff in both stocks and bonds, leading to heightened FX volatility as capital scrambles for safety.

Britain, with its heavy reliance on foreign capital to finance its large trade deficit, could find itself especially vulnerable, while emerging markets with weak currencies and high levels of imported inflation may face even greater pressure. The reality is, when stagflation becomes the dominant narrative, there’s no safe corner in the market—just varying degrees of pain. Hence we might need to add “ Cable” to the other dirtiest shirt in the laundry basket.