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

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 <i>historically</i> 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.