(Bloomberg) -- The euro is up by almost 3% from two-decade lows hit a week ago against the dollar, and option markets suggest the rally has more room to run.

The bet is that US consumer price data due later Tuesday will show inflation is near peaking, therefore challenging the dollar-dominance narrative. That view is behind the greenback’s recent retreat versus its major peers.

Risk reversals, a barometer of market positioning and sentiment, show that traders are now less bearish on the common currency. The shift also reflects the hawkish European Central Bank and a fall in gas prices off highs. Overnight euro-dollar volatility trades around 20%, so a soft inflation number out of the US has game-changing potential and could support the euro further.

However, the dollar’s latest retreat is more about investors taking chips off the table rather than a fresh round of selling, according to Europe-based traders familiar with the transactions who asked not to be identified because they aren’t authorized to speak publicly. Demand for over-the-counter trades in the euro has been split since the latest ECB policy meeting, according to a London broker, so momentum following the inflation data will be important for options positioning given clients’ orders.

Another short-squeeze round could be followed by fresh euro demand, as a move above $1.02 would negate the bearish trend channel which has been in place since February. The single currency is currently around $1.0148, having fallen as low as $0.9864 earlier this month.

• NOTE: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

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