Is Emerging Market Stock Volatility Set to Rise on Stronger USD?September 18, 2014
One of the ways we measure volatility in the stock market is to calculate the average realized volatility for constituents in various indexes. It’s no secrete that volatility has been muted pretty much everywhere, with the emerging markets being no exception. Indeed, by our measure of average 65-day trailing volatility the MSCI EM index is at the lowest level as far back as we have data, at 27% annualized. With the US dollar strengthening by the day, however, we wonder if this trend of lower and lower volatility is set to reverse?
In the chart below we show the trailing 65-day average volatility for constituents in the MSCI EM index (blue line, left axis) plotted against the nominal trade weighted USD index (red line, right axis). We see a fairly consistent positive relationship between the two series (higher USD coincides with higher volatility). Given that the USD index appears to be breaking out of a 5-year long trading range, it might be time for a reversal in the trend of lower volatility in EM stocks, if history is a good guide.