Stepping out of Trump's shadow, the volatility of the dollar has fallen to its lowest level before the election

The foreign exchange market has emerged from the intense fluctuations caused by the "Trump shock" at the beginning of the year, with the dollar volatility index retreating to levels seen before the U.S. presidential election. This marks a significant cooling of investor concerns over the uncertainty of Trump’s policies, as the market returns to traditional driving factors.

Data from CME Group shows that the index measuring the volatility expectations of the dollar against the euro and yen has fallen to its lowest level in over a year this month, after the index surged significantly following Trump's election in November last year. Meanwhile, the dollar index has recovered most of its losses this year, approaching the levels it began to rise at before Trump's victory.

(Daily chart of the dollar index)

Analysts believe that a series of tariff agreements reached between the U.S. and major trading partners such as the EU and China have drained market volatility, while the U.S. economy has performed better than expected in withstanding tariff shocks. Market participants indicate that investors have learned to view policy headlines rationally, avoiding excessive reactions. Chris Turner, head of market research at ING, pointed out: "The world is learning to coexist with Trump, and investors have learned to approach headlines with a calm attitude."

The nearing end of the global major central banks' interest rate reduction cycle has also eliminated another source of market instability. Analysts state that this shift means the dollar is regaining its traditional role as a safe-haven asset and portfolio stabilizer. The dollar, which had plummeted in sync with risk assets after Trump's tariff announcement in April, is now responding again to traditional factors such as interest rate differentials.

Tariff Agreements Calm Market Panic

Before the election, the dollar strengthened due to the "Trump trade," as investors bet that the Republican trade and tax policies would boost the U.S. economy and currency. After April, this trend completely reversed, with the average daily trading volume in the foreign exchange market reaching a record near $10 trillion that month.

Concerns about the impact of trade conflicts on the U.S. economy, along with doubts about the independence of the Federal Reserve, led to the dollar index experiencing its worst annual start since the 1970s. However, since the summer, the dollar has begun to steadily recover, with the rebound in U.S. stocks pushing Wall Street to record highs, providing support for the dollar.

George Saravelos from Deutsche Bank noted in a recent report that the collapse of volatility expectations indicates that the "Trump shock" has ended," with trade tensions easing and fiscal policy in "autopilot" mode.

Federal Reserve's Stance Supports the Dollar

Last month's Federal Reserve meeting provided additional support for the dollar. While cutting interest rates, Powell warned at a press conference that the next rate cut is not a "foregone conclusion."

Investors indicate that this shows the dollar is currently responding to traditional determinants of currency strength and weakness, primarily the interest rate differentials between countries. Turner from ING stated: "We have returned to more traditional forex driving factors."

CME Group data shows that the demand for bullish dollar options has exceeded that for bearish options by the largest margin since February, reflecting an increase in market bets on further dollar strength In addition, the longest government shutdown in U.S. history has led to missing macroeconomic data, which has also suppressed volatility in the U.S. dollar and U.S. Treasury markets.

Analysts point out that investors are avoiding building large positions in the absence of comprehensive data on inflation, the labor market, and consumer spending.

Since the government shutdown began, the ICE Move Index, which measures volatility in the Treasury market, has fallen to a four-year low. This data vacuum has objectively reduced the market's reaction intensity to sudden information, keeping volatility at low levels.

Regaining Safe-Haven Status

Some fund managers indicate that the U.S. dollar is regaining its traditional stabilizer role in portfolios.

Given that the dollar tends to strengthen during periods of global stress, this characteristic was questioned after the Trump tariff announcement in April, when the dollar and risk assets plummeted in sync.

Robert Tipp, head of global bonds at PGIM, believes that despite the rampant discussion about the "end of American exceptionalism," the dollar has been a strong currency over the years from a broader perspective. He views this year's decline in the dollar as a "correction in a bull market," rather than the "beginning of an end."

Rushabh Amin, a portfolio manager at Allspring Global Investments, stated:

"The beginning of the year felt more like an anomaly than a trend. We believe the dollar will continue to serve as a portfolio diversification tool, especially for foreign investors."

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