(Bloomberg) — It turns out that all the \u201cSell America\u201d angst swirling in markets earlier this year was misplaced. <\/p>\n
The real mantra from global investors is more like \u201cHedge America\u201d \u2014 that is, keep snapping up US stocks and bonds but do so while buying derivatives that protect those investments against any further declines in the dollar. <\/p>\n
Starting around mid-year, and for the first time this decade, flows into dollar-hedged exchange-traded funds that buy US assets have outpaced those into unhedged funds, according to Deutsche Bank AG, which said the shift occurred at an unprecedented clip. <\/p>\n
What it boils down to is that the notion of the exceptionalism of American markets, which seemed in jeopardy after President Donald Trump unveiled punishing global tariffs in April, is alive \u201cwith a twist\u201d \u2014 avoiding exposure to the greenback, said Laura Cooper, a global investment strategist at Nuveen in London. <\/p>\n
The hedging \u2014 which involves using derivatives to bet against the world\u2019s primary reserve currency \u2014 helps explain why the dollar is teetering around its weakest level since 2022 even as US stocks have rallied. And now the prospect of more interest-rate cuts from the Federal Reserve is giving a jolt to the phenomenon, by making it cheaper for global investors to mitigate the currency risk that comes with investing in the US. <\/p>\n
\u201cMy sense is the bulk of the adjustment is still ahead,\u201d said Sahil Mahtani, director at Ninety One Asset Management\u2019s Investment Institute in London. <\/p>\n
By Mahtani\u2019s estimate, the wave of fresh dollar hedging could ultimately tally about $1 trillion. This would, he says, merely bring hedging levels from global investors, who own more than $30 trillion of US equities and bonds, back to where they stood last decade. That was before an appreciating dollar and the roaring stock market convinced many that they needed no protection. <\/p>\n
A chorus of banks including State Street Corp., Deutsche Bank, BNP Paribas SA and Societe Generale SA anticipate the hedging will weigh on the dollar heading into next year.\u00a0 <\/p>\n
That pressure suggests that at the very least the currency will struggle to rebound from its roughly 9% slide in 2025, especially with the European Central Bank likely on hold for now. The Bank of Japan is expected to hike as soon as later this year. <\/p>\n
One of the most popular hedging methods for foreign investors involves selling dollars forward to lock in exchange rates. It often translates into greater selling pressure on the dollar in the spot market. The cost of the transaction is largely a function of interest-rate differentials between the US and the other currency.\u00a0 <\/p>\n
The worries around the greenback, traditionally a haven for investors in times of crisis and economic stress, intensified after Trump\u2019s tariff rollout in April. When stocks and US bonds tumbled, so did the dollar, suggesting that money managers were seeking shelter elsewhere, like in the Swiss franc, the euro and the yen.\u00a0 <\/p>\n
Other US asset classes have rebounded since then, stocks in particular, but the dollar went on to its worst first-half performance since the 1970s. Hedging played into the slump. That activity by non-US investors was \u201can important contributor\u201d to dollar weakness in April and May, the Bank for International Settlements has said. <\/p>\n
For nervous investors, the concerns run far deeper than just tariffs. There\u2019s also Trump\u2019s unprecedented campaign to remake the Fed board and his push to get it to rapidly cut rates; there\u2019s his firing of a top government data collector after a jobs report he didn\u2019t like; there\u2019s his feuding with long-time foreign allies and even his growing crackdown on opposition groups and the media. <\/p>\n
Steven Barrow, a strategist at Standard Bank in London, put it this way in a note to clients: \u201cIf there is speculation that the Fed is goosing the economy with rate cuts because of pressure from the White House, it would seem to make sense to love the US stock market and the front end of the Treasury market but to hate the dollar.\u201d <\/p>\n
