Analysts are set to change their predictions about the European Central Bank’s (ECB) actions in the coming weeks. A leaked report has made traders rethink, moving away from earlier expectations of rate cuts in September and perhaps December. Despite this adjustment, the euro hasn’t significantly risen. This is because traders had already factored in about 26 basis points of rate cuts by the year’s end before the report.

Current Rate Cut Expectations

Currently, the outlook for rate cuts has dropped to about 15 basis points by the end of the year, suggesting a 50-50 chance of another cut this year. There are three ECB meetings left — in September, October, and December. The ECB’s current deposit rate stands at 2.00%, which matches the neutral rate estimates of 1.75% to 2.25%. This could explain why the ECB seems hesitant to make further moves. With a stronger euro, there’s a risk of not meeting inflation targets. While policymakers might deny this, de Guindos mentioned a threshold of 1.20 for EUR/USD, showing that it is still a consideration. Given the dramatic changes in rate expectations, it seems wise for derivative traders to shift focus from directional bets to volatility strategies. With the market currently seeing only a 50% chance of one more rate cut this year, uncertainty about the ECB’s next steps is a central theme. This environment indicates that options strategies designed for price volatility, rather than sustained movements, may be more effective.

Volatility Strategies

The declining expectations for a cut in September are further backed by recent data. Eurozone inflation for May unexpectedly climbed to 2.6%, and services inflation remains particularly strong. This provides policymakers with a valid reason to wait and evaluate the situation, making the “leaked report” about holding rates more believable. Thus, we find value in buying volatility through strategies like straddles or strangles on EUR/USD, especially around the upcoming policy meetings. With three decisions left this year, implied volatility might be underestimating the chance of a surprise or a hawkish hold. Historically, the central bank has held rates steady over multiple meetings, a trend the market might be overlooking. Additionally, we should keep an eye on the currency level itself, as noted by the policymaker. His reference to 1.20 in EUR/USD indicates a ceiling at which the central bank may resist further euro strength. For derivative traders, this offers a chance to sell out-of-the-money call options with strike prices near that level, taking advantage of this perceived cap. Create your live VT Markets account and start trading now.

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