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FX vols enter H2 meaningfully cheap versus macro drivers and should mean-revert moderately higher. A U- rather than a V-shaped rebound is consistent with past vol cycles and mixed carry trade positioning. Steep vol curves in G10 should flatten; consider +2M/-6M calendars as subsidized long gamma plays. EUR-cross vols and correlations should cool as data and price momentum rotates away from the Euro.
The G10 monetary policy is to blame; Fed speakers are maintaining a mildly hawkish tone, the usually dovish Draghi has started to sound more hawkish, and BoC governor Poloz made comments that are reinforcing the recent rise in short-end yields.
There will be episodes like the past 24hrs when sentiment sours, but these should be viewed as opportunities to increase exposure to EM FX rather than to chase dollar strength. Even if tightening expectations are modestly re-rated, a slow pace of policy normalization is not expected to upset the apple cart.
There has been a bit of a wobble in risk sentiment with most EM currencies suffering alongside a broad-based risk-off tone in asset markets (equities down, yields up, and oil off the highs).
Buy EURUSD vs EURPLN vol spreads and sell EURNOK – EURSEK correlations, consider medium-term [EURUSD↑, EUR/EM↓] dual digitals. USD correlations should be rebound from multi-year lows as the dollar revives; sell back-end EURJPY vols outright or in spreads vs GBPJPY.
