By Saqib Iqbal Ahmed and Laura Matthews
NEW YORK, July 13 (Reuters) – A solid U.S. dollar rally in 2026, driven by a hawkish Federal Reserve, has found support as global pension funds reverse hedges put on following last year’s “Liberation Day” market unrest.
Rising inflation readings and the appointment of Kevin Warsh as Fed chair have driven up U.S. real, or inflation-adjusted, interest rates in recent months.
Meanwhile, Canadian, Dutch and Danish pension funds have retreated from efforts they launched last year to hedge their dollar exposure, a Wells Fargo analysis of FX hedge ratios shows.
The reversal is easing pressure on the greenback and further undermining the briefly popular narrative that investors were moving away from the dollar in a sell America trade.
Although comprehensive hedging data are scarce, a similar dynamic appears to be playing out among real-money investors elsewhere, said Karl Schamotta, chief market strategist at payments company Corpay in Toronto.
“Because long-duration hedging can be expensive and cut into returns, some of that increase is now being unwound — mostly passively, as firms let hedges roll off without replacement,” Schamotta said.
Hedge ratios, reflecting how much of a fund’s dollar exposure is protected against currency swings, have fallen 5 percentage points over a year at some Danish funds and by a percentage point at some Canadian funds.
Sell America “wasn’t all hype … there were some genuine flows behind it,” said Erik Nelson, global head of FX strategy at Wells Fargo, referring to global pension funds’ hedging efforts.
“But the hedging impulse has faded … those trends have since gone into reverse.”
HAWKISH FED PLAYS A ROLE
With the U.S. currency near a one-year high, expectations for a hawkish Fed act as a hurdle for hedging.
Foreign investors hedge FX risk by selling dollars forward, but because the hedge cost is tied to the interest rate differential between the U.S. and their home country, higher U.S. rates make hedging more expensive and eat into net returns.
With U.S. short-term rates sitting roughly 140 basis points above the euro zone’s, hedging dollar exposures remains expensive for many overseas.
“Higher U.S. real interest rates make dollar investments more attractive, but also make currency hedging more expensive, so big investors have chosen to leave more of their U.S. stock holdings unhedged,” said Garth Appelt, head of FX & emerging markets derivatives at Mizuho Americas.
The dollar’s shifting correlation with U.S. equities has also made it less urgent for foreign investors to hedge.
Markets were jolted in early 2025 after U.S. President Donald Trump’s “Liberation Day” global tariffs. The dollar failed to exhibit its typical safe-haven behavior and tumbled in tandem with U.S. stocks, essentially a double whammy for foreign investors with sizeable exposure to U.S. equities.
“People were losing double the amount on a position that had previously worked for the prior decade as a perfect hedge,” said Alex Moloney, head of macro discretionary, currency solutions at Insight Investment.
This year, the dollar has once again found its feet as a haven currency, particularly during the risk-off episode following the U.S.-Iran conflict.
Separately, the dollar had suffered last year as investors fretted over Fed independence following President Donald Trump’s repeated attacks on then-Chair Jerome Powell. Those worries — and the pressure on the dollar — have eased since Warsh took over as head of the central bank.
BETTER FOR THE BUCK
Less FX hedging, on the margin, removes a potential impediment for a stronger dollar.
Just as hedging flows had acted as a headwind for the dollar, the absence of those flows is likely to act as “a marginal dollar support going forward,” Moloney said.
Much of the dollar’s trajectory will still depend on the continued success of the U.S. AI investment story that remains a powerful draw for international investors, analysts said.
Should investors’ expectations for the health of the AI trade prove too rosy and U.S. growth suffer, funds might review their hedging needs.
But for now the dollar sits pretty.
“You’re still in a situation where the dollar rates, dollar carry, and dollar equity returns are high,” Wells Fargo’s Nelson said. “So until that changes, we’re still in a generally strong dollar world.”
(Reporting by Saqib Iqbal Ahmed and Laura Matthews; Editing by Colin Barr and Kim Coghill)
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