How have foreign holders of U.S. assets changed hedging behavior since the dollar’s mid‑2025 fall?
Executive summary
Since the dollar’s mid‑2025 fall, foreign holders of U.S. assets largely retained positions but materially increased the use of FX hedges—principally short‑dated FX swaps and forwards—to blunt further dollar depreciation, a reaction documented by central‑bank analysis and custodial data [1] [2]. That rush to hedge boosted dollar‑selling flows and became both a proximate driver of the mid‑2025 slide and a force that has evolved unevenly across investor types and regions as hedging costs and tactical views changed [1] [3] [4].
1. BIS and central‑bank evidence: hedging, not wholesale selling
The Bank for International Settlements finds the most plausible proximate cause of April–May 2025 dollar weakness was non‑U.S. investors stepping up hedging overlays—adding FX swap and forward positions while keeping underlying U.S. asset holdings—rather than a mass liquidation of securities [1]. BIS investigators point to intraday patterns (big moves in Asian hours) and related hedging costs and term‑spread dynamics that are consistent with institutional hedging activity, and they note investment funds still showed inflows to U.S. assets albeit more slowly [1].
2. The mechanics: hedging equals dollar selling via swaps/forwards
Practically, hedging U.S.‑dollar exposures with FX forwards or swaps entails selling dollars forward, creating explicit dollar‑selling pressure; short‑term hedges are especially used to protect long‑dated securities because swaps/forwards are typically short‑term instruments [1]. Several market participants and research desks have warned that an aggregate rise in hedging ratios can translate into sustained dollar supply in FX forwards and swaps markets, amplifying currency weakness [5] [6].
3. Who moved first — institutional patterns and regional differences
Large overseas asset managers, pensions and sovereign wealth funds—many sitting on trillions of dollars of unhedged U.S. exposures—were among the first to raise hedge ratios after the twin shock of falling U.S. equities and the dollar; custodial analyses show meaningful but partial increases in hedge ratios (e.g., State Street saw equity managers’ hedging rise to about 24% by October from lower levels earlier in the year) [2] [4]. Research and industry notes estimate substantial pools of unhedged assets remained (roughly $14 trillion unhedged as of mid‑2025 per one estimate), so the potential for further hedging flows has been emphasized by academics and asset managers [7] [8].
4. Timing, costs and the ebb of the initial frenzy
Hedging activity spiked during the acute episode in April–May 2025 and was a key short‑run driver, but the initial “frenzy” did not uniformly intensify thereafter: some managers later trimmed hedges as views stabilized or hedging costs changed, with reports that the pace of new hedging slowed and some firms partially unwound protections [4]. Costs matter: high hedging costs and a previously bullish dollar view kept hedge ratios depressed historically, so when swap/forward costs fell—such as when U.S. rate differentials narrowed with Fed easing—hedging became both cheaper and more attractive [1] [5].
5. Market impact, feedback loops and alternative readings
The aggregate hedging response created a feedback loop—more hedging produced dollar selling that in turn encouraged more hedging—which BIS and market commentators flag as a reinforcing mechanism for the currency move [1] [7]. Alternative interpretations exist: some banks and strategists argue the initial dollar decline also reflected improving prospects outside the U.S. and a reassessment of the dollar’s safe‑haven role, so hedging was one important channel among several [6] [9]. It is also clear in the reporting that data are incomplete—custodial and fund snapshots are useful but imperfect—so the magnitude and persistence of hedging-driven flows remain estimates [4] [1].
6. Forward looking: what will determine future hedging behaviour
Future hedging behavior hinges on three observable variables: (i) hedging costs tied to interest‑rate differentials and FX basis (cheaper hedges incentivize more protection), (ii) the outlook for U.S. policy and risk (renewed confidence would reduce hedging), and (iii) availability of hedged investment products and regional mandates that favor or constrain FX overlay use [1] [5] [10]. Market commentary cautions that while many investors have increased hedge ratios, significant unhedged exposure remains, meaning further rounds of hedging could still generate sizable dollar flows [7] [8].