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Donald Trump’s tariff threats against China last Friday sent shockwaves through the FX market, causing a sharp jump in volatility risk premiums. While Trump has since dialed back his rhetoric, the heightened implied volatility has been slow to subside, signaling ongoing market uncertainty.
For weeks, FX implied volatility had hovered near historic lows, reflecting relatively calm spot market activity. However, the sudden spike served as a wake-up call for traders, reminding them of the risks of complacency. This newfound caution could limit how quickly volatility levels return to normal, especially with renewed fears of future market shocks.
Looking ahead, volatility risks may intensify as we approach the late-October Federal Reserve meeting. Adding to the uncertainty is the rescheduling of the U.S. CPI report to October 24. With this being the only major economic data release before the Fed meeting, traders are bracing for surprises, which has added extra risk premiums to the CPI release date.
In the currency markets, EUR/USD risks appear more balanced. The 1-month risk reversal, a key gauge of directional bias, lost its longstanding topside premium during last week’s USD recovery. While it briefly regained some momentum after Trump’s tariff comments, it has since settled into neutral territory.
Meanwhile, AUD/USD and USD/JPY saw the largest increases in implied volatility among G10 currencies and continue to hold a premium over their peers.
In emerging markets, Latin American currencies experienced a pronounced spike in volatility premiums, with USD/BRL leading the charge. Already under pressure from domestic fiscal concerns, USD/BRL’s 1-month implied volatility surged nearly 4 points to 14.0 since Friday. This move rippled across other emerging market currencies, as well as Asian FX options, amplifying the broader reaction on Monday.
Despite this recent surge in volatility, current levels remain closer to recent and long-term lows than the elevated peaks seen following April’s U.S.-China tariff escalation. This suggests that markets are not yet fully pricing in the possibility of a full-blown trade war. However, for those betting on further escalation, there may still be opportunities to capitalize on undervalued volatility if tensions reignite.
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Patrick has been involved in the financial markets for well over a decade as a self-educated professional trader and money manager. Flitting between the roles of market commentator, analyst and mentor, Patrick has improved the technical skills and psychological stance of literally hundreds of traders – coaching them to become savvy market operators!