Synopsis:

RBC highlights a growing role of currency risk in global portfolios, particularly for non-US asset managers, as the US Dollar emerges as a key driver of portfolio volatility. The shift is prompting institutions to raise hedge ratios, potentially leading to large-scale USD selling.

Key Points:

• Currency Risk Rising Sharply Outside the US:
  The share of FX risk in total portfolio risk is increasing for non-US investors, especially in Europe (EUR), Canada (CAD), and Australia (AUD).

• US Dollar Is the Main Risk Driver:
  The USD is the largest contributor to total portfolio volatility for non-US managers, despite being considered an uncompensated risk.

• Expect Increased Hedging Activity:
  As investors seek to neutralize FX volatility, RBC expects more widespread USD hedging, particularly among institutional managers.

• Magnitude of Hedging Potential Is Huge:
  Non-US assets under management (AUM) total $74.5 trillion, concentrated in Europe, Canada, China, the UK, Japan, and Switzerland.
  A 5% increase in hedge ratios globally would imply over $2 trillion of USD selling.

• Market Impact May Be Uneven:
  Due to liquidity constraints, CAD, CHF, and select EM currencies may experience more domestic spot price volatility from increased hedging flows than larger markets like the EUR.

Conclusion:

RBC sees a secular shift toward higher USD hedging in global portfolios in 2025, driven by rising FX-induced volatility. While this could result in significant USD outflows, the impact on smaller, less liquid currencies could be more pronounced, requiring a measured approach to avoid excessive spot market disruption.