Buy America, sell the dollar: how investors are building defenses in the U.S. market

International investors rushed to exit the U.S. market after the U.S. trade war began, but then quickly returned. Now it is breaking record after record again, the situation with bonds has stabilized. But there is one exception - the dollar.

Calls to "sell America" were not popular among international investors for long. They chose another approach - to "hedge America", i.e. to continue buying U.S. stocks and bonds, but at the same time to protect their investments from a further decline in the dollar with the help of derivatives, Bloomberg writes.

While optimism reigns in the stock market, fueled by the rapid development of artificial intelligence technologies, analysts' views on the prospects of the U.S. currency remain purely pessimistic.

There is a consensus on the market regarding the prospects of the dollar for the period until the end of the year in the situation when the U.S. Federal Reserve starts the cycle of easing monetary policy. This is what ING analysts wrote in mid-September before the meeting at which this cycle started - then the Fed reduced the interest rate by 0.25 percentage points to 4-4.25%.

ING expected the dollar to weaken starting in October, thanks largely to three rate cuts before year-end (including September's) cumulatively by 0.75pc.

The dollar should be pressured by the narrowing of the difference between the level of interest rates in the U.S. and the eurozone, where the ECB has apparently stopped lowering them for the time being. As a result, the euro exchange rate, according to ING's forecast, should rise from the level of $1.17, around which it has been fluctuating since July, to $1.2 by the end of the year.

Fed rate cuts and massive hedging of dollar positions help explain why the U.S. currency continues to weaken despite an influx of international investment into the U.S. market. Since the April lows, when stocks collapsed after Trump announced total import duties, the S&P 500 and Nasdaq Composite indices are up nearly 35% and 50%, respectively. Yields on 10-year and 30-year Treasury bonds, which reached as high as 4.6% and 5.09% in the spring on fears of rising government debt and budget deficits among other things, fell to 4.1% and 4.7%, respectively.

Meanwhile, the dollar, which began falling before April, since Trump's inauguration on January 20, has fallen 13% against the euro. Without hedging, this would have resulted in a loss for European investors in the S&P500 index, which rose 12% over the same period.

The dollar index (the exchange rate against a basket of currencies of major U.S. trading partners), has fallen 10.6% under Trump.

And this is not the end of dollar weakening, analysts believe. ING expects the euro exchange rate at $1.22 in a year, Goldman Sachs forecasts the euro to strengthen to $1.25 over the same period.

The buildup of hedging positions will contribute significantly to this process, according to analysts at State Street, Deutsche Bank, BNP Paribas and Societe Generale, among others.

Among them is Sahil Mahtani, chief investment officer at Ninety One Asset Management in London. "It seems to me that the bulk of the position adjustment is still to come," he told Bloomberg.

Mahtani estimates that a new wave of hedging against a falling dollar could end up totaling about $1 trillion. That would bring hedging by international investors holding more than $30 trillion in U.S. stocks and bonds back to the levels of the past decade, he says. That is, to the period before the strengthening dollar and booming stock market convinced many that they didn't need protection.

One of the most popular ways of hedging for foreign investors is selling dollars under forward contracts, which allows fixing the current rate. This increases pressure on the currency on the spot market as well.

"Anti-dollar" positions are growing at an unprecedented rate, according to Deutsche Bank. For the first time this decade, the inflow of international investors' funds into exchange-traded funds of U.S. assets with a hedge against the fall of the dollar exceeded the inflow into non-hedged funds, the bank's analysis of more than 500 funds showed. Hedged equity funds accounted for more than 80% of inflows, while similar bond funds accounted for 50%.

That helps explain why the dollar remains weak despite global investors reacquiring stocks and bonds in the U.S. after a springtime flight from them, George Saravelos, director of global currency market analysis at Deutsche Bank, said in the report.

"The implications for the currency market are clear: even though foreigners have returned to buying U.S. assets (albeit in smaller volumes), they do not need the accompanying dollar risk. For every dollar asset purchased with hedging, an equivalent amount of currency is sold to remove the currency risk," he wrote.

Investors are showing confidence in the growth of the U.S. stock market, especially large technology companies, but the proportion of those expecting the dollar to weaken is at a high, a July survey of institutional investors by Goldman Sachs showed.

Positive investor sentiment has returned to January levels, when the view that US assets will yield more was a defining feature of global markets.

Although investors have diversified heavily since the spring events, with inflows into other markets, mostly developed markets, about 51% of the 800 respondents were bullish on the S&P 500 and only 32% were bearish.

But there has been a paradigm shift, and views on the outlook for the U.S. stock market and the dollar have diverged, including over the budget and government debt situation, said Oskar Ostlund, global director of strategy and market analytics at Goldman Sachs Global Banking & Markets.

Trump's budget bill only makes the situation worse: the Congressional Budget Office estimates that the national debt will nearly reach 100% of GDP in 2025 and could reach 107.2% in 2029, surpassing the 1946 record (106%).

"Against the dollar, there are more than seven times as many 'bears' as 'bulls' right now," Ostlund noted. This is the highest level of negativity in almost 10 years that the bank has been conducting surveys.

Such a one-sided view makes Goldman Sachs analysts wary. "A very strong consensus by itself is not a reason for a market reversal, but it does make the market susceptible to relatively sudden changes, which even a minor factor can trigger," says Ostlund.

His colleague Brian Garrett advises investors to think about hedging against a fall in the S&P 500 index and the euro.

Another important consequence of the divergence between the dollar and the stock market is that the dynamics within this market have become extremely heterogeneous. Shares of export-oriented U.S. companies (helped by the weakening dollar) are rising much faster than those of domestic-oriented companies (which are suffering from the rising cost of imports).

Compiled by Goldman Sachs, the index of 50 "blue chips" in the U.S., which have the largest share of foreign revenue, has grown by 21% since the beginning of the year, and its shares Meta Platforms, Philip Morris, Applied Materials overtook the S&P 500 index, writes the Financial Times. Meanwhile, the index of shares of companies with the largest share of domestic sales, such as T-Mobile US and Target, added only 5%.

This article was AI-translated and verified by a human editor