European investors are once again facing a textbook currency hedging environment as the dollar weakens and the cost of protection falls. With the euro expected to strengthen further, portfolio strategies are increasingly being shaped by how much, not whether, to hedge U.S. exposures.
“What we can see in the data is inflows into U.S. markets look very in line with recent years,” said Sam Zief, head of global FX strategy at J.P. Morgan Private Bank in an interview with Investment Officer. “And the FX hedging, after the big increase in the second quarter, has levelled off since the summer.”
The levelling-off comes after a sharp rise in hedge ratios by European pension funds and insurers in the spring, led by Danish funds. While those moves have since stabilised, the case for hedging has only strengthened as costs drop. The price of protection has already fallen from around 2.5 percent in the spring to about 2 percent today, and could decline further as the Federal Reserve begins cutting rates.
“Once the Fed delivers the cuts we expect, and provided the ECB doesn’t cut, it’s likely to become more like one to 1.5 percent,” Zief said. “That would take it back to the lowest level since the hiking cycles began in 2022.”
Classic dollar drivers
Zief, who turned bearish on the dollar earlier this year, sees three classic drivers behind the current shift: a slowing U.S. economy, the Fed’s easing cycle, and narrowing growth and rate differentials with Europe. These forces point to the euro moving into the 1.20 range against the dollar in the coming months. For unhedged investors, that would translate into a meaningful drag on returns.
“We think with high conviction that the dollar is likely to weaken another three to five percent,” Zief said. “If that is going to impact a client’s portfolio and long-term goals, then they should hedge and be aware of that.” He added that hedge ratios should rarely be at the extremes: “When an investor has no hedge, they’re taking a view, just like they are if they’re fully hedged. The starting point probably shouldn’t be zero or 100, but something more in the middle.”
Risks both ways
Could the dollar surprise on the upside? Zief notes the main risk would be a U.S. economy proving more resilient than expected. “If the economy reaccelerates or inflation rises further, the dollar could strengthen instead of weakening.” Conversely, a sharper fall would require global investors to cut U.S. allocations more aggressively. He highlighted the dominance of the AI theme in U.S. markets and political volatility, including tariff policy, as key factors to monitor.
Despite those risks, his conviction remains clear: “We have high conviction that we’re moving into the 1.20s,” he said.
State Street’s longer view
At State Street Investment Management, Aaron Hurd, senior portfolio manager in the currency group, also sees scope for a weaker dollar over the medium term. “We see scope for EUR/USD to move toward 1.35 over the next 3–5 years,” he told clients, citing the slowdown in the U.S. jobs market, trade tariffs, and the Fed’s easing cycle.
Hurd also highlighted a structural shift: “As the U.S. becomes a less reliable trade and security partner, the incentive for EU investors to reduce their concentrated exposure to U.S. assets, or at least increase their average currency hedge ratios is growing.”
Relative to the G10 currencies, State Street is neutral-to-positive on the euro in the coming months, with French political uncertainty likely to cap near-term gains. Over the medium term, however, Hurd sees solid support from factors such as higher defence spending, the proposed 500 billion euro German infrastructure fund, strong household balance sheets, low unemployment, and positive real wage growth.
“These developments strengthen the case for euro appreciation over the medium term,” he said.
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