US Stock Market: Dollar rally gains support as global pension funds unwind FX hedges, easing pressure on greenback

The U.S. dollar's strong rally in 2026 is receiving fresh support as major global pension funds scale back currency hedges that were put in place after last year's "Liberation Day" market turmoil, reducing a key source of selling pressure on the greenback, according to a Reuters report.

The dollar has been buoyed by rising U.S. real interest rates following stronger inflation readings and the appointment of Kevin Warsh as Federal Reserve chair, reinforcing expectations that the central bank will maintain a hawkish policy stance. Reuters reported that the shift has prompted overseas institutional investors to rethink the cost of hedging their U.S. dollar exposure.

Data analysed by Wells Fargo show that pension funds in Canada, the Netherlands and Denmark have retreated from the hedging strategies they adopted during last year's market volatility. Hedge ratios, which measure the proportion of dollar exposure protected against currency fluctuations, have declined by around five percentage points at some Danish pension funds and by about one percentage point at certain Canadian funds, as per the Reuters report.


The reversal has weakened the narrative that global investors were abandoning U.S. assets in a broader "Sell America" trade. According to Reuters, analysts believe some of the capital flows that had previously weighed on the dollar have now moved in the opposite direction.

Experts said that long-term currency hedging has become increasingly expensive and has reduced investment returns, leading many institutions to allow existing hedges to expire without replacing them.

Reuters also cited Wells Fargo's global head of FX strategy Erik Nelson, who said there were genuine investor flows behind last year's hedging activity, but the momentum has since faded and the trend has reversed.

Higher U.S. rates raise hedging costs
A key driver behind the shift has been the widening interest-rate gap between the United States and other developed economies. Foreign investors typically hedge currency risk by selling dollars forward, but the cost of doing so rises when U.S. interest rates significantly exceed those in their home markets.

U.S. short-term interest rates remain roughly 140 basis points above those in the euro zone, making dollar hedging particularly expensive for many overseas investors.

According to Reuters, experts noted that higher U.S. real interest rates have made American assets more attractive while simultaneously increasing the cost of protecting against currency fluctuations, encouraging investors to leave a larger share of their U.S. equity holdings unhedged.

Dollar regains safe-haven appeal
The changing relationship between the dollar and U.S. equities has also reduced the urgency to hedge.

During the market turmoil triggered by President Donald Trump's "Liberation Day" tariffs in early 2025, the dollar weakened alongside U.S. stocks instead of acting as a traditional safe-haven asset, amplifying losses for foreign investors holding American equities.

However, Reuters reported that the dollar has since re-established its haven status, particularly during the recent risk-off period following the U.S.-Iran conflict.

Investor concerns over Federal Reserve independence have also eased following the transition from Jerome Powell to Kevin Warsh as Fed chair, removing another factor that had previously weighed on the U.S. currency, Reuters said.

Supportive backdrop for the dollar
Analysts told Reuters that lower levels of FX hedging remove another obstacle to further dollar strength because institutional investors are no longer generating the same volume of forward dollar sales that previously acted as a headwind.

Even so, Reuters reported that the dollar's longer-term direction will continue to depend heavily on the strength of the U.S. economy and sustained investor confidence in America's AI-led investment boom, which remains a major attraction for global capital.

Should enthusiasm around artificial intelligence investments weaken or U.S. economic growth disappoint, institutional investors could once again reassess their hedging strategies. For now, however, higher U.S. interest rates, attractive dollar yields and strong returns from U.S. equities continue to underpin the greenback, according to Reuters.