Hedging the dollar

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Pushkin

The US dollar is down by about 10% so far this year.

That is a decent whack.

And it comes despite the fact that global investors are still snapping up US assets.

This is a bit of a weird pairing, to be honest.

And what it is telling you is that investors, sure, they still want to buy lovely US stocks in lovely US companies, but there's a but.

Investors are buying other currencies when they buy US stocks to do what boring people like us call hedging.

Hedging is the new not hedging, which is nice and confusing when you host a podcast called Unhedged.

So today on the show

So today on the show, we're asking, do we need to rename this podcast?

And more seriously, why does this all matter?

This is, for now, Unhedged, the Markets and Finance podcast from the Financial Times and Pushkin.

I'm Katie Martin, a markets columnist down in the basement of FTHQ in London.

And I'm joined by the very Reverend Robert Armstrong off of the Unhedged newsletter over in New York City.

Listeners, you'll be pleased to hear he has just finished his breakfast.

Rob, what did you have?

I had a cinnamon raisin bagel

with cream cheese, which is a very classically New York kind of breakfast.

The breakfast of Time.

Purchased from a man in an aluminum cart, which is also classically New York.

Please for you.

So look, let's just accept that the world still wants to buy America, right?

This is still a thing, right?

If you want to buy growth, if you want to buy exciting companies or stocks and exciting companies, they just happen to live in the States.

And so people still want to.

We have the best companies.

This much we know.

Yeah, whatever, whatever.

But they are hedging away the dollar risk.

This has been like a big topic over the course of

this year is the extent to which global investors are like, I like your stocks, I don't like your currency.

Like, why is that happening, do you think?

Well, for a long time, the dollar was a kind of one-way bet.

And you bought U.S.

assets, which for the last 20 years have been going up pretty steadily.

And the dollar rarely, if ever, hurt you.

Those two facts are connected, of course.

When there's a lot of capital flow into the United States to buy US assets, those assets go up and investors have to buy the dollar in order to purchase them.

So that creates support under the dollar.

But starting in the very beginning of this year,

the dollar has not been so good.

And it was like everyone simultaneously woke up to the fact that if you live abroad

And you buy American assets, you are in fact taking currency risk.

It is not a neutral position currency-wise.

If you're sitting in America and you buy, I don't know, Thai stocks, you know perfectly well you better think about the Thai buy.

You don't naturally think about it in this environment, about the dollar, until the dollar falls 10%, which between January and June it did,

which is a pretty big move for the dollar.

It is a pretty big move.

And so there was some very nice research that everyone was talking about last week from George Saravelos over at Deutsche Bank, who we should get on this show at some point.

But anyway, he was saying that about the start of this year, hedging rates in US assets, so the amount of dollar exposure that investors were hedging when they were buying US stocks at the start of this year was roughly zero.

Like nobody bothered because, as you were just saying, Rob, like, why would you?

The stocks go up, the dollar goes up, you win twice, everybody's happy.

Now,

more than 80% of inflows into the US are hedged.

That's massive.

That's a total switcheroo, a total turning on its head of everything we know to be right and true about markets.

Like,

there's clearly some deep unease here.

There's some unease.

I'm going to play the role I always play on this show and try to defend poor old America from the mean attacks from the clever British lady.

So the United States is starting a cycle of interest rate cuts, or at least so the market thinks, and the Fed has hinted.

Well, we had a slice off interest rates, didn't we, in the U.S.

last week?

So it has already started.

It has already started, but how long it will continue is an open question we can discuss at another time.

The rest of the world is sort of done with their rate-cutting cycles, or at least that's true of Europe and Japan is kind of in a neutral position.

And when interest rate differentials change, currencies change.

So if America is going to have relatively lower interest rates relative to the rest of the world, it makes sense that its currency should weaken some.

So that's part of it.

And part of it is just that the dollar was very strong at the beginning of the year.

It was at a multi-year high, and it was at the top of its range, as some technical market magician might say.

And there was some correction there.

So I think there's no question there's some unease about the U.S.

fiscal situation and the quality of its governance right now.

But I'm not sure how big that is.

Well, what I would say is like the dollar conspicuously started falling well before the Fed started cutting again just the other day.

So it's not just rates, but let's talk for a little bit about that rates outlook because

last week, like I say, there was a decision from the Fed.

They cut 25 basis points, as people like to say when they want to sound clever.

So a quarter of a percentage point of interest rates.

