Euro Hits Near Two-Month Low, 60% of Options Bet on Further Weakness

EUR/USD extends losses amid Fed rate hike and shifting market sentiment

The euro fell to a near two-month low against the U.S. dollar on Wednesday, as options traders increased their bets on further euro weakness following the Federal Reserve's latest rate hike.

The euro declined for a third consecutive trading session, dropping 0.2% to $1.1426. Options market indicators show sentiment is increasingly turning bearish, with positioning for the year-end approaching levels last seen in mid-August.

Key Drivers

• Policy divergence fading: Market pricing now reflects further tightening by the Fed, eroding the "policy divergence" theme that had supported the euro throughout the summer.
• Energy price headwinds: Persistently high energy prices are weighing on the eurozone's growth outlook, even as oil prices head toward a sixth consecutive daily decline.
• Political uncertainty: France faces another difficult budget battle in a divided parliament, while Chancellor Friedrich Merz's CDU party is dealing with the fallout from its worst-ever result in a German state election.

Options Market Shifts

Data from the Depository Trust & Clearing Corporation (DTCC) shows the shift accelerated after the Fed's decision last week. Following the European Central Bank's latest rate hike, options exposure was nearly evenly split between bullish and bearish positions. However, since the Fed meeting, approximately 60% of total notional principal has been allocated to bearish euro bets.

The data also reveals that euro hedging is extending further along the curve. Since the Fed meeting, the weighted average maturity of bearish euro exposure has lengthened by more than 10%, while lower strike prices have attracted increased interest.

Analyst Perspectives

Joachim Nagel, ECB Governing Council member, warned that if high energy prices persist, officials may need to raise rates to levels that restrain economic growth. "We may have to enter the mildly restrictive territory of monetary policy," he said.

Elias Haddad, Global Markets Strategy Head at Brown Brothers Harriman in London, noted that the contrast with the U.S. economy continues to support the dollar. "The growth advantage of the U.S. relative to other major economies keeps the dollar risk tilted to the upside," he said, though he acknowledged that tightening by other major central banks may limit the dollar's potential to reach new cyclical highs.

Matthew Hornbach, Global Macro Strategy Head at Morgan Stanley, said higher U.S. interest rates and political risk premiums unfavorable to the euro make it more difficult for EUR/USD to rise.

Deutsche Bank, however, sees limited room for further euro declines. The bank's analysts expect EUR/USD to trade in a range, citing resilient global growth and significant dollar tail risks that should limit euro weakness, while Fed rate hikes and high energy prices cap upside potential.