A U.S. holiday and month-end FX rebalancing flows have muddied the waters this week, but while near-term FX volatility risks might have peaked for now, price action in FX options highlights a need to hedge future potential USD strength and FX volatility.

The USD setback reached its limits after Wednesday's London fix as some traders reinstated long USD positions. EUR/USD dropped back to $1.0528 Thursday from a $1.0587 recovery-high on Wednesday and now consolidates.

Shorter-dated implied volatility is edging lower and 1-month contracts are being further eroded by their post-Christmas holiday expiry dates. One-week options will include the Dec. 6 U.S. NFP data to reinflate their risk premiums from Friday.

EUR/USD risk reversals have seen a significant retracement from last Friday's new multi-month highs for USD calls over puts, which suggests any renewed EUR/USD descent toward 1.0300 will be far less rapid now that some significant barrier options have been erased. However, the USD Trump trade remains popular

Demand and support for broader-based implied volatility shows that a majority of currency pairs are bracing for increased realised FX volatility when Donald Trump takes the U.S. reins in January.

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(Richard Pace is a Reuters market analyst. The views expressed are his own; Editing by Kevin Liffey)

((Richard.Pace@Thomsonreuters.com))