Volatility's new clothes
Source: ALPIMA Ltd
One of QE’s remarkable effects, in addition to low interest rates, has been to reduce volatility. This, however, only works within a single currency.
As witnessed in the last few weeks, volatility is coming back via the FX door, and in a big way.
At nearly 12%, the Deutsche Bank Currency Volatility Index (CVIX) is up 141% since its July 14 low. Over the same period, the US Dollar Index (USDX) rose by 23%.
This impacts all portfolios, even the most diversified.
The chart below shows the correlation between a USD-based diversified portfolio and the USD Index over the last 2 years, and since Feb 2015.
Just when many had got used to a world of low volatility, it comes back in a different form and affects even the most diversified portfolios.
Luckily, this form of volatility can be hedged systematically.