Steeper EUR vol curve on ECB’s soft taper As has become par for the course in recent years, the December ECB meeting surprised by delivering a soft taper that reduced the pace of asset purchases, but forestalled a vicious bond market rout by offering a maturity extension sweetener and keeping open the possibility of increasing program size/duration as required.

For the Euro, this hawkish surprise comes a few months ahead of our expected timeline, and should partially offset the dollar drama unfolding since last month’s US Presidential elections as well as any low-intensity European electoral stress next year to restrict EURUSD to a fairly tight 1.04 – 1.08 range over coming months.

Longer-dated implied vols, especially expiries spanning the Dutch and French elections should, however, prove to be a more reliable, persistent store of event risk premium and relatively immune to tactical gamma developments.

On the flip side, the FOMC is likely to raise its target range for Fed Funds interest rates by 25bp to 0.50%-0.75%, almost exactly one year after the first rate step that brought an end to zero percent interest rates (December 16th 2015). At the time the FOMC decision did not have a sustainably positive effect on the dollar. The whole year that is now coming to an end was characterized by speculation.

But for now, FOMC’s forward guidance is also equally significant at this juncture to keep overall directional exposure on USD light ahead of this event given the combination of an accelerated move in US rates, crowded shorts in Treasuries and modestly rich USD valuations. One should see whether Fed keeps the door open for two more hikes in 2017 or not.

The stern US dollar has been strengthening fails to drive gamma performance: fade rich USD vols and skews. The EURUSD action, is characterized by relatively range-bound spot markets from last two years with only rupture of realized volatility, is not enough to support an imminent rise in volatility.