The euro is taking on a bigger role in the global currency options market as traders skirt around the US dollar given the risks from unpredictable US policy and a global trade war.
There’s been a shift in trading volumes. Around 15-30 per cent of contracts tied to the US dollar versus major currencies were switched to the euro, looking at data from the Depository Trust & Clearing Corporation for the first five months of this year versus the final five months of 2024. There are also signs that the euro is being used as a haven – traditionally the US dollar’s role – and for bets on big moves.
While deals involving the US dollar still dominate in the US$7.5 trillion-a-day currency market, this could be early evidence that the greenback is facing greater competition as the world’s reserve currency. Traders are sidestepping the US dollar after its biggest slump in years, with Europe’s common currency looking like a key beneficiary as the region’s markets seize on billions in government stimulus spending.
“If we’re moving to an environment in which the European flow story is more important, then we could be moving to an environment in which it’s euro pairs which are driving everything,” said Oliver Brennan, options strategist at BNP Paribas.
The growing optimism towards European assets is also seen in the stock market. Wall Street strategists expect loosening monetary policy and increased government spending to boost the Stoxx Europe 600 Index by 3 per cent by the end of the year, handing investors annual returns of about 10 per cent, according to a survey conducted by Bloomberg.
The euro, in the meantime, has rallied 11 per cent against the US dollar so far this year, hitting its highest since 2021 at above US$1.16. The US dollar has slid against every major currency, with a gauge down over 7 per cent to its lowest since 2022. That’s undermining trust in US assets.
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And the slump may not be over yet. Hedge fund heavyweight Paul Tudor Jones just predicted another 10 per cent drop for the US dollar over the next year. Risk reversals, a gauge of options sentiment, are becoming increasingly negative on the US dollar against the yen, whereas they are turning less bearish on euro-yen – a “really important signal” on the euro for Brennan.
As markets question the US dollar’s stability, implied volatility in the euro against the yen is looking the calmest in nearly four years relative to swings between the greenback and Japanese currency.
“The market is thinking that dollar-yen will be more volatile than euro-yen in a negative market shock, which is the opposite to how the market has traded these events in the past,” said Brennan. “If that’s the thinking, then it means the market sees the euro as more of a safe haven than the dollar.”
The cost of options is also a driver, said Ben Ford, currency strategist at Macro Hive. While implied volatility generally has eased after spiking in April’s market chaos, it stands at nearly 11 per cent over three months for dollar-yen, compared with under 9 per cent for euro-yen.
“The market is finding cheaper ways to express its view, especially given the view is probably for euro outperformance,” Ford said.
Traders also seem to be favouring the euro over the US dollar when it comes to hedging or betting on big directional moves on the yen. That’s evident in so-called 10-delta fly spreads, a gauge of demand for outsized swings, where the gap between euro-yen and dollar-yen has been steadily widening since April.
Of course, the US dollar has been written off many times before. Just at the start of this year, the euro was languishing near parity with the greenback, with many investors certain the common currency’s value would fall below its US peer.
Instead Trump’s April’s tariff announcements saw investors dump US dollar assets. While US stocks have recovered since then, the dollar risk premium remains elevated, and it may require a return to US exceptionalism to reverse the trend, according to Tanvir Sandhu, chief global derivatives strategist at Bloomberg Intelligence.
Meanwhile, the European Central Bank’s President Christine Lagarde has called on policymakers to seize the moment and increase the euro’s global profile. French officials were also reported to be lobbying for additional measures aiming at raising the currency’s importance.
“There’s a push and a pull – the pull has been that there’s potentially more safe assets to buy in Europe and more growth expectations in Europe,” said Brennan. “And the push has been tariff uncertainty, risks to US exceptionalism, and the macro story.” BLOOMBERG
