Hot development in the dollar: New wave of selling

The reluctance of major global market investors to take positions against dollar weakness carries the risk of creating a wave of selling pressure. In particular, it is noteworthy that the hedging ratios applied by investors holding assets outside the US have reached their lowest point since 2015.

Global data reveals that investors operating in markets such as Japan, Canada, and Taiwan had hedged only 41 percent of their foreign currency positions as of mid-year. This ratio, the lowest level recorded since 2015, signals a significant shift, especially as the dollar's status as a safe haven has begun to be questioned recently.

In previous years, hedging transactions, which were rapidly increased against the dollar's depreciation, had weakened after the US currency gradually gained stability. Investors, meanwhile, have begun to turn toward low-hedge positions that offer higher returns for most of the last decade.

This decline in hedging ratios indicates that investors' risk appetite has increased or that they have moved away from the need to protect against exchange rate fluctuations due to high costs. However, there is growing concern that if market sentiment changes rapidly, the low hedging ratio could lead to sharp movements in the currency.

This growing risk in the foreign exchange market stems from the simultaneous debate over two fundamental pillars: the dollar being seen as a safe haven in volatile environments and the high cost of hedging transactions. Investors are trying to secure their portfolios against fluctuations by turning to buying their own national currencies by selling dollars through derivative products. However, considering the weight of US assets in international portfolios, increasing the hedging ratio could directly pave the way for large-scale dollar sales.

The calculations are based on a simulation conducted by Bloomberg on foreign currency-denominated assets worth a total of 4.6 trillion dollars across six major markets. Accordingly, it is projected that an increase of just 5 percentage points in the hedging ratio could bring about approximately 230 billion dollars in new dollar sales in the market.

Laura Cooper, head of the London-based macro credit team at Nuveen, which manages a 1.4 trillion dollar portfolio, stated, "Given the size of foreign investors' positions in US assets, a dramatic change in positioning is not required to impact the market. Foreign investors hold significant amounts of US assets, so even small changes in hedging ratios can create notable currency flows."

The current outlook keeps the potential for large-scale dollar sales on the agenda as investors look to protect their portfolios in the event of a possible sudden market shock. It is pointed out that even a partial change in strategies could pave the way for significant fluctuations in foreign exchange markets due to an increase in hedging ratios.

News Source: 12punto