But the really interesting thing there was there's a new boy at the Fed.

Is there not?

Robert Armstrong.

It's not you.

Who's the new boy?

Stephen Miran.

I think I'm saying that right.

I was saying it Moran for a long time and have been informed that it's wrong to say it that way because I get all my information from print, so I have no idea how anything is pronounced.

But he is a guy who is the chair of the White House Council of Economic Advisors.

He has taken leave from, but not quit that job and has been appointed to what might be just a temporary replacement job at the Fed.

So in the eyes of the market and the world and God and et cetera, et cetera, he is the White House's man on the monetary policy committee of the Fed.

Yeah, he's Trump's guy.

He's the first kind of very, very clearly Trump guy to get an important job like this at the Fed.

And he thinks we need to take a massive whack off of interest rates by the end of the year.

And he's way out of the consensus of the rest of the country.

Coincidentally, he just happens to agree with what Trump has wanted for U.S.

interest rates for a long time.

As he told us over the weekend, that was based on his own analysis of the data.

Here's the thing.

Just before I came down to record this, actually, I was talking to an investor who was like, you know, this guy, Stephen Miran Miran, however you want to pronounce it, he turns up, it's his first day at the Fed, right?

You know, he's been in the building a matter of hours.

And first of all, he calls for a much bigger cut in interest rates than the Fed actually delivered.

He wanted half a percentage point.

The rest of the Fed settled on a quarter of a percentage point.

But then you have this thing called the dot plot, which is where members of the rate setting committee at the Fed put a little, you know, they pin the tail on the donkey.

They say, this is where I think interest rates either should or will be by, you know, the end of the year, the middle of next year, and so on and so forth.

And there's a little picture with all the dots on it.

You can see where the spread is.

It's all very childish, but this is just how markets work.

They work on dots.

And his dot was like, there's a bunch of dots, and his dot is like, woo, way below all the others.

So he's saying, by the end of this year.

I laughed out loud when

I saw the plot, I laughed out loud.

It looks like a bunch of kids playing all the playground all happily together, playing ring around the rosie, and the one reject kid, none of the other dots will play with.

Because it's anonymous.

You can't see whose dot is whose, but it's like, oh, but everyone knew who it was.

It's Stephen Moran's first day at the Fed, and suddenly a dot has appeared that says that by the end of this year, we need one and a quarter percentage points more of interest rate cuts over the course of this year.

Now the Fed has got two more scheduled opportunities to move interest rates over the course of this year.

So that would involve

two gigantic cuts over

like the sort of cuts that you only get in in the middle of a crisis.

In a panic.

Or is he calling for a recession?

Or you get like two normal-ish sized cuts and then maybe an extra cut, like an emergency cut that that comes in between meetings, which, to reiterate, is only what you do when everything is terrible and fire is raining from the sky, like you have a huge pandemic or whatever.

So,

you know, he's not going to get his way because he's going to be outvoted, as you can see from all the other dots.

But this is a very early sort of, you know, little taster for what a Trumpy Fed would do if it was allowed to get its way, right?

I think that's right.

And I think

it brings to all of our attention the question of:

is the dollar telling us

that

people are worried about the monetary policy of the United States and the fiscal policy of the United States?

Because the two are indeed related.

Is the market saying

we want to put all these hedges in, which you've just described, which explain the weaker dollar?

Because

I think we should note that putting in a standard hedge on your equity portfolio requires you to sell dollars, basically.

Without going into the mechanics of it, lots of people hedging dollars creates downward pressure on the dollar.

And we know that's self-fulfilling and it's all a bit silly, but it is what it is.

It is what it is.

So

is the hedging about

Goodness gracious, we have a bad fiscal situation in the United States, meaning they are spending a heck of a lot more money than they're taking in in revenue, and they plan to continue doing so.

And

the president is intent on taking over the central bank such that interest rates will be kept artificially low.

Normally, when you have a dangerous fiscal situation, the central bank would be the grown-up and keep rates tight so that the fiscal hijinks wouldn't cause inflation.

Is the market saying there will be no adult supervision?

The United States will keep spending money like a drunken sailor and taxing like, I don't know, a person who doesn't tax.

And one of those people.

And

there will be no counteracting responsibility from the Fed.

And yeah, mix in.

You've got you're on a path to a Trumpy Fed that is, you know, you are not in Kansas anymore.

This is a completely different beast.

