Last week’s FX volatility reached crisis-like levels, sparking fears of deeper market stress. A breakdown in traditional correlations and talk of coordinated dollar devaluation suggest global investors are bracing for structural shifts in US policy, ING’s FX analyst Chris Turner notes.
Extreme FX volatility signals market stress
“EUR/USD and USD/JPY briefly witnessed one week implied volatility trading at 20% late last week. That’s extreme, and – barring a global financial crisis – those levels of volatility don’t typically last for long. Thankfully, the financial plumbing system seems ok so far, and it’s worth taking a quick look at what happened last week.”
“Much was made of the breakdown in the traditionally positive correlation between US yields and the dollar, leading a few commentators to start describing the US as an ’emerging market’. There have been a few, very rare periods over the past 30 years when US Treasury yields and the dollar have briefly diverged – normally at times of extreme stress. That seemed to be the case last week with heavy deleveraging in the US Treasury market, where the basis trade was probably being unwound.”
“But one theme that might develop further, and one that might be prompting the buy-side around the world to be raising the FX hedge ratios on their US investments, is this idea of a Mar-a-Lago accord. If this is some kind of blueprint for how Washington rewires the global trading system, then after oppressive tariffs, Washington tries to secure agreements on stronger currencies from trading partners. US Treasury Secretary Scott Bessent has been tasked with leading the trade negotiations with Japan and South Korea.”