ABSTRACT
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. © 2022 The Journal of Structured Finance. All rights reserved.
ABSTRACT
Trade disputes and the impact of the COVID-19 pandemic on global supply chains have drawn much attention to the notion of "deglobalization." The common concern is that the steady trend of globalization and its many benefits may reverse. But the globalization trend is not a monolith. In this article, we show that although trade globalization has stalled since the Global Financial Crisis (GFC), financial globalization has continued to increase. We further show that financial globalization has a much more significant impact on portfolios than trade globalization. The primary mechanism of this impact, US dollar hegemony, impacts portfolios primarily through increased spillover of US monetary policy shocks. The two implications for investors are: (1) global equity markets have become increasingly correlated and are likely to stay that way, and (2) this increased correlation reduces the benefits of portfolio diversification and leads to a more concentrated exposure to US monetary policy shocks.