Why FX traders are betting on the euro not the greenback

by Naomi Tajitsu and Vassilis Karamanis

The euro is taking on a bigger role in the global currency options market as traders skirt around the dollar given the risks from unpredictable US policy and a global trade war.

There’s been a shift in trading volumes. Around 15% to 30% of contracts tied to the 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 the euro is being used as a haven — traditionally the dollar’s role — and for bets on big moves.

While deals involving the dollar still dominate in the $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 dollar after its biggest slump in years, with Europe’s common currency looking like a key beneficiary as the region’s markets benefit from 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 SA.

So far this year, Europe’s common currency has rallied 11% against the dollar, hitting its highest since 2021 at above $1.16. Meanwhile the dollar has slid against every major currency, with a gauge down over 7% to its lowest since 2022. That’s undermining trust in US assets.

And the slump may not be over yet. Hedge fund heavyweight Paul Tudor Jones just predicted another 10% drop for the dollar over the next year. Risk reversals, a gauge of options sentiment, are becoming increasingly negative on the 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 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% over three months for dollar-yen, compared with under 9% 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 favoring the euro over the 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 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 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.

“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 BNP’s Brennan. “And the push has been tariff uncertainty, risks to US exceptionalism, and the macro story.”

Copyright Bloomberg News