Euro Volatility Peaks Post-Elections, Nears 1.0580 vs Dollar

Key Takeaway

• Euro volatility surged to nearly 6% post-elections, with EUR/USD potentially dropping to 1.0580 from 1.0606.
• US inflation data and Fed's dot plot could influence euro's short-term trajectory, especially if dovish signals emerge.
• Political uncertainty in the euro-zone and rising inflation diminish prospects for ECB rate cuts, impacting euro strength.

Euro Volatility Increases

The euro has experienced a significant increase in volatility following the recent parliamentary elections in the euro-zone. Traders have quickly incorporated a political risk premium into euro-zone assets, leading to elevated options prices over the next month. The euro’s volatility curve has shifted dramatically, with one-month volatility rising to nearly 6% from 5%. This change indicates that currency traders are now considering the possibility of the EUR/USD pair declining to as low as 1.0580, compared to 1.0606 on Friday.

The recent elections have added a layer of uncertainty to the euro, which has been primarily influenced by the dollar-side of the equation this year. The political risk premium now attached to the euro has further dampened its prospects. According to Ven Ram from Bloomberg, "The euro, however, has a life beyond the short term. The currency has been yanked about this year preponderantly by the dollar-side of the equation, and beyond the French legislative elections, that will continue to be the case."

Impact of US Economic Data

This week’s inflation data from the US and the Federal Reserve’s dot plot will also play a crucial role in determining the euro’s short-term trajectory. Currently, Fed fund futures are pricing in approximately 36 basis points of Fed loosening this year. If the Fed reveals a dovish dot plot indicating the possibility of two rate cuts, the futures’ pricing may adjust, which would also affect the euro, albeit modestly.

Last week’s non-farm payrolls data showed that the US economy remains robust, which could keep the euro under pressure. The strong US economic data suggests that the Federal Reserve may find it challenging to implement the three rate cuts it has outlined for 2024. This scenario could further impact the euro’s performance against the dollar.

Political Uncertainty and ECB Easing

The outcome of the European parliamentary elections has made the prospect of another interest rate cut in the euro-zone even more unlikely. French President Emmanuel Macron’s call for a snap legislative ballot has added to the political uncertainty surrounding the euro, which is expected to persist for at least a month. This political uncertainty does not bode well for inflation in the euro-zone, which has been on the rise.

Austria’s central bank governor, Robert Holzmann, expressed concerns about the euro’s recent weakness even before the election results. Holzmann stated, "If the Federal Reserve isn’t able to put through three rate cuts this year as outlined in its dot plot, it would certainly have an impact on the exchange rate, and with it inflation." With euro-zone inflation hovering closer to 3% than 2%, the European Central Bank (ECB) has already acknowledged that price pressures will remain elevated through this year and next, making the case for a second rate reduction tenuous.