Dollar Exposure Soars as Investors Cut Back on Hedges

The world's unusually high dollar exposure is putting the currency at risk of steeper declines if sentiment suddenly turns, according to recent data.

Across markets including Japan, Canada, and Taiwan, investors have hedged just 41% of their foreign-currency exposure as of June 30, the lowest since at least 2015. This is down from more than 50% over the past four years.

The rate gap that made hedging expensive is shrinking, with three-month dollar hedge costs for yen-based investors dropping to a four-year low of 2.75%, from a high of 6% in October 2023. For euro-based investors, they've dropped to a two-year low of 1.32%. This has led some investors to cut back on their hedges and return to an approach that had worked for much of the past decade: assuming the dollar would rise or hold up during volatile market conditions.

However, this strategy is being challenged by two pillars: high hedging costs are decreasing, and the dollar's haven status is also being questioned. The greenback has weakened against most G10 peers as investors revive the debasement trade, which views US policies as eroding the currency's value.