Euro Outlook: Options Traders Cut Bearish Bets
Euro Outlook: Options Traders Cut Bearish Bets
The euro neared a key technical barrier Friday afternoon. What can traders and investors expect?
- The euro benefits from ECB hawks pushing back on market bets.
- Options traders continue to abandon bearish bets via risk reversals.
- Technical charts show a decisive moment for the euro at key Fib level.
The Euro (/6EH4) attempted to break above a key technical barrier on Friday.
Prices rose above the November high of $1.1070 before trimming some gains through midday New York trading. A break above the level would mark a significant move for bulls and put the currency at highs not traded since August.
Even if the Euro doesn’t clear the level this week, bulls may attempt to continue driving the currency higher over the coming weeks amid broader dollar weakness. The market moved to price more easing from the Federal Reserve next year, with swaps now pricing in more than 150 basis points of cuts next year.
Traders expect the ECB to cut rates in 2024
Meanwhile, markets expect the European Central Bank (ECB) to start cutting in the first half of next year. However, a more outspoken hawkish camp exists within the ECB compared to the Fed. Recently, several ECB members, including Bostjan Vasle, Slovenia’s central bank governor, Joachim Nagal, Bundesbank President, and Klaas Knot, De Nederlandsche President, have pushed back on the dovish narrative.
Still, Europe faces a dire economic reality compared to the United States. If economic indicators deteriorate further, it may force those hawkish members to concede their positions. One headwind to the already slowing economy is that fiscal spending is set to plunge. European Union ministers agreed recently on a new set of rules to curb spending, although the new framework is lenient compared to the pre-pandemic agreement. Still, it sets the EU on a path of restrained spending amid record-high debt levels.
Options market signals more Euro appreciation
The options market is signaling some bullish activity for the euro. Euro risk reversals have been rising and are close to positive territory. A rise in risk reversals—which represent the difference in implied volatility (IV) between out-of-the-money (OTM) puts and calls—can point to further appreciation in the underlying because it signals that there is more demand for calls versus puts, which increases the implied volatility for those calls and thus the premium.
We are using the risk reversal measure as a sentiment indicator or implied volatility skew for the underlying Euro currency. When traders are more willing to pay that premium, it reflects a bullish view of the currency. The chart below illustrates this correlation.
Euro technical forecast
The November high we discussed earlier coincides with the 61.8% Fibonacci retracement level from the June to October move. Both today's and November’s attempts both failed on an intraday basis to clear the level. That said, it’s a decisive technical moment. A close above the Fibonacci would bode well for bulls, while bears would see another failure as a potential opportunity to short the currency.
Thomas Westwater, a tastylive financial writer and analyst, has eight years of markets and trading experience. @fxwestwater
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