Dollar Volatility Dips as Carry Trades Persist, ING Reports

The US dollar’s volatility has dropped to multi-month lows as carry trades remain in demand, according to a recent note from ING, signaling a period of relative calm in the foreign exchange market.

Why volatility is sinking

ING analysts point to a combination of factors compressing the dollar’s implied volatility, a key measure of expected price swings. The primary driver is the persistence of carry trades, where investors borrow in low-yielding currencies like the yen or Swiss franc and invest in higher-yielding assets, often including the dollar. As long as these trades remain profitable and central banks hold a steady policy course, volatility tends to stay subdued.

Data from the Cboe FX options market shows the one-month dollar index volatility hovering near its lowest levels since early 2022, as of late March 2025. This reflects not only market positioning but also a lack of major catalysts on the horizon, such as surprise central bank moves or geopolitical shocks.

Implications for traders and the broader market

For currency traders, low volatility often encourages higher leverage and risk-taking, but it also means thinner profit margins on directional bets. The carry trade environment, however, can shift quickly if economic data surprises or central banks alter their guidance.

ING’s note emphasizes that the current calm may be deceptive. The bank warns that a sudden repricing of interest rate expectations—particularly if the Federal Reserve signals a slower pace of cuts or if inflation data comes in hot—could spark a volatility spike. Similarly, any escalation in trade tensions or geopolitical risk could unwind carry positions rapidly.

What to watch next

Investors should monitor upcoming US inflation reports, Federal Reserve speeches, and any signs of stress in global funding markets. A sustained break in volatility could signal a shift in market regime, making it essential for traders to stay nimble despite the apparent tranquility.

Conclusion

The US dollar’s low volatility environment, driven by persistent carry trades, offers both opportunities and risks. While the calm may persist in the near term, history shows that volatility can return swiftly. Understanding the underlying drivers—central bank policy, market positioning, and global risk sentiment—remains crucial for navigating the FX market.

FAQs

Q1: What is a carry trade in forex?
A carry trade involves borrowing a currency with a low interest rate and using the proceeds to buy a currency with a higher interest rate, profiting from the interest rate differential. It is a popular strategy when volatility is low.

Q2: Why does low volatility affect the US dollar?
Low volatility reduces the risk of adverse price movements, making carry trades more attractive. This can increase demand for higher-yielding currencies like the dollar, supporting its value, but it also means fewer trading opportunities for those seeking large swings.

Q3: How can a trader prepare for a sudden volatility spike?
Traders can use options to hedge against volatility, maintain diversified positions, and stay informed about economic data releases and central bank communications. Setting stop-loss orders and managing leverage are also prudent measures.