European currencies are gaining strength as investors move away from US assets. A recent report indicates that the European Central Bank may have asked banks to test their US dollar funding requirements. There are concerns about the Federal Reserve possibly limiting access to emergency US dollar swap lines. While this scenario is not likely, it could accelerate the move away from the dollar.

Potential Movement in EUR/USD

A rise to 1.150 in EUR/USD may be premature without clear signs of economic harm in the US due to tariffs. If the G7 summit does not resolve trade tensions and Treasury markets remain weak, another increase in EUR/USD could happen. Investing carries risks, including the possibility of financial loss. This information is for informational purposes only and should not be considered a recommendation to buy or sell any assets. Always do your research before making investment decisions. What we see is traders reacting to signs of stress in dollar funding markets. When central banks like the ECB request commercial banks to test their risk exposure, it usually indicates that policymakers are contemplating a situation where access to dollar liquidity could become limited. This often occurs during market disruptions or when global funding costs rise. We should also consider that the US Federal Reserve may reduce its emergency dollar swap lines. Although this change is not expected immediately, the discussion around it creates an environment where reliance on the dollar feels less secure. We believe the market is beginning to recognize that alternatives, especially in Europe and partly in Asia, could become more appealing. This doesn’t mean a complete overhaul, but shifts can start when old beliefs about liquidity and access change even slightly.

Geopolitical Influences and Expectations

We already see capital flowing back to European assets, made more attractive by tighter real rate differentials and a more synchronized fiscal-monetary environment. This alone doesn’t automatically justify a rise to 1.150 in EUR/USD, but if this trend continues alongside persistent weakness in US Treasuries, the euro could rise further without a crisis prompting it. Looking ahead, much will depend on how the upcoming geopolitical events, especially the G7 summit, affect trade discussions. If officials leave without providing clarity on tariffs or future regulations, we may see another increase in EUR/USD. This would not be due to improved fundamentals in Europe, but rather the ongoing reassessment of risk in the United States. News about tighter dollar liquidity, alongside these developments, would further indicate this trend. Traders appear to view EUR/USD movements as more than just temporary. There’s increased interest in long-term positions, suggesting that they are preparing for more than a brief rally. This indicates that pricing is not just a reaction to current events but is also anticipating potential policy differences or funding changes. Timing is crucial. The current period offers an opportunity to examine carry dynamics and instrument volatility amidst relatively minimal changes. For example, the options market is leaning towards call options, with premiums rising faster than puts. This trend may continue unless the picture for Treasury yields shifts dramatically. In the short term, a smart strategy is to adjust short-dated exposures and monitor how central banks manage liquidity discussions in their upcoming meetings and minutes. If they start discussing stability tools or collateral availability more frequently, it will be significant beyond just foreign exchange. We are closely observing funding terms in Europe, the US, and Japan for signs of stress or implicit support. Ultimately, everything relies on how trade relations evolve, particularly US tariff policies and supply chain issues. If conditions worsen, US real yields may face ongoing pressure, potentially affecting the bond market, which could heighten the necessity for gradual diversification in institutional investment strategies. On a technical note, implied volatilities are still providing good opportunities for directional bets, especially in gamma terms. However, it’s essential to monitor skews for signs of overcrowding, which have started to flatten. This could suggest new risk environments are developing. A steepening skew, particularly in longer-dated options, would require quick adjustments to exposure. As the week progresses, the continuation of this trend will depend on market flows. European data, while not strong, is not declining rapidly enough to interrupt current price movements. Therefore, traders should stay alert to Treasury auctions, communications from the ECB, and any sudden shifts in cross-currency basis markets. Changes in these areas often precede shifts in overall market sentiment and have historically helped us identify turning points in currencies and volatility ahead of the broader market. Create your live VT Markets account and start trading now.

here to set up a live account on VT Markets now