The cost of U.S. dollar/euro options continued to climb higher last week as the greenback hit a 17-month low against the European currency. Implied volatility rose to 10.15% Wednesday from 9.75% at the start of the week. "It's not screaming up by any means, but [vol] is steadily going up as the dollar gets weaker," said one trader. As a result, and as continued weakness in the U.S. equity markets indicates, the trend will continue for the foreseeable future. Spot was USD0.955 Wednesday. A common trade was for investors to buy six-month and one-year euro calls struck at parity. "People are hedging themselves on the back end in case the euro goes beyond that," noted one trader. That helped push 25-delta risk reversals 25% higher from 0.8 vol to one vol. "Everyone expects there will be a manageable appreciation of the euro for the time being," he said.
The U.S. current account deficit is weighing on the dollar in the current weak economic environment, according to Jason Bonanca, currency strategist at Credit Suisse First Boston in New York. "The current account deficit has started to matter again--when you have a retrenchment of [corporate] balance sheets, currencies with big deficits are going to suffer," he said, referring to the dollar. Bonanca argued the deficit is less significant in times of economic expansion but said in the current environment it becomes a concern. In those times, currencies backed by current account surpluses, such as the euro, are more attractive. CSFB's house view is for the euro to reach USD0.98 in the next three months and for it to rise to USD1.03-1.05 in the next year.