A close examination of disclosures from pension funds and insurance companies around the world reveals a striking fact: some of the largest holders of US assets have limited protection from a weak dollar, which exposes the currency to the risk of steeper declines if investor sentiment suddenly shifts.
In markets including Japan, Canada, and Taiwan, these investors hedged only 41% of their foreign currency exposure as of June 30, the lowest level since at least 2015, according to Bloomberg calculations based on data from six markets where such figures are available. While this data doesn't provide a complete picture, it does offer a glimpse into how last year's sudden rush to hedge against dollar losses, triggered by President Donald Trump's imposition of global tariffs, has faded as the U.S. currency has gradually stabilized.
As they reduce their hedges, investors are returning to an approach that proved successful for most of the past decade. The dollar tended to rise, or at least hold its ground, when markets experienced volatility, thus mitigating losses on US stocks and bonds when converted back into investors' local currencies. With the cost of hedging rising, there was little incentive to pay for protection.
The danger now lies in the fact that the two pillars on which this strategy rests – the high costs of hedging and the dollar’s status as a safe haven – are facing challenges simultaneously.
New pressures on the dollar
The dollar has fallen by about 2.3% this quarter, declining against most of its G10 peers, as investors revived the so-called currency devaluation trade—the view that US policies will undermine the dollar's value. Treasury Secretary Scott Bisent's moves to support the yen and curb rising US Treasury yields exacerbated these concerns, as did doubts about whether Federal Reserve Chairman Kevin Warsh will raise interest rates to curb inflation, given Trump's efforts to lower borrowing costs.
Hedging protects investors from currency fluctuations by using derivatives to sell dollars for their local currencies. Since US assets make up a significant portion of global investment portfolios, increased hedging effectively means increased dollar sales.
Laura Cooper, head of macro credit at London-based Nuveen, which oversees $1.4 trillion in assets, said: Given the size of foreign investors' holdings of U.S. assets, it doesn't take a major shift in investment positions to have an impact.
She added: Foreign investors hold a huge stock of US assets, so even slight shifts in hedging ratios can generate large flows in the foreign exchange market.
A five-percentage-point increase in hedging ratios would translate into transactions of around $230 billion, according to Bloomberg estimates based on $4.6 trillion in foreign currency holdings across the six markets, which also include Australia, Denmark, and Finland.
The estimate excludes major markets such as the UK and the Eurozone, but the countries it covers still represent a significant share of US asset holdings. Japan is the world's largest foreign holder of US Treasury securities, accounting for approximately 10% of foreign holdings, while Canada and Taiwan are among the top 10 holders.