Fresh evidence of that love of US bonds came Thursday, with government data showing foreign holdings of Treasuries rose to a record in July.\u00a0 <\/p>\n
Overseas investors collectively own about $20 trillion of US stocks and some $14 trillion in US debt, including Treasuries, mortgage and corporate bonds. They\u2019ve cut hedge ratios on US fixed income by some five percentage points and stocks by around two points in recent years, according to Ninety One Asset Management\u2019s Mahtani, who cited academic research.\u00a0 <\/p>\n
\u201cSimply rewinding those modest moves would create roughly $1 trillion of dollar-selling FX trades,\u201d he said.\u00a0 <\/p>\n
Nailing down investors\u2019 hedging activity precisely is tricky because of the challenge of tracking all the cash flowing around the world. Currency trading, for example, comes to about $7.5 trillion daily.\u00a0 <\/p>\n
So estimates across Wall Street banks tend to vary. Data from State Street, one of the world\u2019s largest custodian banks, shows a stabilization in hedging ratios on US assets held by foreign investors such as mutual funds, pension funds and insurers, after a decline from April levels. The ratio is now around 56%. For comparison, it was about 70% in mid-2023. <\/p>\n
\u201cForeigners are unlikely to sell US assets \u2014 they are most likely to increase the hedge ratio,\u201d said Lee Ferridge, a strategist at State Street. \u201cThe hedge ratio is crucial for the dollar story.\u201d <\/p>\n
Goldman Sachs Group Inc. analysts pointed out that the dollar started the year with high allocations and low hedge ratios \u2014 an unusual combination. Since then, there\u2019s been an adjustment to that stance. \u201cOn net, data released so far show fairly consistent but relatively small shifts in FX hedge ratios from global pension funds,\u201d the analysts wrote, pointing to reductions in unhedged exposure by Swedish, Danish and Finnish funds this year. <\/p>\n
Of course, money managers aren\u2019t necessarily diving into hedging en masse. <\/p>\n
\u201cFor our actively managed fixed-income products, we have not increased hedging positions against either currency risk or US Treasury yields,\u201d said Ryan Chang, head of fixed income at Taipei-based CTBC Investments Co. The greenback is unlikely to fall sharply given a scenario of gradual Fed rate cuts, he said. <\/p>\n
While there are signs of a pickup in hedging, for many investors it\u2019s a process that plays out over years. But some big investors, such as pensions in Canada, Europe and Australia, have already signaled increases.\u00a0 <\/p>\n
\u201cWe will be seeing a few more of these because investment committees have had time to look at this and to approve hedging programs,\u201d said Alfonso Peccatiello, chief investment officer at Palinuro Capital in Amsterdam. <\/p>\n
A Bank of America Corp. survey this month of 196 global fund managers overseeing about $490 billion showed that 38% of respondents said they\u2019re looking to increase currency hedges against a weaker dollar \u2014 the highest level since June.\u00a0 <\/p>\n
For Stephane Deo, senior portfolio manager at Eleva Capital in Paris, the move to hedge his US stock investments came at the start of the year. <\/p>\n
The firm put on the hedge when the euro was trading at $1.05, near the weakest since late 2022. It has since appreciated to above $1.17, putting it among the Group-of-10 currencies that have logged double-digit gains against the greenback this year. <\/p>\n
Part of Deo\u2019s reasoning was that he expected the Trump administration to push for a weaker dollar. The firm had rotated heavily toward European stocks at the end of 2024 and shed exposure to US shares ahead of Trump\u2019s April tariff announcement. <\/p>\n
\u201cWe have since reinvested in the US,\u201d he said. \u201cSo our dollar hedge is a position we intend to keep, as for the moment we expect the US stock market to rise along a weakening dollar.\u201d <\/p>\n
–With assistance from Naomi Tajitsu, Stefani Reynolds, Alice Gledhill, Betty Hou, Julien Ponthus, Matthew Burgess, Ruth Carson and Vassilis Karamanis. <\/p>\n
(Adds Bank of America survey result under subheading \u2018Unhedged Camp.\u2019) <\/p>\n