Global pension funds and insurers hedged just 41% of their dollar exposure as of June 30, the lowest since 2015, leaving unhedged currency risk that could become roughly $230 billion of dollar selling if institutions rebuild protection as hedge costs fall to multi-year lows.
A decade-low wall of unhedged dollar exposure sits on the books of the world's biggest pension funds and insurers, and the falling cost of buying protection is making that position harder to defend. Institutions across six major markets hedged only 41% of their foreign-currency assets as of June 30, the least since records began in 2015, and a modest swing back toward hedging could translate into roughly $230 billion of dollar selling.
"Hedge ratios were similarly low in 2013, but the macro backdrop is now the reverse of that period," said Shoki Omori, chief Japan fixed-income strategist at Deutsche Bank. Additional Bank of Japan rate hikes, a softer dollar and insurers' reduced tolerance for exchange-rate swings are combining to create conditions for a sharp increase in hedging, he said.
Bloomberg's survey of pension funds and insurers across Japan, Canada, Taiwan, Australia, Denmark and Finland put the average hedge ratio at 41% of foreign-currency assets, down from 56% in 2020. Australia sat lowest at 27%, followed by Canada at 38%, Taiwan at 43%, Japan at 46%, Denmark at 49% and Finland at 51%. The Bloomberg Dollar Spot Index has fallen 2.1% to 99.29 since July 1, while the Wall Street Journal Dollar Index is down 1.9% in the third quarter.
The stakes are outsized because the hedging process itself runs through derivatives that sell dollars. Bloomberg estimated that if investors in those six countries raised the hedge ratio on their roughly $4.6 trillion of foreign holdings by just five percentage points, it would require about $230 billion of dollar-futures selling — a flow large enough to deepen the currency's slide and feed a self-reinforcing loop in which institutions also pare dollar assets or pause new purchases.
The constraint that kept institutions unhedged is easing. The three-month cost of hedging dollars for yen-based investors has dropped to 2.75%, a four-year low, from a peak of 6% in October 2023, while euro-based hedging costs fell to 1.32%, the lowest in two years, as interest-rate differentials between the United States and other major economies narrowed.
Lower costs lower the barrier to re-establishing protection. "Given the scale of foreign holdings of U.S. assets, even a small change in hedge ratios can translate into meaningful currency flows," said Laura Cooper, global macro credit head at Nuveen. Nathan Thooft, chief investment officer of multi-asset solutions at Manulife Investment Management, said investors could begin rebuilding hedges if markets keep trimming expectations for Federal Reserve rate hikes and spreads narrow further, creating sustained dollar selling pressure.
Japanese investors are the pivotal swing factor. As the largest foreign holders of U.S. Treasuries, accounting for about 10% of overseas holdings, they hedged only 41% of new foreign bond purchases in the first half of 2026, down from 62% in 2024, according to Deutsche Bank. Omori flagged three triggers that could push them back toward protection: further BoJ hikes that narrow the US-Japan yield gap, a larger dollar decline that prompts risk committees to activate currency hedges, and a new solvency framework for Japanese insurers that raises their sensitivity to exchange-rate volatility.
The dollar's safe-haven credentials are also being questioned. U.S. fiscal policy, long-end Treasury yields and debate over Fed independence have led investors to reassess how much the currency will appreciate during market stress, the traditional rationale for holding unhedged dollar assets. "If confidence in the dollar's ability to rally in stress periods fades, large unhedged currency exposure becomes harder for institutions to accept," said Noureldeen AlHammoury, chief market strategist at Equiti Group.
The pain of staying unhedged is already visible in Korea, where large insurers cut hedge ratios to about 80% and smaller firms below 50%. The National Pension Service raised its hedge ratio on overseas investments to 15% from 10% in April, yet more than 85% of its book remains exposed. Over three months, the currency-exposed version of the TIGER US S&P500 exchange-traded fund returned minus 7.44% versus positive 1.23% for the hedged version — a gap of 8.67 percentage points. A 10% appreciation of the won would cut won-based returns by about 8.5 percentage points even if dollar asset prices were unchanged.
Hedging more does not mean dumping U.S. stocks or bonds; institutions can keep those holdings while selling dollars through forwards to cut currency risk. That distinction matters for Treasury demand. Erik Nelson, a foreign-exchange strategist at Wells Fargo, cautioned that monetary policy will still set the dollar's medium-term direction, with hedging acting more as a short-term amplifier. But he added that falling hedge costs leave room for investors to add protection, and if the dollar weakens even as risk-off sentiment builds, hedging could turn quickly and accelerate the decline.
This article is for informational purposes only and does not constitute investment advice.
