Financial Globalization and Its Implications for Asset Allocation in a Dollar World

Unprecedented monetary policy measures carried out by the US Federal Reserve in response to the COVID-19 pandemic have raised the question of whether US dollar hegemony will continue going forward. In this article, the authors examine the multi-faceted nature of dollar hegemony with a focus on its relationship with globalization. They find that the US dollar is the dominant currency in global economic activities ranging from trade to cross-border banking, and this USD strength is reflected in the ability of US Treasuries to diversify local economic shocks. While they find that US Treasuries provide historically better diversification for local equity risk than local sovereign debt, in an ultra-low interest rate world, investors will likely need to consider alternative hedging approaches. As an illustration of a potential alternative, the authors turn to the currency markets and show that a short euro versus long Japanese yen position has had stable to improving performance as a hedging tool. The key message is that alternative hedging strategies merit a robust discussion and consideration in a low-yield environment.