Hedging Ratios at Multi-Year Lows
TREE NEWS reports: Global institutional investors holding trillions in US assets are increasingly unprotected against a weaker dollar, with hedging ratios across major markets falling to their lowest level since 2015. Bloomberg data covering six markets—including Japan and Canada—shows pension funds and insurers hedged only 41% of their foreign exchange exposure as of June 30. This is down from over 50% four years ago and marks a decade-low.
The total foreign currency holdings in these six markets are estimated at $4.6 trillion. A five-percentage-point rise in the hedging ratio would trigger roughly $230 billion in currency flows—potential dollar selling pressure that could accelerate quickly if sentiment shifts.
Why Hedging Costs Are Falling
The core rationale for low hedging—high costs and the dollar’s safe-haven status—is now eroding. The cost for Japanese investors to hedge dollar exposure for three months has dropped from a peak of 6% in October 2023 to 2.75%, a four-year low. Eurozone investors see costs at 1.32%, the lowest in two years. As rate differentials narrow, rebuilding hedges becomes more attractive.
Manulife’s chief investment officer for multi-asset solutions, Nathan Thooft, notes that if markets continue to price out Fed rate hikes and spreads tighten further, investors may begin rebuilding hedges, creating sustained dollar selling pressure.
Dollar’s Safe-Haven Status Questioned
Beyond costs, the dollar’s structural safe-haven appeal is being challenged. The US Treasury’s large-scale long-end bond purchase program to suppress borrowing costs, and coordinated US-Japan FX intervention, raise doubts about whether US authorities are willing to sacrifice dollar strength for financial stability. Equiti Group’s chief market strategist Noureldeen AlHammoury explains that if confidence in the dollar’s reliability during market stress falls, investors will be less tolerant of large unhedged currency exposure.
Importantly, investors don’t need to sell US assets. They can hold stocks or bonds while selling dollars forward to increase hedging. This distinction means US asset demand may remain robust even if the dollar weakens.
Japan: A Potential Flashpoint
Japan’s exposure is particularly acute. Deutsche Bank estimates Japanese investors hedged only 41% of new overseas bond purchases in H1 2025, down from 62% in 2024. Shoki Omori, Deutsche Bank’s chief Japan fixed income strategist, notes the last time hedging was this low was 2013, which preceded a decade-long dollar bull market. Today’s environment looks like a mirror image.
Omori identifies three potential catalysts for hedge rebuilding: further BOJ rate hikes compressing rate differentials, a sharp dollar drop forcing risk committees to demand protection, and new solvency regulations limiting insurers’ tolerance for currency volatility.
Key Takeaways for Investors
- Dollar downside risk is building: Even a modest rise in hedging ratios could generate significant USD selling pressure.
- Watch Japan: As the largest foreign holder of US Treasuries, any shift in Japanese hedging behavior will have outsized impact.
- Euro may benefit: Falling hedging costs and large unhedged US equity positions in Europe could make the euro a primary beneficiary of any rebalancing.
- US assets can still thrive: Investors can hedge currency risk without dumping US stocks or bonds, so a weaker dollar doesn’t necessarily mean weaker US markets.
