The U.S. dollar's drop against major currencies this week fueled front-end option buying across the curve, as investors who had liquidated positions before the holidays looked to set up new ones going into this year. The euro closed at a two-month high of USD1.2088 Wednesday and, against the yen, the dollar fell to JPY116.31 Wednesday from JPY117.77 last week. One-month implied volatility for EUR/USD closed at a six-month high of 9.41% Wednesday, while for USD/JPY one-month implied volatility rose to 8.88% Wednesday from 8.3% last week.
Traders were seeing two-way short-term flows, across all major dollar crosses and with a range of strikes. Investors took the opportunity to unload dollars ahead of Friday's unemployment report. "Everyone's lightening up dollar positions," a trader said. "There's a great deal of uncertainty and no one wants to go into unemployment long dollars. You want to be long options inside two months."
Several factors played a role in the dollar's decline, market officials said, including the release of soft economic data and the minutes of December's Federal Reserve meeting, which many interpreted as signaling a foreseeable end to the rate-hike cycle. "The longer the Fed continues to raise rates, the better for the dollar in the short term," said Peter Frank, senior FX strategist at ABN AMRO in Chicago, noting ABN's forecast is for rates to rise up to but not past 5% through mid-year. "The end to interest rate hikes is a slow burning issue which undermines the dollar in the medium term."