So like,

again, one of the things that investors keep talking to me about is that they've got like these kind of diagrams on their office walls with all the little pictures of all the Fed voters on it.

And

you have red voters and blue voters.

You know, all of a sudden, the market is thinking about who is making interest rate decisions based on their political affiliations.

Now, I've been doing this an awfully long time.

I have never heard of that before.

It's never been relevant who appointed which member of

the Fed rate setting committee.

A cold-hearted cynic like me would say it's always been a bit political, but it wasn't talked about before.

But I think taking a step back,

let's say this is the situation.

Let's assume that we've put our finger on the world's anxiety.

Fed not very grown up.

government spending a lot of money, Fed not very responsible or very stern under the control of Trump.

Does it make sense that the world would continue to buy U.S.

stocks?

I say, yes, it does make sense.

You know, they start to look like a safer asset, relatively speaking.

In a world that's a mess, owning equity in the best companies in the world seems like a smaller.

Well, we should note, actually.

Does it make sense?

Just let me move on.

Let me move on.

Does it make sense the world would continue to buy U.S.

bonds?

Well, maybe less so, maybe less so than than equities, but we're talking about treasury bonds here.

Well,

maybe if you were buying long-term treasury bonds, you'd want to get paid a little more for doing so.

But it's not like the rest of the world is in a beautiful fiscal situation.

Two points on that.

First of all, the rest of the world is not in a very good fiscal situation.

But so you look at Europe, France is being France and having one of its periodic political crises.

France gonna France.

France going to France, but that's not particularly hurting the Euro.

So it's a sign that there's enough downward pressure on the dollar that other countries can have like full-blown political crises and you won't be able to tell it from the currency.

The other point that I think is worth underlining here, apart from the fact that, again, going back to Deutsche Bank's research, about half of the flows into US government bonds now are hedged as well, which again is a big run-up.

But you have this combo of the world still wants to own nice, growthy companies in the US,

and the world doesn't want to hold dollars, it wants to push down the dollar.

If you're Donald Trump, that's pretty great, actually, because you want a weaker currency because you think it will help your exports.

Terms and conditions may apply, but they're thinking he's wanted a weaker dollar for ages.

So, actually, you know, there's a lot of talk about market vigilantes, right?

The stock market biting back, the currencies market biting back, the bond market biting back.

Actually, not only are they giving Trump a pass by being quite sort of quite relaxed and not particularly volatile, but they're actually rewarding him, giving exactly what he wants, which is higher stocks and a weaker dollar.

And the economy, while it is slowing down, is okay.

The only price he's really paying is we do have

a bit of tariff-driven inflation.

Which could easily become a lot of tariff-driven inflation.

It 100% could.

And it's preventing him from getting the even lower interest rates than he would otherwise get.

If goods inflation wasn't going up, the Fed could be cutting them.

And so he has, you know, that that's been an imperfect outcome.

But all things considered, most of the items on his wish list, he has gotten.

So there we are.

But I would say on the thesis

that

what we're seeing in the dollar and dollar hedging speaks to the fiscal monetary mess the United States is digging itself into.

And the institutional mess.

Don't forget that one as well.

And the institutional, the institutional mess.

Look, the dollar's been going sideways since kind of the last week of June.

In other words, we're not seeing it bleed out steadily.

And as the controversy around the Fed has increased in pitch, we have not seen the dollar weaken hand in hand with that.

And these relationships don't have to be one-to-one, and the timing is always questionable.

But we have, over the last couple of months, seen a stabilization of the dollar.

And I think we have to mention that in this conversation.

But if the dollar doesn't pick up while France has quite literally set fire to itself, then, you know, when can it, really?

So all in all, is your assessment that Trump will be very happy with the state of the world markets-wise, right now?

Well, I would say this.

There's a disappointment that the weaker dollar has not bought him more balanced trade flows.

In our new chart of the week,

We now do a Saturday unhedged newsletter thingy where we do one great chart and send it out to readers.

You can sign up, check the show notes for how.

And what has not happened with a 10% weaker dollar plus tariffs has not changed the trade balance.

People are just paying the tariffs and continuing to buy more stuff from abroad than they do from U.S.

manufacturing.

So that wish has not come true.

Although I suppose you could argue

that shifting trade flows takes a long time and maybe over time the tariffs plus the weaker dollar will have an issue.

Sure, sure, sure.

