Currency options show euro-dollar focus is looking past the European Central Bank and Federal Reserve meetings in January and giving a lot more attention on the March policy meetings, Bloomberg strategist Vassilis Karamanis writes. Until then, the euro is likely to trade within a familiar territory versus the greenback, especially as year-end flows may cloud the short-term direction after the Fed liftoff.
Option volatility term structure shows the 3-month tenor is the most demanded across the curve. This is no coincidence as three-month options expire on March 17, the day the Federal Open Market Committee begins its policy meeting while ECB meets on March 5.
Options also suggest that January meetings aren’t particularly ground-breaking for market participants. Fed Funds futures currently show no probability assigned to a January hike, a 40.5 percent chance for a March hike and a 66.7 percent probability for a June rate increase. As inflation is now the main driver of Fed’s dot plot, traders may surmise the Fed would want more than one Consumer Price Index reading before assessing its next move. The next U.S. CPI data is due on January 20.
ECB’s March meeting is pivotal in determining further stimulus chances, as new inflation and growth projections will be available by then to the Governing Council, according to two people familiar with the situation.
Fresh catalysts for the common currency to break out of its recent $1.05/$1.11 range may not be seen for some time after Fed’s Chair Janet Yellen delivered a two-pronged message with the lift-off -- the U.S. economy is performing well and the Fed is in no rush to raise rates again.
Year-end flows may also cloud the short-term picture. Two traders in London, who asked not to be named as they are not authorized to speak publicly, say that corporate year-end orders are significantly greater than those in previous years. Moreover, some investors may feel more comfortable in reacting to Fed’s hike with some delay as not every market participant has a mandate to immediately act upon news releases, one of the London traders adds.
Risk reversals, a gauge of market positioning and sentiment, show euro-dollar bias is slightly skewed to the downside as bullish greenback sentiment is increasing in the short-term while holding steady on the longer tenors.
Note: Vassilis Karamanis is a FX strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice