FX Daily: Surprisingly low volatility keeps carry trade dominant

What the desk is arguing

ING argues that FX markets are surprisingly calm despite geopolitical and inflationary pressures. Traded volatility is at the low end of five-year ranges, allowing carry trades to remain profitable.

Low volatility discourages hedging and encourages investors to seek yield. This has sustained demand for high-yielding currencies like the Australian dollar and Norwegian krone.

The desk implicitly rejects the notion that the current risk environment should lead to higher volatility. They suggest that without a significant shock, the carry trade will persist.

Where it sits in our coverage

Our coverage does not maintain a consensus target for AUD or NOK specifically. However, we broadly agree with ING that low volatility supports carry trades, aligning with our view that risk appetite remains resilient.

We note that ING's analysis is qualitative and does not cite specific targets, but it complements our own monitoring of VIX and FX implied volatility. The absence of a specific currency pair limits direct comparison.

How other firms see it

JPMorgan shares a similar view, noting that low volatility favors carry strategies, particularly in emerging markets. They expect this environment to persist through Q1.

Barclays is more cautious, arguing that the current calm is fragile and that a Middle East escalation could spike volatility quickly. They recommend hedging tail risks.

Goldman Sachs sees the low volatility as a reflection of market complacency. They expect a re-pricing as inflation data remains sticky, which could challenge carry trades.