And it doesn't encourage foreign companies to set up shop in the U.S.

if the Immigration Department or whatever you call it goes around arresting all the people building the arresting them yes this is this is an extremely unclear thing to happen when you've just

at your car plant in the United States so let me ask you maybe we should sort of round this discussion out by predicting the most unpredictable thing in the world, which is the dollar.

Oh, no, never make predictions.

So let's have a little little

never make predictions about currency.

But remember, at the beginning of the administration, people thought the dollar was going to strengthen because people were going to be buying dollars to pay the tariffs.

And it has been, and that was kind of a very consensus call about the dollar.

It was perfectly wrong.

That's when the dollar index was at 110.

Now the dollar index is at 97.

Let's pick

Euro dollar.

Here to the end of the year.

End of the year, where does the, you know, is the dollar index higher or lower than it is today at the end of the year?

Katie Martin, well-known markets prognosticator, what do you say?

I think dollar lower into the end of this year.

I've done this entirely to make you uncomfortable.

I think dollar lower into the end of this year.

The sort of punchy end of the consensus is that the Euro will end this year at about $1.20.

I'll take the over on that and say $1.22.

How about that?

What about you?

Just to be contrary, I think the dollar strengthens a little bit.

Team America will police it.

We have this pattern in markets where we have a panic because of some loopy thing the president does.

The latest loopy thing is the Stephen Marin effect.

But the markets have shown that they absorb these things and talk themselves into saying things will be fine.

I think the hedging effect is already in place and that the dollar will be a bit stronger.

You are really sticking to your stereotype as Mr.

American.

Let us take take a moment to remind our readers what our record is with marketplace.

It's terrible.

Just don't

smart about anything, especially non-currencies, because everyone knows they are basically impossible.

Everyone is wrong about currencies, but we manage to be even wronger than the average person.

Wronger wronger.

Yeah,

even wrongerer with the Unhedged podcast.

Right, listen, we're going to have to jump off for a sec, and we will be back in just a little moment with Long Short.

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Okey-doke, it's time for long short, that part of the show where we go long, a thing we love, or short, a thing we hate.

Rob, have you got anything prepared for the class?

I do.

I am short my own career choices.

I was just reading a story.

Yes, I know what you're going to say.

I am am also limit short my career space.

By our colleague Costas.

And so it's about this trader who works at a hedge fund, who used to be a Financial Times journalist, is now a hedge fund trader and just got paid $100 million to switch hedge funds.

This guy's name is Steve Sherm.

Now, Rob Armstrong once worked at a hedge fund.

Rob Armstrong

has written a lot about hedge funds for the FT, just like this guy.

Whereas my $100 million, Katie?

Maybe if you're wish to know.

And the reason is I've basically screwed up the whole thing.

I went from hedge funds to journalism.

This guy went from journalism to hedge funds and now he's got the $100 million

and I have a dog.

But is he happy?

Oh, yes, I note he is.

Yeah, probably it's outrageously happy.

I couldn't even make it like, I really struggled to read the rest of the story because I was so outraged that a former journalist could be earning so much money.

I'll tell you something else outrageous.

I am short matcha.

Too many people are drinking matcha beverages.

My daughter likes it.

Gross.

It tastes like

silage.

It's kind of dirt, isn't it?

It's basically a dirt-flavoured matcha.

Apparently, matcha sales have doubled in the UK.

Everyone loves matcha.

Apparently, about 4% of all drinks sold in cafes contain matcha.

It's green.

It's not for human consumption.

It tastes like some sort of grassy silage nonsense.

It's a no from me.

And

just as we were getting ready for this section of the show, our editor Brian said that someone tried to give him

a blue cheese martini at the weekend.

This is why the dollar is weak, actually.

This is why the dollar is weak.

The beverage situation has gotten completely out of control.

People are drinking matcha and blue cheese martinis, and it's going to bring the global financial system to its knees.

God, have we not suffered enough?

Listeners, on that deeply unpleasant note for which I apologize unreservedly, we have got to get out of here, but we are going to be back in your ears later this week, so listen up then.

Unhedged is produced by Jake Harper and edited by Brian Erstadt.

Our executive producer is Jacob Goldstein.

Topa Vorges is the FT's acting co-head of audio.

Special thanks to Laura Clark, Alistair Mackey, Greta Cohn and Natalie Sadler.

FT premium subscribers can get the Unhedged newsletter for free.

A 30-day free trial is available to everyone else.

Just go to ft.com/slash unhedged offer.

I'm Katie Martin.

Thanks for listening.