Global investors have dramatically reduced their protection against dollar weakness, with hedging rates falling to just 41% of foreign-currency exposure as of June 30, according to Bloomberg calculations. This represents the lowest hedging rate since at least 2015, as reported by Bloomberg. The data covers six markets including Japan, Canada, Taiwan, Australia, Denmark, and Finland, though excludes major markets like the UK and euro area. Japan stands out as the world's largest foreign holder of US Treasuries, accounting for about 10% of overseas holdings, while Canada and Taiwan rank among the top 10 holders. As per Bloomberg, this shift reflects a return to historical patterns where the dollar typically strengthened during market volatility, cushioning losses on US stocks and bonds when converted to home currencies.
The decline in hedging reflects a shift back to historical patterns where the dollar typically strengthened during market volatility, cushioning losses on US stocks and bonds when converted to home currencies. Three-month dollar hedge costs for yen-based investors have dropped to a four-year low of 2.75% from a high of 6% in October 2023, while euro-based investors see costs at a two-year low of 1.32%. According to Bloomberg estimates, a five-percentage-point increase in hedge ratios would translate into approximately $230 billion of transactions based on $4.6 trillion of foreign-currency holdings across the six markets. The risk now is that two pillars underpinning that strategy — high hedging costs and the dollar's haven status — are being challenged at the same time, with the greenback down about 2% this quarter and weakened against most G10 peers as investors revive debasement trade concerns.
The dollar has declined about 2% this quarter and weakened against most G10 peers as investors revive debasement trade concerns. Treasury Secretary Scott Bessent's moves to support the yen and contain rising US yields have fueled these concerns, as have doubts over Federal Reserve Chair Kevin Warsh's approach to inflation amid Trump's push for lower borrowing costs. Laura Cooper from Nuveen, which oversees $1.4 trillion, noted that given the scale of foreign holdings of US assets, even small shifts in hedge ratios can drive meaningful FX flows. The factors that drove hedging down from more than 50% over the past four years are starting to shift, with the rate gap that made hedging expensive shrinking as the Iran war and surge in energy prices push central banks globally toward higher rates.
Investment managers are recommending diversification away from dollar-heavy foreign-currency baskets, with Stuart Simmons from QIC Ltd. questioning whether the US dollar remains the most reliable defensive tool in an era of increased geopolitical uncertainty. Nathan Thooft from Manulife Investment Management suggests that if markets continue pricing out Fed hikes and interest-rate differentials narrow, investors may rebuild hedges, creating steady USD selling pressure. The potential for increased hedging may be greatest in Japan, where hedging rates for new foreign bond purchases fell to 41% in the first half of this year from 62% in 2024. As per Deutsche Bank's estimates for Japanese investors, they hedged 41% of new foreign bond purchases in the first half of this year, down from 62% in 2024. Shoki Omori from Deutsche Bank notes that the last time hedging was this thin, in 2013, the dollar was entering a 10-year bull market, while today's macro environment looks closer to its mirror image.
