Dollar Retreats, Hedged ETFs Surge: What International Flows Really Indicate

The Unprecedented Rise of Hedged ETFs: A Historic Trend Reversal

In a detailed analysis, Nicholas Sargen from the Darden School of Business highlights that the dramatic rise in hedged products has reshaped the relationship between US market performance and the US dollar—and could signal a sustainable regime change.

Since President Trump's speech, dubbed the « Day of Liberation » last spring, international appetite for US assets has been questioned. Stock markets had declined, bonds had followed suit, and the dollar had depreciated, suggesting that investors might be turning away from the US.

However, the rebound since then has contradicted this initial interpretation: the US stock market has reached new all-time highs, Treasuries have bounced back, and international flows have intensified.

The contradiction? Despite these massive purchases, the dollar has continued to weaken, losing about 10% in effective exchange rate terms in the first half of the year. Many attribute this weakness to the Fed's monetary easing, which diminishes the appeal of US bonds and compresses interest rate differentials with the rest of the world.

Sargen points out a more decisive mechanism: the systematic hedging of currency risk by international investors. They continue to buy US stocks—especially tech and AI-dominant multinationals—but they are shedding dollar risk.

This decoupling of assets and currency is central to the current dynamic.

According to the Bank for International Settlements, the dollar's decline in April and May is largely due to the rise in these hedging operations. Foreign investors have maintained their positions in US assets but have massively sold their dollar exposure in the futures markets.

To gauge the scale of this phenomenon, just look at the flows into ETFs.

According to a Deutsche Bank report, 2025 marks a turning point: for the first time in a decade, dollar-hedged ETFs investing in US stocks have attracted more capital than their unhedged counterparts.

The proportion is striking:
– Start of the year: 80% of flows went to unhedged ETFs;
– Last three months: 80% of the roughly $7 trillion invested in non-US domiciled US equity ETFs are now hedged.

This shift reveals two key insights:

Foreign investors are no longer buying the dollar. They want the US economy, the dynamism of multinationals, but not the currency's volatility.

Hedging itself acts as a selling force on the dollar, further accelerating its mechanical decline.

This trend aligns with the rise of American AI giants: their sectoral dominance attracts structural flows, but foreign investors seek to neutralize currency fluctuations that could offset some performance.

Historically, this behavior is unprecedented. In the 1980s or 1990s, most foreign investors hedged their US bonds but rarely their stocks.

Financial globalization has changed the landscape: US equity positions held by non-residents have increased fivefold since 2008, reaching nearly $17 trillion by mid-2024, while foreign-held long-term bonds exceed $12.7 trillion.

This rise in sophistication deeply modifies the impact of international flows on the foreign exchange market.

A Vulnerable Dollar and a Now Central Political Risk

The decline of the dollar is not paradoxical; it results from financial mechanics, changes in habits, and the monetary context.

However, Sargen also identifies a deeper political risk.

The greenback remains historically high, and the interest rate differentials that have supported it are expected to keep narrowing as the Fed lowers its benchmark rates.

In a classic scenario, a dollar decline would be « benign » if accompanied by rising stocks and easing bond yields. However, this scenario hinges on a key factor: confidence in the Federal Reserve's independence.

The Trump administration is increasingly pressuring to speed up monetary easing, even as inflation still exceeds the 2% target by a point. If the Fed were to yield to these pressures—as it did in the early 1970s—the market could question its credibility. This would be the scenario where the dollar no longer just erodes; it nosedives.

The « Day of Liberation » episode demonstrated how violently markets can react when doubts arise about the stability of the US economic regime. The appointment of Scott Bessent to trade negotiations had then reassured investors. There is no guarantee of a similar buffer today.

For now, caution takes precedence: investors continue buying American stocks... but without exposing themselves to the currency.