SA���ʴ�ı

Making regimes explicit is part of the solution. Currency markets spend long stretches in different states – strong-dollar trends, weak-dollar recoveries, often punctuated by range-bound consolidation. The risks investors face in each state are not always symmetrical.

Near the start of a strong-dollar cycle, leaving some exposure unhedged may participate in the move. Late in the cycle, however, the same stance becomes less about opportunity and more about unrewarded crash risk.

A structured investment policy that allows hedge ratios to move within a defined band as the dollar stretches away from long-run valuation anchors could build this logic into the portfolio. A board or investment committee can set a strategic range – say 50-100 percent hedged – and define a small set of indicators: valuation, interest-rate differentials, and/or realized volatility. The key is to move away from ‘set and forget’ hedging and toward a regime-aware discipline that changes slowly, deliberately, and for pre-agreed reasons.

One reason hedging decisions are so contentious is that they sit at the intersection of two powerful forces: the lure of carry and the fear of a crash.

When US interest rates are materially higher than those in Europe or Japan, hedging dollar assets back into euros, sterling, or yen can be a return drag. Leaving exposures unhedged looks like the rational way to avoid paying for protection that never seems needed.

During the last phase of dollar strength and US monetary tightening, this calculus encouraged investors to let hedges lapse. The cost of selling dollars forward rose as rate differentials widened. Equity and credit portfolios denominated in foreign currencies often enjoyed a double boost from rising US markets and a stronger dollar, reinforcing the impression that hedging was unnecessary.

But this carry-friendly equilibrium rarely lasts. As the dollar climbs, valuation metrics flash red. When the turn comes, it can be painfully sharp. For investors who harvested carry by staying unhedged, the payoff profile suddenly flips. The steady drip of avoided hedging costs is replaced by a large, uncomfortable FX loss that can overwhelm asset performance.

Early in an upswing, when valuation is reasonable and rate differentials are widening, accepting some unhedged exposure may participate in both spot and carry. Late in the cycle, when the dollar looks rich and policy risks accumulate, paying away some carry to rebuild hedge ratios is less about giving up return and more about buying crash protection.

The major catch is that the carry-versus-crash trade-off is not the same for everyone. It depends on your base currency, liability profile, and domestic rate backdrop.

The impact of dollar cycles on hedging decisions is not uniform. A euro-based investor, a UK pension fund, and a Japanese insurer holding the same US equity index experience very different incentives when deciding how much to hedge.

Exhibit 1: USD spot price and FX rates over the last 20 years (Nov 2005-Nov 2025)

USD spot price and FX rates over last 20 years 

Source: Bloomberg. Data as of 28 November 2025. Please note that past performance is not a guide to the future.

For European investors, US assets have often offered both higher yields and currency upside. Over recent strong-dollar phases, leaving US exposure unhedged boosted returns as the dollar climbed. When the cycle turned, the FX line item went from tailwind to headwind – there have been years when dollar weakness erased underlying US market gains. For this group, hedging smooths swings without losing the strategic benefit of diversification.

Japan flips the economics. With domestic yields compressed and the yen historically lower-yielding than the dollar, domestic investors often earn positive carry from hedging US assets back into yen. For a Japanese life insurer, running fully hedged dollar bond portfolios can actually raise expected returns after accounting for currency effects, while aligning assets to yen liabilities.

Swiss or Nordic institutions face a third problem: they may want dollar exposure for its defensive qualities but still need to report results in a single base currency. Hedging policy cannot be imported wholesale. It must be rooted in the currency of liabilities, portfolio structure, and how each institution experiences the cycle.

These regional contrasts sharpen the case for a regime-aware framework. The common need is a toolkit and governance process that let investors adjust hedges methodically, without improvising in the middle of the next FX lurch.

An interesting subplot emerges when hedging flows impact the dollar cycle itself. As hedging volumes balloon and derivatives turnover climbs to record levels, these flows are becoming a visible driver of the dollar, especially around inflection points.

Exhibit 2: Dollar assets are a large share of non-US investors’ portfolios

^1��Excluding foreign portfolio assets held by US residents.
Source: BIS Bulletin, , as of 20 June 2025.

After long periods of dollar strength, foreign investors in US assets often find themselves heavily exposed. When the narrative suddenly shifts – because of policy surprises, geopolitical shocks, or softer US data – those unhedged positions become raw material for a wave of defensive hedging. Managers who left currency risk on at the top of the cycle rush to lock it down once the move is underway.

When large institutions simultaneously try to raise hedge ratios, the result is a surge in demand to sell dollars forward. The alternative is to build more of the desired hedge in advance, when markets are calm and liquidity is deep, and to use periods of pronounced dollar strength to methodically nudge hedge ratios higher rather than lower.

Ultimately, there is no single ‘right’ hedge ratio that applies across currencies, cycles, or institutions. Governance ties the toolkit together: clear policies, predefined ranges, and documented triggers for shifting hedge ratios help distinguish deliberate, regime-aware adjustments from ad-hoc reactions.

In a world where FX moves can quickly magnify or erode hard-won returns, hedging is less a binary choice and more an ongoing process. The challenge is to be more thoughtful and intentional about how much currency risk to run, and why. Meanwhile, recognizing that the so-called ‘right’ answer will always be specific to each investor's base currency, liabilities, risk tolerance and macro views on where the dollar and other major currencies go next.