Hedged Flows, Fractured Regime: The New Shape of Dollar Dominance
- The ValueCritic
- 3 minutes ago
- 5 min read
In its latest US dollar analysis, the Bank for International Settlements (BIS) highlighted something unusual. The dollar was weakening sharply, but not during US trading hours. The heaviest selling came during the Asian session, right as Treasuries were rallying. This wasn’t a typical risk-off move. It wasn’t panic. It was hedging. Foreign investors weren’t dumping US assets. They were adjusting their exposure, layering on FX hedges, cutting unhedged dollar positions, and shifting into EM debt and gold. At first glance, it looked tactical. But as the behavior spread, from Taiwan’s insurers to Korea’s pensions to Japan’s megaholders, it became clear, something deeper was changing.
What’s happening here is a shift in how foreign investors manage their currency risk. They’re still heavily invested in US assets, like stocks, bonds, and corporate credit, but instead of holding those positions “naked” (unhedged), they’re now choosing to protect themselves from swings in the USD. This protection usually comes through tools like short term currency forwards or cross currency swaps, which allow investors to lock in exchange rates and avoid surprise losses if the dollar weakens (as seen below).
And its a big change not a technical detail. For years, many investors chose not to hedge because the dollar was strong and hedging was expensive. But now, that’s starting to shift. According to Apollo’s research, the cost to hedge the dollar, especially against the euro and yen, has risen again in 2025. This is making unhedged exposure less attractive, especially for big institutional players like insurers and pension funds, who have long-term liabilities in their own currencies. As hedging becomes more common, it changes the flow of capital, instead of buying US assets and holding the dollars outright, investors are selling dollars in the spot market as part of their hedging strategy. That subtle shift puts more pressure on the dollar, even if they’re still buying the underlying assets.
It could be argued that a recent driver of this market action has been primarily due to the expectation in a change in US trade and fiscal policy. The world cannot accumulate US assets unless the US runs a current account deficit or issues liabilities (via Treasuries, MBS, or corporate debt).
So when both the fiscal deficit and the trade deficit contract, the global private sector’s net acquisition of US assets is constrained. If foreign central banks or sovereign wealth funds still wish to hold dollars, someone else must sell. This has been particularly true since the implementation of tariffs which have seen record revenues resulting in the first surplus in US government budget for June since 2016. This starts to explain the rotation we see, not driven by disillusionment, but by plumbing constraints.
However despite the recent headlines, of reduced longterm holdings of US assets by foreigners, total YtD flows into US equity funds remain positive (~$146B), underscoring that this is a diversification story, not a wholesale exodus. The nuance, flows are diverging across risk preference, hedging capacity, and marginal reserve availability. EM central banks (eg. China, ASEAN) may be selling Treasuries and rotating to gold or regional debt. Global asset managers, however, still favor US markets, but increasingly hedge FX or use options overlays.
Added to this, even with rising hedging costs and some rotation into EM or gold, the US still holds a powerful edge, its capital markets are simply deeper, more liquid, and more efficient than anywhere else in the world. US companies, especially in tech, finance, and healthcare, can raise money more easily, use leverage more effectively, and return capital to shareholders through dividends and buybacks. This structure helps boost their profit margins and gives them a valuation premium compared to firms in other countries.
You can see it in the data below.
This is what keeps foreign investors coming back. Even if they’re hedging their dollar risk more actively, they still want exposure to US companies because those companies consistently generate strong, reliable returns.
However, If current trends hold, we could be heading toward a world where capital flows aren’t just centered around the USD anymore, but spread more widely across regions and currencies. Its not a total abandonment of the USD but a smarter, more selective, and more risk aware in how each country holds it. Here’s how that might look:
1) More capital flowing into regional markets - As it becomes more expensive to hedge USD dollar exposure, some investors may start putting more money into local markets, especially in places like India, Southeast Asia, and Latin America. These regions offer improving financial infrastructure, growing economies, and often higher yields. The shift doesn’t mean they’ll replace the US, but they’ll likely slice off a slightly larger piece of the global capital pie.
2) Less unhedged dollar buying by central banks - Countries that used to park trade surpluses in Treasuries and other US assets might slow down their dollar accumulation, especially if they worry about FX losses. Instead, they might move into gold, EM bonds, or hold more local currency reserves. This doesn’t kill demand for US assets, but it changes the type of demand, more cautious, more diversified, more hedged. For example despite countries seeing increase demand of USTs, growth is slowing according to the latest TIC data.
3) US assets still attract but with currency protection - Even with the shift, the US will likely keep attracting capital, especially into high-margin, high growth sectors like tech and AI. But the difference is that foreign investors won’t hold that exposure unhedged anymore. They’ll use currency forwards or swaps to protect themselves. That means the dollar’s global role may stay strong, but the way it's held will look very different.
4) Rise of new “safe assets” outside the US. As investors diversify, they’ll also look for new places to store capital safely. That could mean more demand for Euro denominated bonds, Japanese government bonds, or even new Indian sovereign issues. If these countries step up and offer liquid, trusted financial products, we may see a broader range of global “safe assets”not to replace Treasuries, but to complement them.
The rebalancing underway is not de-dollarization in the dramatic sense. Rather, it's the beginning of a redefined dollar regime, one where the dollar remains central, but no longer circulates as freely in unhedged form. Hedging costs, balance sheet scarcity, and political bifurcation (eg. tariffs, sanctions) are shifting how and where the dollar flows. We are witnessing a transition from simple flows to complex overlays, and from passive dollar accumulation to active risk-managed allocation. The implications are profound, not for the end of the dollar, but for the architecture of global capital itself.