Introduction

In currencies, we are observing a trend where clients are diversifying away from the dollar, either by hedging back to their base currency or repatriating to their home markets. The Korean won, Japanese yen, and certain others present great opportunities for diversification. This is seen as the beginning of a significant shift from dollars as part of the portfolio rebalancing channel.

Global Cross-Border Investment Overview

• The largest external creditors are located in Europe and Asia, with significant contributions from the Euro area, Japan, Korea, and Taiwan. These regions have accumulated substantial investments in U.S. assets.
• At the beginning of the year, global foreign ownership of U.S. assets included $18 trillion in equities and $15 trillion in bonds. This marks a significant increase in foreign investment in U.S. markets.
• Since 2011, there has been a six-fold increase in U.S. equity ownership and a doubling in U.S. bond ownership by foreign entities. This growth is attributed to both valuation effects, as U.S. assets have outperformed, and flow effects, driven by foreign creditor countries seeking investment opportunities in the U.S.

US Net International Investment Position

• The U.S. now has a substantial net international investment position deficit, nearing 100% of GDP, compared to 20% a decade ago. This reflects the extensive foreign investment in U.S. assets.
• There are concerns about the potential impact of post-Trump policy uncertainty, which may lead to nervousness among foreign investors regarding their overweight positions in U.S. assets.
• Investors are distinguishing between frustration with U.S. policy and the need for portfolio rebalancing due to overcrowded dollar assets. This may lead to shifts in investment strategies.

European Investment Trends

• European asset managers have initiated equity repatriation flows into Europe, the latest data marking the largest such movement since 2022. This indicates a shift in investment focus back to European markets.
• There is a sense of disappointment among managers regarding the U.S. approach, particularly concerning tariff risks and perceived unfair treatment of Europe. This sentiment is influencing investment decisions.
• European managers are also motivated by positive growth prospects, such as the German defense and infrastructure stimulus plan, which is expected to drive economic growth over the next five years.

Official vs. Private Sector Investment

• Official sectors, especially in Asia, have been slow to react to changes, maintaining investment biases similar to those before Trump's presidency. This includes a continued focus on U.S. assets.
• In contrast, private managers in Europe have been quicker to rotate investments into home markets, reflecting a more agile response to changing conditions.
• The mechanisms of investment shifts include selling U.S. dollar assets and purchasing foreign assets, as well as owning U.S. dollar assets and hedging them back to the home currency.

FX Hedging and Dollar Valuation

• The most significant potential for foreign exchange (FX) moves is seen in FX hedging strategies rather than direct asset allocation changes. This is where investors are focusing their efforts.
• There has been a breakdown in the correlation between the dollar and risk, which has implications for FX hedging strategies. This has led to increased attention on managing currency exposure.
• Large official sector asset managers are running historically low FX hedge ratios, which may lead to adjustments in hedging strategies. For example, Japan's GPIF has reduced its hedge ratio from 70% to 45%.

Non-Dollar Currency Opportunities

• Countries with large U.S. savings, such as Korea, Japan, and the Euro area, have the potential for adjustments in hedge ratios or asset allocation. These adjustments could lead to significant dollar selling flows.
• The recent nine sigma event in Taiwan, which saw a 7% move over two days, was unprecedented. While similar magnitude moves are unlikely, it highlights the potential for significant currency shifts.
• Korea, Japan, and the Euro area are identified as regions with opportunities for non-dollar currency investments, driven by their large pension sectors and potential for currency moves.

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