Dollar rallies as global pension funds drop expensive FX hedges

Global pension funds are scaling back currency hedging on their U.S. equity holdings, removing a significant drag on the dollar. Funds in Canada, the Netherlands, and Denmark are allowing existing hedges to expire without replacing them, according to Wells Fargo data. The shift effectively weakens the narrative of a broader "Sell America" trade.

The primary driver is the widening interest-rate differential between the United States and other developed economies. With U.S. short-term rates sitting roughly 140 basis points above those in the euro zone, the cost of selling dollars forward has become prohibitively high. Some Danish pension funds have reduced their hedge ratios by around five percentage points, while certain Canadian funds have cut theirs by about one percentage point.

"There were genuine investor flows behind last year's hedging activity, but the momentum has since faded and the trend has reversed," said Erik Nelson, Wells Fargo's global head of FX strategy. By abandoning these positions, institutional investors are no longer generating the same volume of forward dollar sales that previously weighed on the currency. This creates a more supportive backdrop for dollar strength.

Rising U.S. real interest rates and stronger inflation readings have simultaneously made American assets more attractive and hedging more expensive. The dollar has also re-established its traditional safe-haven status, having weakened alongside U.S. stocks during President Donald Trump's "Liberation Day" tariffs in early 2025. It has since recovered ground during the recent risk-off period triggered by the U.S.-Iran conflict.

Investor confidence has been further bolstered by the transition from Jerome Powell to Kevin Warsh as Federal Reserve chair. The appointment has reinforced expectations of a sustained hawkish policy stance and eased prior concerns over central bank independence.

However, the dollar's long-term trajectory remains tied to the health of the U.S. economy and the sustained appeal of its AI-led investment boom. If enthusiasm for artificial intelligence cools or economic growth disappoints, institutions may quickly reassess their unhedged positions. For now, attractive dollar yields and strong U.S. equity returns continue to underpin the greenback.