Summary

  • Deutsche Bank said the U.S. dollar could face long-term downward pressure as it becomes increasingly reliant on foreign capital flowing into the U.S. stock market.
  • Deutsche Bank said the weakening inverse correlation between the dollar and stocks could put downward pressure on the currency if overseas investors expand currency hedging, and that they may seek to reduce dollar exposure if the dollar also falls when U.S. equities decline.
  • Deutsche Bank said high hedging costs and low foreign-exchange market volatility could limit downward pressure on the dollar, but broader hedging by overseas investors could still become a long-term driver of dollar weakness as the currency’s reliance on inflows grows.

Forecast Trend Report by Period

The U.S. dollar could face long-term downward pressure as it becomes increasingly reliant on foreign capital flowing into the U.S. stock market, Deutsche Bank said.

Bloomberg reported on November 10 that, in a recent report, Deutsche Bank said the dollar’s moves have become more closely tied to sentiment in U.S. equities, weakening its traditional role as a risk-off hedge. As a result, the bank said, the currency could come under downward pressure if overseas investors increase hedging on dollar-denominated assets to reduce exchange-rate risk.

The dollar has historically tended to strengthen when U.S. stocks fall. That allowed foreign investors to offset part of their losses from falling share prices through gains in the dollar, often reducing the need for separate currency hedges on U.S. assets. But Deutsche Bank said that incentive is fading as the inverse correlation between the dollar and stocks weakens.

George Saravelos, Deutsche Bank’s global head of FX research, and other strategists wrote that the key factor in determining hedge ratios going forward will be further changes in the correlation between the dollar and equities. If the dollar also weakens when U.S. stocks decline, overseas investors may seek to reduce their dollar exposure.

Deutsche Bank surveyed pension funds and life insurers in more than 12 countries on their currency hedging of dollar assets. Sweden, Switzerland and the euro zone still maintain high dollar exposure, while Chile, Canada and the U.K. have already adjusted their hedging strategies to a significant degree.

Still, high hedging costs and low foreign-exchange market volatility were cited as factors that could limit downward pressure on the dollar. Because investors would have to bear additional costs to reduce currency risk, there is limited near-term incentive to sharply increase hedging on dollar assets.

Deutsche Bank said further changes in the correlation between U.S. equities and the dollar could also affect the currency-hedging strategies of global institutional investors. In particular, the bank said that, with the dollar increasingly reliant on inflows into U.S. stocks, broader hedging by overseas investors could become a long-term factor behind dollar weakness.

Suehyeon Lee