Market News

BY Vassilis Karamanis

(Bloomberg) -- The euro is set for its best weekly performance in 16 years after Germany’s historic pledge to ramp up spending for defense and infrastructure.

The currency rose as much as 0.8% to $1.0871 on Friday, its strongest level in four months, taking its surge in the week to almost 5%. Options volumes in the euro-dollar pair hit a record high on Wednesday, according to data from the Depository Trust & Clearing Corporation, with bullish wagers accounting for 70% of total demand in the week, versus February’s average of just over 50%.

Germany’s formal departure from decades of fiscal reticence is a game-changing moment for currency traders. With hundreds of billion of euros set to be marshaled, the European Central Bank has less need to push on with rate cuts to spur economic growth, according to Brown Brothers Harriman strategists.

Meanwhile, strategists at Bank of America Corp. revised up their forecasts for the euro, citing this week’s fiscal announcements and predicting the currency could rally around 6% by year-end to hit $1.15.

“The announced German fiscal package is a watershed moment for the euro,” said the BofA strategists led by Michalis Rousakis. “Meanwhile, policy uncertainty poses downside risks to US growth.”

Short-term options sentiment in the common currency, as depicted by so-called risk reversals, rose to bullish levels last seen half a decade ago. In the long-term, traders are the least bearish on the euro in three years.

Immediately after the German spending plans were unveiled, hedge funds added bullish options structures that targeted a move as high as $1.20 into year-end, according to FX traders familiar with the transactions who asked not to be identified because they aren’t authorized to speak publicly.

Options that pay out on a rally above $1.12 and $1.15 have also been in play since then. The DTCC data show large interest this week for $1.10 strikes, while traders also bet on a move above $1.20 over the next year.

--With assistance from Greg Ritchie.

(Updates with details of BofA’s call in fourth paragraph.)