EUR/USD fell below 1.170, and this move points to a possible test of 1.160 in the coming days. Equity market moves were described as the main driver of the pair.
Short-term rate differentials also moved sharply. The EUR:USD two-year swap rate gap widened by 20bp, moving from -80bp to -100bp since the start of the week.
That level is close to pre-war readings. This shift reduced support for the euro that had come from relative central bank rate expectations.
In the UK, the pound fell as markets priced in a higher chance of Andy Burnham entering the prime minister leadership challenge. EUR/GBP carried a risk premium, measured as short-term overvaluation, of 0.8%.
Past periods of stronger political and fiscal concern saw risk premia above 2%. The article notes upside risk for EUR/GBP.
We are seeing a major technical breakdown in EUR/USD below the 1.170 level, which strongly suggests a test of 1.160 is coming soon. This opens up clear opportunities for bearish positions. Derivative traders should consider buying put options with strikes around 1.1650 or 1.1600 to capitalize on this expected move.
A key reason for this weakness is the widening two-year swap rate gap, now back to -100 basis points, a level we have not consistently seen since before the 2022 conflict. This shift is supported by last week’s U.S. Core PCE data coming in firm at 2.9%, while the flash estimate for Eurozone HICP for April 2026 softened to 2.1%. This data reinforces the view that the Fed will remain on hold longer than the ECB, continuing to pressure the euro.
We saw a similar divergence play out during the 2014-2015 period when the Fed began its tightening cycle well ahead of the ECB, leading to a prolonged downtrend in EUR/USD. Current market sentiment mirrors that period, with implied volatility on one-month options ticking up from 5.5% to 6.2% this week. This suggests the market is pricing in more downside risk and traders should be positioned accordingly.
In the UK, political uncertainty is creating a separate opportunity, pushing EUR/GBP higher. The rising probability of a leadership challenge from Andy Burnham is adding a risk premium to sterling, which we currently measure at 0.8%. This presents a case for establishing long EUR/GBP positions through futures or call options.
Looking back, we know these political risk premiums can expand significantly, as seen during the UK’s mini-budget crisis in the autumn of 2022 when the premium briefly exceeded 2.5%. The current 0.8% premium seems modest by comparison, indicating substantial upside potential remains for the cross. Traders could structure trades like bull call spreads to target a move towards the 0.8650 level in the coming weeks.
