ING says DXY-weighted one-month implied volatility has fallen below 5.50, breaching the January, May and June lows and, excluding the Christmas 2025 dip, reaching its lowest level since 2021. This has occurred despite the military re-escalation between the US and Iran and the risk of a new Federal Reserve tightening cycle. ING links the compression to volatility staying contained between March and May even as rates and commodity prices moved sharply, with AI-fuelled equity resilience helping anchor currencies and prolonging a low-volatility carry-trade backdrop.
The bank judges risks are skewed higher for both FX volatility and the dollar in the near term, arguing that if oil prices only partly reflect a potential supply shock, the chance of non-linear rallies increases. Even so, it also outlines a scenario in which Middle East tensions de-escalate, oil prices fall and the front end of the USD curve allows more dovish flexibility. Under that set of conditions, ING expects a weaker dollar after the summer.
Low Volatility and FX Market Calm
We are currently seeing DXY-weighted one-month implied volatility drop below the 5.50% threshold, reaching its lowest level since 2021. Despite recent geopolitical friction in the Gulf and shifting Federal Reserve policy expectations, currency markets remain incredibly calm. This quiet environment, heavily anchored by a resilient stock market, has made foreign exchange options unusually cheap.
Given these conditions, we believe derivative traders should actively buy underpriced FX volatility before the summer ends. Purchasing short-term US Dollar call options or volatility straddles offers an asymmetric risk-reward profile right now. Historically, when G7 FX volatility dips below 6%, it rarely stays there for long before a sharp upward spike.
Strategies and Outlook for the Dollar
We must also closely monitor energy markets, as Brent crude oil is highly sensitive to Middle East tensions and could trigger a non-linear dollar rally. If oil prices suddenly spike, the greenback will likely surge alongside FX volatility. To hedge against this, traders should consider long-volatility strategies on commodity-linked currency pairs.
As we look past the summer into autumn, our baseline projection shifts toward a broader weakening of the US Dollar. If Middle East tensions cool and oil prices ease, the Federal Reserve will have more room to adopt a dovish policy stance. We suggest preparing to transition from long-USD tactical options to short-USD positions by late September.
