US Dollar: Exposure stays elevated – BNY

BNY’s Geoff Yu notes that cross-border investors’ Dollar holdings remain close to multi-year highs, driven by strong United States (US) asset exposure with fewer FX hedges. Federal Reserve (Fed) expectations and the Dollar’s yield advantage underpin this stance, while limited tightening by the European Central Bank (ECB) and policy easing in China reduce alternatives. Yu warns that unhedged flows still pose currency risk if US assets underperform.

Cross-border holdings and Fed expectations

"Fed expectations have not moved materially over the past week, but cross-border investors’ aggregate dollar holdings remain at their highest level since April 2025. That comparison needs caveating: the April episode was distorted by the extreme moves around the Liberation Day tariffs. Today’s dollar exposure is different."

"By late Q2, however, Fed expectations had become the dominant driver, with the dollar’s yield advantage making hedges increasingly expensive. That advantage now looks durable. The ECB is stepping back from additional tightening, China is effectively easing, and other major central banks show little appetite to push hikes further."

"Unhedged asset flows are still a currency risk. FX balances may be secondary to asset performance for now, particularly in externally owned sectors such as tech, but concentrated asset weakness could quickly challenge the “U.S. exceptionalism” narrative."

"Some of that risk could rotate into more defensive U.S. sectors, rather than out of the dollar altogether. Barring a clear Fed pivot, limited alternatives should keep USD exposure well above long-term averages."

"If the data continue to validate disinflation, investors should look to fade that exposure by adding dollar hedges and positioning for curve flattening."