NEWS ANALYSIS: Dollar holdings worth trillions could seek currency protection

Singapore — As US President Donald Trump’s grand plan to redefine global trade whipsaws the dollar, investors who hold tens of trillions’ worth assets in the currency may for the first time in decades be seeking ways to protect the value of those holdings.

Such has been the unquestionable faith in the dollar for years that just a fraction of the $33-trillion of global money invested in US markets is protected, or hedged in market parlance, for currency volatility.

That may have changed this week as the dollar and US treasuries — both historically first among equals as refuges during crises — became the biggest casualties of a market rout triggered by the US president’s reciprocal trade tariffs.

Treasury yields have surged this week as both US and overseas investors fled, and the dollar is down sharply against the euro, yen, Swiss franc and almost every other currency.

An index measuring the dollar’s value against six other major currencies is below 100 for the first time in nearly two years.

“The US has provided decades of certainty, stability, independence of the central bank, rule of law,” said Vis Nayar, chief investment officer at Eastspring Investments.

“The drivers of US exceptionalism, things like immigration have pretty much gone away. Tariffs are likely to be viewed as a tax rise. And we’ve got an administration that feels that a weaker dollar might help them. Not a good cocktail for unhedged investors.”

US markets have punched above their economic weight thanks to the confidence in the dollar. While the US economy accounts for about 26% of global GDP, Wall Street gets more than a third of global equity investment.

Foreigners owned $33-trillion of dollar-based stocks and bonds at the end of 2024, of which $14.6-trillion was in debt, and the rest in stocks.

Investors in higher-yielding equity markets typically do not hedge their portfolios, analysts say, but currency volatility can be painful for bond investors whose returns are in single-digits or low double-digits.

Brutal swings may force their hand into putting on currency hedges, wherein they would use derivative contracts to sell dollars for their home currencies, or even just exit US markets.

Analysts at financial consultancy Exante Data estimate a one percentage point increase in investor hedging ratios could mean as much as $320bn in dollar selling.

Given how low hedging ratios are, analysts expect a 10-15 point increase in such hedging, if the dollar keeps falling, implying trillions of dollars could be sold in exchange for other currencies.

Pensions and lifers

Japanese pension giant GPIF and life insurance firms (lifers) are among the biggest holders of US assets. The country’s exposure to dollar markets was about $2-trillion at the end of 2023.

The yen’s nearly 6% rise this month and 10% gains in three months are toxic for their holdings, for it will mean less yen per dollar investors eventually bring home. The yen is currently ¥143.2/$.

Japanese lifers have steadily reduced their hedging ratios, and the country’s pension funds almost never hedge.

Analysts at Nomura estimate lifers have about ¥60-trillion ($419.64bn) worth of foreign assets, of which only 30% is hedged, but were expecting that ratio to rise this year if the Bank of Japan raises interest rates.

“If Japanese investors are more concerned about the US economy, they will increase their repatriation and currency hedging more aggressively than we currently expect, maybe the dollar-yen could decline to 135 or something like that,” said Nomura analyst Jin Moteki.

Yunosuke Ikeda, head of macro research at Nomura in Japan, points to Japanese retail investors as another yen exchange rate dynamic. He estimates they invest about ¥1-trillion a month.

“They have very consistently been buying US equity funds, and they are not hedged at all. I don’t think they would move all at once, but if they did, it would have the potential to strengthen the yen by seven big figures,” Ikeda said.

Exante Data analyst Shekhar Hari Kumar’s back-of-the-envelope estimates show that with overseas assets of about $700bn, a 10-point increase in GPIF’s hedging ratio would translate into about $70bn in yen buying.

“The range of potential hedging flows by Japanese investors is between $100bn and $250bn if the yen continues to appreciate and the fund complex increases hedge ratios,” he said.

Large pension funds in Britain, Australia, Switzerland, Canada and other countries and global lifers are also big investors in US debt.

As a fall in the dollar and treasuries gathered pace, financial supervisors in Europe made the rounds to quiz the banks they oversee.

Supervisors including the European Central Bank and national regulators asked about holdings of US government bonds, according to a person with direct knowledge of one such call. That gives an insight into regulators’ worries about an asset that always went unquestioned and their fears of the contagion from US policy.

A spokesperson for the ECB declined to comment.

Exante estimates currency hedging ratio for pensions and sovereign wealth funds (SWF) in 2023 varied from effectively zero in Japan and South Korea to around 40% in Australia and the Netherlands and about 65% in Sweden and Switzerland.

A 10 percentage point change in hedging ratio implies as much as $58bn in forward dollar sales by the Australian pension and SWF sector, they said.

Richard Franulovich, head of currency strategy at Westpac, said in a note that Australia’s net international equity assets totalled A$656bn in the fourth quarter of last year, and hedging ratios had been falling.

His estimates are that a 1 percentage point rise in system-wide currency hedging of equities will result in a A$8.7bn of hedging demand.

“A lift in superannuation forex hedging ratios could produce a significant flow-based tailwind for the Australian dollar,” he said.

Reuters