In World of Macro Menace, FX Traders Are Either Clueless or Calm

(Bloomberg) -- Facing macro threats on both sides of the Atlantic, traders of currency options appear either remarkably calm or paralyzed by uncertainty.

Right now, investors are weighing everything from the impact of monetary easing in Europe against U.S. rate cuts, to President Donald Trump’s impeachment drama and the global trade conflict. Yet those dramas barely show up in prices for euro-dollar derivatives.

That suggests market participants are reluctant to take strong directional bets on the world’s most-traded currency pair. Risk reversals, a gauge of options sentiment and positioning, are trading at similar levels in all tenors from one month out to 10 years. That’s rare, according to Morgan Stanley.

“Valuation arguments and Fed rate cuts would suggest the euro should be stronger,” said Athanasios Vamvakidis, head of G-10 foreign-exchange strategy at Bank of America Merrill Lynch. “However, the ECB’s policy, and trade tensions would suggest the euro should be weak against the dollar.”

The previous quarter was the single currency’s worst in more than a year. It fell 4.2%. That suggests a lot of bad news may have already been in the price, said Ned Rumpeltin, the European head of currency strategy at Toronto-Dominion bank.

Europe’s single currency, undervalued according to the Bank for International Settlements’ model, has stayed fairly resilient as the Trump administration got the green light to impose tariffs on as much as $7.5 billion worth of European exports in retaliation for illegal government aid to Airbus SE. A composite purchasing managers index for the euro area Thursday showed growth in the region is stagnating.

No Conviction

Yet there is a sense in the market that the ECB is probably at the end of the line as far as policy ammunition is concerned. Rumpeltin forecasts the euro will hold around $1.09 by the end of the year before appreciating a touch to $1.10 in the first quarter of 2020.

“I suspect it is a once-bitten, twice-shy market psychology,” said Rumpeltin. “Having seen a multitude of false breaks in both directions in recent months, investors may have learned the hard way not to chase the market and overload the boat.”

A lack of conviction in euro-dollar trading is also apparent in the volatility market, said Philippos Kassimatis, a co-founder at hedging advisory firm Maven Global. He noted that implied volatilities below 6% for both the one-month and six-month horizon -- as well as the low spread between realized and implied price swings -- have shown the market is not expecting sharp moves in either direction.

“While we have seen a number of European corporates increasing their hedges as the euro moves lower, the pace is gradual,” he said. “They don’t expect any sharp moves down, but also they don’t anticipate a strong reversal of the current dollar trend either.”

--With assistance from Todd White.

To contact the reporter on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net

To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Todd White, Sid Verma

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