Investors Push Dollar-Hedge Ratio to Two-Year High

Investors raised dollar hedges to a two-year high this quarter.

Hedging surges as currency risk climbs

The shift took some time to develop. Rising doubts about U.S. Policy direction and renewed global risk prompted asset managers and corporate treasuries to add more protection against currency swings. Market analysis from MSCI shows that currency risk has been trending up since 2020, and investor positions responded during bouts of stress, including the April 2025 episode when the dollar weakened even as equity volatility spiked.

Fund managers say they're reacting to a different mix of threats than they faced a few years ago. Central-bank policy uncertainty, concerns over fiscal paths, and a broader web of geopolitical and climate-related risks are changing how the dollar behaves in crises — and how investors price that behavior.

As a result, the ratio of dollars hedged in many global portfolios has climbed to its highest point in two years, according to market flow patterns tracked by industry researchers. Funds are buying put protection, increasing forward sales, and extending currency overlay programs to blunt swings in local-currency returns when translated into dollars.

That rush to hedge is measurable. MSCI's work points to steady increases in currency risk across major developed-market pairs, and market positioning data from futures markets show shifts consistent with more hedging activity. And the World Economic Forum's Global Risks Report 2026 captures the broader backdrop: more experts see acute risks this year, which feeds demand for downside protection across asset classes.

Which currencies look mispriced — and why it matters

Some currencies appear undervalued when looking at long-term measures. Using purchasing-power-parity as a reference, MSCI's estimates show big gaps: the Japanese yen appears about 70% undervalued versus the dollar, the Canadian dollar about 35% undervalued, and the euro roughly 16% undervalued. Those aren't precise timing signals.

These serve as indicators of relative value.

When long-run fairness metrics diverge this much, investors have to decide whether to bet on mean reversion or to protect against policy-driven moves that can last. Many have chosen protection. Hedging reduces the impact of sudden dollar strength on non-U.S. Assets and cushions returns if a weaker dollar reverses quickly.

Hedging comes with costs. There are costs — option premia, negative carry on forward contracts, and opportunity costs if the dollar keeps weakening. That's why the decision to add hedges depends on both the outlook for exchange rates and the firm's tolerance for performance drag versus downside insurance.

How global risks push hedging higher

The broader risk environment is driving more investors to buy protection. The World Economic Forum's Global Risks Report 2026 surveyed more than 1,300 experts and mapped threats across short, medium and long horizons. It points to intertwined shocks: supply-chain strains, climate events, and geopolitical frictions that feed market stress.

Small firms are affected as well. International Trade Centre data cited in related global policy work show that micro, small and medium-sized enterprises account for 95% of firms worldwide and about 60% of jobs. Many of those businesses lack sophisticated FX tools and face higher barriers when global volatility spikes. Corporates with robust treasury operations are using hedges to shield cross-border revenues; smaller firms often can't, which widens the gap in resilience.

Corporate treasuries that can hedge are doing so more often and for longer horizons. They're layering strategies — mixing forwards, swaps and options — to tailor protection and manage costs. Meanwhile, multi-asset funds are increasingly explicit about currency overlays, treating currency not as an afterthought but as an active component of risk budgeting.

Flows and positioning: what the data show

Market flow data and futures positioning point to a clear trend. Since 2020, currency exposures in institutional portfolios have become more volatile, and that has coincided with rising demand for hedging instruments. Commodity Futures Trading Commission-derived positioning and private-market flow analysis referenced in MSCI's research show investor shifts that align with increased hedging.

Hedge funds and global macro managers have been active both for directional bets and for relative-value protection. Pension plans and sovereign wealth funds, which face liabilities in many currencies, are increasing systematic hedges to smooth funding ratios. The result: higher notional volumes traded in currency forwards and options, and longer average hedge tenors in some segments.

Hedging strategies vary among investors. Passive index-tracking strategies still face cost constraints and often choose partial hedges or time-limited overlays. Active managers tend to fine-tune. The mix of approaches explains why aggregate hedging ratios jump during periods of worry — and then sometimes ease when the perceived threat recedes.

Practical trade-offs for investors and firms

Hedging more reduces headline volatility measured in dollars. It can make a foreign equity allocation look more stable to a U.S. Pension fund. Still, hedging can reduce returns if currencies move favorably, and it demands operational resources.

Smaller exporters and importers, many of them MSMEs, often lack access to the range of tools big corporates use. International initiatives and platforms aim to expand access to trade finance and risk-management products, but adoption is uneven. The policy push to support smaller firms' access to FX tools is ongoing, and it matters for real-economy resilience.

For allocators, the math is a balancing act. Hedging decisions rest on forecasts for exchange-rate drivers — interest-rate differentials, fiscal positions, and growth gaps — and on the cost of insurance. Many investors are leaning toward partial hedges that mitigate worst-case scenarios while leaving room for upside if the dollar falls.

What could change the trend

Several developments could flip the calculus. A clear pivot in Federal Reserve guidance, a sudden improvement in fiscal outlook, or a coordinated easing of global tensions could weaken demand for hedges. Conversely, a surprise shock that strengthens the dollar as a crisis haven would likely push hedging ratios even higher.

Right now, asset managers say they're running stress tests with a wider array of scenarios — including cases where the dollar behaves differently from past crises. That flexible planning is one reason more investors are adding layered hedges rather than relying on a single instrument.

Still, hedging will remain a question of cost versus protection. Firms with long-dated foreign liabilities or predictable currency revenues will probably keep higher hedge ratios. Others will pick and choose.

MSCI's purchasing-power-parity estimates put the yen about 70% undervalued, the Canadian dollar about 35% undervalued and the euro about 16% undervalued versus the U.S. Dollar.