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Euro calls rally to highest since 2009 as Draghi defied: Options

By Inyoung Hwang

The options market isn’t convinced European Central Bank President Mario Draghi will succeed in his aim to weaken the euro.

The cost of bullish wagers on the Euro Currency Trust rose to the highest level since September 2009 relative to bearish bets last week, according to data compiled by Bloomberg. The U.S.-listed exchange-traded fund that tracks the euro versus the U.S. dollar has slipped 0.1 percent since Draghi unveiled stimulus measures for the euro-area economy.

Draghi said in May that the strong euro is “a serious concern.” On June 5, the ECB cut its deposit rate to minus 0.1 percent, becoming the first major central bank to take one of its main rates negative. The ECB also opened a 400 billion-euro ($544 billion) liquidity channel tied to bank lending. That had little effect on the 18-nation shared currency as Federal Reserve Chair Janet Yellen affirmed a commitment to hold the main U.S. rate near zero for a considerable time.

Investors pared bearish bets amid uncertainty over what the ECB may do next to boost the region’s economy, according to Hidetoshi Honda of Mizuho Corporate Bank. Short interest on the euro ETF out of shares outstanding has dropped to 72 percent from 96 percent on June 2, according to data from research firm Markit.

“There’s not much left on the table for the ECB,” Honda, a currency strategist at Mizuho in London, said by phone. “We’ve been trading on this divergence of central bank policies for a while. We expect the Federal Reserve to tighten, continue tapering and hike rates soon. In the euro area, a rate hike is quite a distance away. Most of that has been priced in.”

U.S. Rates

The euro increased 0.3 percent to $1.36 on June 27. The currency reached a 2 1/2-year high of $1.3993 on May 8. It has been climbing against the U.S. dollar for almost two years as the euro-zone economy moves on from the sovereign-debt crisis that dragged it into its worst-ever recession in 2009.

“Some bears have thrown in the towel,” Axel Merk, who oversees $400 million as president and founder of the Palo Alto, California-based Merk Investments LLC, said by e-mail. “The ECB’s actions earlier this month were aimed at weakening the euro, but the ECB’s hands are tied. A negative deposit rate doesn’t cut it when there are no deposits left at the ECB.”

Calls betting on a 10 percent rally in the ETF cost 0.3 point more than puts pricing in a 10 percent decline on June 25, according to three-month implied-volatility data compiled by Bloomberg. Puts have cost more than calls in the last year by an average of 2.1 points.

Bearish Options

Bearish options volume for the euro ETF, known by its ticker symbol FXE, has slumped. The number of puts that changed hands was 8,266 in the week ended June 27, data compiled by Bloomberg show. That’s 80 percent lower than the 40,507 in the week ended June 6 when Draghi spoke.

“The U.S. is clearly headed in the opposite direction of the ECB, so the dollar should strengthen against the euro,” Marshall Gittler, head of global foreign-exchange strategy at IronFX Financial Services Ltd, said by telephone from Limassol, Cyprus. “There’s a good chance the ECB will further loosen measures later in the year if the current policy proves to be ineffective. The Federal Reserve’s going to have a hard time not tightening when inflation is getting close to their target.”

U.S. Inflation

While the Fed’s target inflation rate is 2 percent, its preferred gauge for inflation rose 1.8 percent in May from a year earlier, the biggest 12-month increase since October 2012, data showed on June 26. Speaking earlier this month, Yellen downplayed concerns about asset-price bubbles and incipient inflation.

Hedge funds and other large speculators increased bearish wagers on the euro to 57,503 contracts in the week ended June 27, figures from the Washington-based Commodity Futures Trading Commission. It reached 61,835 contracts on June 20, the highest since May 2013 and compares with 2,175 wagers on May 16.

The median estimate of economists and strategists in a Bloomberg survey is for the euro to weaken to $1.34 by September and to $1.32 by the end of the year.

The VStoxx Index, which measures the cost of Euro Stoxx 50 Index options prices, rose 3.4 percent to 15.3 on June 27. The Chicago Board Options Exchange Volatility Index, known as the VIX, fell 3.2 percent to 11.26.

U.S. interest rates should remain low as the Fed caps them with further guidance and quantitative easing, while implicitly targeting inflation of above 2 percent, according to Stephen Gallo, the European head of currency strategy in London at Bank of Montreal. In the euro zone, inflation-rate divergence with the U.S. eventually leads to higher rates, he said.

“The looser-for-longer mentality the Fed seems to be sticking with is dollar negative,” Gallo said by phone. “We think the euro is going to challenge $1.38 again.”

[Bloomberg]

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