FX volatilities currently trade at higher levels than before but we have to realize that previous abnormally low levels in 2014 were the exception, not the rule. Hedging costs increased partly because of higher FX volatility but there are other factors at work as we described above.

Seen from a perspective of self-interest it’s hard to argue that EM central banks want to see aggressive depreciations of their own currencies. If it’s not in the interests of EM central banks to competitively devalue their currencies, what about the role played by the Fed and by corollary the USD? The question is who benefits from a strong or aggressively strengthening USD?

The Fed clearly don’t due to imported deflation effects. Commodity producers are one obvious casualty of USD appreciation.

On the contrary this is exactly contrary to what they need. From the USD’s perspective it’s hard to see who really benefits materially from a stronger USD in the current environment.

Putting it altogether this implies that volatilities in a structural sense will struggle to increase markedly, both from a USD perspective and from an EM perspective.

The corollary of this is that carry trades should continue to perform well, for the moment at least. Front end volatilities (implied and realized) are likely to decline further. In my view, investors with a long volatility bias, seeking to benefit from a so-called currency war, are likely to be disappointed.

Importantly, we do not estimate the likelihood of declining asset prices but rather we aim to identify buying opportunities in the FX volatility markets in order to reduce hedging cost.