Major changes in the foreign exchange market! The loss of "American exceptionalism" may mean that the decline of the US dollar has just begun

The theory of American exceptionalism is coming to an end, which may lead to a massive sell-off of the dollar.

Goldman Sachs analysts Karen Reichgott Fishman and Lexi Kanter stated in their latest report that the decline of American exceptionalism and the increasing risk of a U.S. economic recession are driving a shift in foreign exchange hedging strategies.

The report shows that since early 2025, investors hedging foreign exchange risks in U.S. stocks with the Japanese yen have achieved an annualized return that is 11.6 percentage points higher than unhedged portfolios, while U.S. stock investors hedging foreign exchange risks in European stocks have seen returns decrease by 22.9 percentage points.

Therefore, Goldman Sachs believes that foreign investors should increase their foreign exchange hedging ratio for U.S. stocks (especially Japanese yen and euro investors), while U.S. investors should reduce their foreign exchange hedging ratio for non-U.S. stocks, or even directly hold non-dollar assets—this means that demand for the dollar will decrease, and the dollar may continue to depreciate in the future.

Deutsche Bank further pointed out that after the tariff shock on April 2, the euro has performed better than the dollar. As the Eurozone actively takes measures to enhance the supply of safe assets, strengthen defense, and relax fiscal policies, the euro's attractiveness as a safe-haven asset is rising, and it is expected to become a "substitute" for the dollar.

Goldman Sachs: The decline of American exceptionalism calls for a change in hedging strategies

Goldman Sachs emphasized that as global economic growth becomes more balanced and the outlook for overseas returns improves, the simultaneous decline of the dollar and U.S. stocks is becoming more frequent and persistent. On April 3, the S&P 500 index and the euro/dollar experienced the largest single-day combined decline since 2000.

The report outlines four main factors that investors should consider when deciding whether to reduce foreign exchange exposure:

1. Portfolio Composition: Foreign bond investments almost always require full hedging, while the hedging decisions (and ratios) for foreign stock investments depend on broader factors.
2. Cross-Asset Correlation: Specifically, whether the currency of the target market is "riskier" than the investor's domestic currency, or whether it has a higher correlation with the domestic stock market.
3. Arbitrage Trading: That is, the relative interest rate differences between foreign economies and the investor's domestic economy.
4. Economic Outlook: Particularly the likelihood of a U.S. (or global) economic recession during the investment horizon. For companies hedging international business exposure, arbitrage trading and the potential state of the global economic cycle are the most relevant factors, along with foreign exchange valuation.

Considering these factors, Goldman Sachs believes that in light of the rising risk of a U.S. economic recession, falling stock prices, and ongoing uncertainty in U.S. policies and increased foreign exchange volatility, foreign investors should increase their foreign exchange hedging ratio for U.S. stocks (especially Japanese yen and euro investors), while U.S. investors should reduce their foreign exchange hedging ratio for non-U.S. stocks, or even directly hold non-dollar assets.

The increase in U.S. investors' investments in other currency assets, along with foreign investors raising their foreign exchange hedging ratio for U.S. stocks, may lead to a decrease in demand for the dollar. Goldman Sachs therefore believes that the dollar will continue to depreciate in the coming year. According to previous mentions by Wall Street Insights and a report from UBS, the foreign exchange hedging ratio for foreign investors in U.S. stocks is only 20%, which means that most U.S. assets are unhedged. Once market sentiment reverses, it could quickly trigger a sell-off of the U.S. dollar. UBS warns that approximately $14 trillion of unhedged U.S. assets are at risk. If foreign investors reduce their holdings by 5%, it could trigger a $700 billion sell-off of the U.S. dollar.

Although Goldman Sachs believes that due to the role of the U.S. dollar in global financial markets, the dollar will still strengthen when the market is under severe pressure, the likelihood of the dollar's structural underperformance is increasing as global economic growth becomes more balanced and the exceptionalism of the U.S. diminishes.

Is the Euro Rising as a New "Safe Haven"?

Deutsche Bank strategist Tim Baker pointed out in a report released on the 4th that the euro is becoming a "substitute" for the U.S. dollar.

The report states that after the tariff shock on April 2, the U.S. dollar strengthened against the Australian dollar, New Zealand dollar, and Norwegian krone, while remaining stable against the Swedish krona, British pound, and Canadian dollar. Meanwhile, the Eurozone is actively taking measures to enhance the supply of safe assets, strengthen defense, and relax fiscal policies, all of which enhance the euro's appeal as a safe-haven asset.

Data from the International Monetary Fund (IMF) shows that global reserve managers have been working to diversify their portfolios in recent years and reduce their reliance on the U.S. dollar. Since the first quarter of 2020, they have increased their allocations to the Canadian dollar, Japanese yen, and Australian dollar by 40% to 50%. However, changes in euro allocations have been minimal.

The report notes that in the 2010s, the euro accounted for more than a quarter of global foreign exchange reserves. However, the Eurozone debt crisis and subsequent negative interest rates led to a sharp decline in its share. Over the past decade, the euro's share of foreign exchange reserves has been about one-fifth.

The report suggests that if the euro can return to its previous levels, it could mean an inflow of over €600 billion.

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