How to cope with a weak dollar: Should we sell dollar assets or hedge against the dollar exchange rate?

Since the beginning of 2025, the US dollar has fallen 8% from its peak, and Goldman Sachs expects this trend to continue. In the face of the ongoing weakening of the dollar, Goldman Sachs believes that hedging against dollar exchange rate risks is more effective than directly selling dollar-denominated assets.

On August 2, according to news from the Wind Trading Desk, Goldman Sachs stated in its latest research report that since the beginning of 2025, the dollar has fallen 10% against the currencies of developed economies, with a trade-weighted decline of 8%. Although the dollar rebounded from its low in early July, the depreciation trend is expected to resume. However, historical data shows that the performance of other assets during periods of dollar weakness can vary significantly, depending on the specific drivers pushing the dollar lower.

Goldman Sachs analysts Dominic Wilson and Vickie Chang pointed out in the latest research report that if the dollar continues to weaken, diversifying stock investments and reducing allocations to the US market is reasonable, and emerging market assets may benefit. However, the value of hedging against dollar exchange rate risks exceeds the value of simply reducing dollar-denominated assets.

Goldman Sachs believes that the ongoing structural depreciation of the dollar is more likely to stem from investors' reduced willingness to marginally allocate to US assets and the potential dovish shift in Federal Reserve policy. These factors driving the dollar's weakness do not pose significant risks to US stocks or US bonds.

Historical Experience: Significant Differences in Asset Performance During Dollar Depreciation

Data shows that since 1980, the real trade-weighted dollar index has experienced at least seven significant depreciations of over 10%. By analyzing the asset performance during these historical periods, Goldman Sachs found that, apart from the foreign exchange market itself or closely related assets like gold, the performance patterns of other assets show significant differences.

During periods of dollar depreciation, the US stock market has often risen, but it tends to underperform overseas markets when measured in dollars. However, in developed markets, this underperformance is often minimal, and after hedging against exchange rate impacts, US stocks have not actually underperformed.

During dollar depreciation periods, US Treasury yields and yield spreads have both risen and fallen, indicating that there is no fixed relationship between interest rate trends and dollar weakness.

It is noteworthy that gold has recorded gains during all periods of dollar depreciation, reflecting its monetary properties within the commodity system. In contrast, other commodities like oil, while experiencing more frequent price increases, show relatively poor consistency in performance.

Macroeconomic Driver Analysis: Three Key Factors Driving Dollar Trends

Goldman Sachs constructed an analytical model based on US stocks, US bonds, and the dollar, extracting three factors: "US Growth," "US Monetary Policy," and "Non-US/Risk Premium."

The research found that while changes in market expectations for US growth varied across different periods of dollar depreciation, all periods of dollar depreciation involved a dovish shift in Federal Reserve policy and a combination of rising risk premiums for US assets or positive factors from non-US markets.

Several events this year have confirmed this analytical framework: concerns about US growth, expectations for a dovish shift in Federal Reserve policy, upward revisions of European growth expectations, concerns about the sustainability of US fiscal policy, and concerns about the independence of the Federal Reserve have all contributed to the weakening of the dollar from different angles, but their impacts on other assets vary Specifically:

Concerns about U.S. growth often lead to a simultaneous weakening of the dollar and U.S. stocks, creating downward pressure on U.S. Treasury yields.

Expectations of a more accommodative Federal Reserve policy would weaken the dollar, while lowering U.S. yields and boosting U.S. stocks.

An improvement in Europe's growth outlook may also weaken the dollar, but it is accompanied by a rise in U.S. stocks and an increase in U.S. Treasury yields.

Investment Strategy: Hedging is Better than Reducing Holdings

Based on historical analysis and current market conditions, Goldman Sachs has put forward clear investment recommendations.

Goldman Sachs believes that the continued reduction in investors' willingness to marginally allocate to U.S. assets will lead to further structural depreciation of the dollar. In the baseline scenario, the Federal Reserve's policy may also be more dovish than expected. These factors driving the dollar's weakness may not pose significant risks to U.S. stocks or bonds.

Regarding stock investments, Goldman Sachs stated that if the dollar remains weak, there is indeed a rationale for diversifying investments and reducing allocations to the U.S. market, with emerging market assets potentially benefiting in the baseline scenario. Goldman Sachs noted:

However, considering that the returns of U.S. stocks after hedging during many periods of dollar weakness are comparable to global markets, the argument for hedging foreign exchange exposure in U.S. stock allocations is stronger than the argument for reducing U.S. stock holdings.

Goldman Sachs also specifically pointed out that deeper structural risks surrounding U.S. fiscal policy or the independence of the Federal Reserve may become more pronounced, potentially putting further pressure on the dollar while also raising the yield curve and posing certain risks to U.S. stocks.

These tail risks are a key reason why allocating bearish positions on the dollar in the current investment portfolio may be independently useful, while also reinforcing the necessity of moderately diversifying investments into non-U.S. assets