The exchange rate is the asset
For a euro-based investor, the most consequential decision in a dollar position is rarely the security itself; it is whether the dollar is owned alongside it. A holding in US large-cap equities or Treasuries is, from Valletta, two exposures stacked together: the underlying return in its home currency, and the euro value of the dollar in which that return is denominated. Over short horizons the second exposure is noise; over a decade it can be the dominant term in the equation, and it is the term most clients have never explicitly chosen.
The point is easily understood with magnitudes. The euro spent much of the past cycle between roughly 1.05 and 1.12 against the dollar, with episodes below parity. A move from 1.08 to 1.25 over several years is a depreciation of the dollar of around 14 percent in euro terms. For an unhedged dollar bond portfolio yielding low single digits, that translation swing can erase the better part of a decade of coupon; for an unhedged equity book it can quietly subtract several points a year from a return that looked perfectly satisfactory in dollars. The asset did its job; the currency undid part of it.
We frame this note around a softer dollar not because we forecast a precise path, but because the conditions that supported persistent dollar strength have weakened. Real-rate differentials have narrowed as the ECB and the Federal Reserve converge, the US runs twin deficits that require continuous foreign financing, and the dollar entered this period historically rich on most valuation measures. None of that guarantees decline, but it does mean the asymmetry euro investors enjoyed for years, where the dollar tended to rise and rescue unhedged positions, can no longer be assumed.
How a weaker dollar moves through a euro portfolio
The translation effect is not uniform across asset classes, and treating it as such is the most common error we see in client books. Consider dollar fixed income first. A high-grade dollar bond is, in essence, a stream of dollars of known size; the currency adds volatility without adding expected return, because the investor is not compensated for the exchange-rate risk in the way an equity holder arguably is. On unhedged dollar bonds, currency moves typically dominate the total return at horizons shorter than the bond's own duration. This is why we treat the hedge on developed-market fixed income as close to mandatory: the entire reason to hold the bond, its defensive and income-generating character, is compromised if a 10 percent currency swing can swamp a year of carry.
Equities are a subtler case. A globally diversified US company earns in many currencies and carries an implicit, shifting hedge of its own; a weaker dollar often flatters the reported earnings of US exporters even as it reduces the euro value of the share price. The two effects partially offset, and over multi-decade samples fully hedging foreign equity has tended to add cost and tracking error without improving risk-adjusted return for a euro investor. Our default on equities is therefore to leave the bulk unhedged and to manage dollar exposure through how much US equity we own, not through an overlay bolted on top.
The carry maths has quietly flipped
For most of the last decade, hedging dollars back into euros carried a meaningful cost. With US rates well above euro rates, the forward points an investor paid to roll a hedge were punitive, often more than 2.5 percent annualised at the peak of the divergence. That cost was the honest reason many European allocators ran unhedged dollar bonds: the hedge ate the yield pick-up that drew them to dollar paper. Leaving the currency open was a yield decision dressed as a currency view.
As the rate gap narrows, that arithmetic reverses. As euro rates approach US rates the cost of the hedge collapses, and the carry on hedging can turn positive: the euro investor is paid to remove dollar risk rather than charged for it. This is the single most underappreciated development for European books. A decision that used to require sacrificing yield to gain stability now offers both together.
The figures are worth keeping concrete. A euro investor holding a dollar bond yielding around 4.5 percent who hedges at a cost of 2.5 percent nets roughly 2 percent, often below what the same-quality euro bond yields outright, which made the unhedged version tempting. As the forward cost falls towards zero, the hedged position keeps close to its full yield while shedding the volatility, and the unhedged version becomes simply a less efficient way to own the same income with a large uncompensated currency bet attached.
Sizing the hedge, not betting on the dollar
We are deliberate in distinguishing a hedging policy from a currency call. Raising the hedge ratio on dollar fixed income is not a wager that the dollar falls; it is the removal of a risk for which the investor is not paid. We would hold that view even if neutral on the dollar's direction, because the volatility reduction stands on its own and, with carry now favourable, no longer costs anything to obtain.
In practice we are moving the strategic hedge on developed-market dollar bonds towards full, recognising that the precise ratio should reflect each client's base currency, liabilities and liquidity needs. On equities we are holding the structural hedge low and expressing any softer-dollar view through allocation, with a modest preference for euro-area and broader European equity. Where a client wants explicit downside protection against a sharp dollar move, we prefer optionality with defined cost to a static forward hedge that bleeds carry in the wrong scenario.
Gold deserves a mention here. For a euro investor it has historically behaved partly as a dollar hedge and partly as a monetary hedge, and a structurally softer dollar has tended to support it in both roles. A measured allocation complements a portfolio reducing its passive dollar length and earns its place on diversification grounds alone.
The counter-argument we take seriously
The principal risk to this framing is that the dollar's defensive character reasserts itself at exactly the wrong moment. In acute risk-off episodes, capital flows towards dollar liquidity regardless of valuation or rate differentials, and the currency rises when almost everything else is falling. A euro investor who has fully hedged dollar assets forgoes that cushion. The hedge that looks prudent in a calm, converging world removes a genuine shock absorber in a violent one.
We do not dismiss this. It is the strongest case for leaving some dollar exposure open, and it is why we draw the line where we do: hedging the fixed-income book, where the defensive logic is about stable income rather than crisis convexity, while leaving meaningful unhedged dollar exposure inside the equity and gold allocations, where the safe-haven property is most useful. The aim is to keep the dollar's insurance value where it pays.
There is also model risk in assuming convergence continues. Should US growth and inflation reaccelerate while Europe stalls, rate differentials could widen again, the carry on hedging could turn negative, and the dollar could resume its climb. We hold this view with conviction in its logic but humility on its timing, and have built the positioning so that being early is inexpensive rather than punishing.
What this means for clients
First, look through your portfolio to its currency composition, not just its asset composition. Many European families discover they are carrying 30 to 40 percent dollar exposure they never consciously selected, accumulated through global equity funds, US-listed holdings and dollar bond allocations. The task is to measure it and then decide deliberately how much to keep.
Second, the hedging decision now favours action on the fixed-income side in a way it did not three years ago. The cost that once made leaving dollar bonds unhedged defensible has largely gone, and the case for hedging that sleeve has strengthened accordingly. This is portfolio construction rather than market timing, but the window in which it is cheap to act is open now.
Third, resist the temptation to hedge everything uniformly. The instinct to remove all currency risk is understandable, but a blanket hedge on equities tends to cost more than it saves over time and strips out a useful shock absorber. The disciplined approach is to hedge where the investor is unpaid for the risk, the bond book, and to express any softer-dollar view through allocation and selective optionality elsewhere. We would be glad to discuss how these principles apply to your own mandate, and will revisit the carry maths as the rate cycles evolve.
This note is house research and reflects the views of the Macro desk at the time of writing. It is not investment advice or an offer.
