The pairing of disappointing U.S. inflation data and indications the European Central Bank will raise rates in March led to option buying on the euro/U.S. dollar cross last Thursday. Officials said sentiment the single currency will rally was fueled by news one of the Federal Reserve's most closely watched inflation measures, the core personal consumption expenditures price index, increased by only half the expected rate last month. "It looks like there will be a pull back in euro/dollar which is in the process of bottoming out and will move higher next year," said Ian Stannard, currency strategist at BNP Paribas in London.
Traders said option players reacted by jumping on short-dated euro puts/dollar calls to capture cheap volatility. The single currency was trading around USD1.18 spot on Thursday and one-week implied volatility for the cross was hovering above 8%. Maturities were typically one-day or one-week and some euro puts were striking above USD1.20, one official said.
Another trader, however, saw no significant volumes of directional trading on the pair. "The market doesn't really know where it wants to go," he said. Officials across the board agreed euro/dollar activity was one of only a few notable movers last week, as market liquidity dried up in the lead up to the holidays. "Action has fallen away and liquidity has become less and less every day," said one trader at a European house, noting only larger dealers and brokers continued to trade.
