Dollar weakness triggered an unusual spike in volatility of other currencies

A weakening dollar raises the cost of hedging trades in other currencies worldwide, disproving the theory that costs should fall when the US currency weakens.

The correlation between the dollar and the volatility index of the top 10 currencies, which shows the level of investor confidence, economic stability and market concerns, fell to its lowest level in 7 years this week. The correlation held positive for most of the past 15 years. This shift shows that traders are preparing for sharper market fluctuations rather than the stability associated with a weak dollar.

On Monday, May 12, the dollar rose on the back of a trade deal between the US and China, and monthly hedging costs fell to their lowest level since late March. But the dollar weakened in the following days due to lower US inflation figures and speculation that President Donald Trump favors a weak dollar. This increased the demand for hedging. Such changes indicate that the currency market is preparing for a prolonged decline in the US currency.