Easing the Dollar Squeeze: Interest Rate Impact on Global Investors

Fund manager Michael McNair, in an article titled "The Dollar Squeeze," theorized that the US Treasury Secretary needs to push interest rates lower to reduce foreign exchange hedging costs. The goal is to reassure international investors that their returns on dollar-denominated assets will be protected from the effects of currency devaluation.

McNair points out that the Treasury Secretary, as a former FX trader, has the expertise to handle dollar depreciation. This, in turn, represents a key motivation behind the White House's pressure on the Federal Reserve to cut rates.

Impact of Tariff Announcements

President Trump's tariff announcements on April 2nd caught international investors off guard. Many investors had already allocated a significant portion of their assets to US assets, but hadn't hedged currency risks due to the high cost of hedging. As a result, by 2021, foreign real money investors had largely abandoned currency hedging. McNair cited Asian life insurance companies as an example, with these companies reducing their hedge ratios from 90% to 45%.

Instead of selling equivalent dollar forward contracts, many large overseas institutions opted to simply buy dollar-denominated assets, such as US Treasuries, directly. A flatter yield curve, where long-term US Treasury yields are not significantly higher than the federal funds rate, means that the interest rate differential – the main incentive for foreign insurers to invest in US bonds – is eaten up by hedging costs.

An Example

For example, if a 10-year US Treasury yields only 160 basis points more than a comparable German government bond, and the cost to hedge currency risk is about 2%, the trade becomes unprofitable for European insurers.

The same principle applies to Asian life insurance companies, who were once such important holders of US bonds. McNair estimates that half of their foreign bond portfolios are unhedged. If unhedged, a 2% drop in the dollar in one day can wipe out an entire year's worth of yield advantage.

The Bottom Line

The tariff threats announced by the Trump administration, coupled with public calls for a weaker dollar, forced international investors to directly unwind their exposure to dollar-denominated assets.

McNair highlights that the US Treasury faces a problem: If foreign capital flows have been funding the trade deficit, who will now buy US bonds, particularly those with longer maturities?

For example, Japan has ended yield curve control (a strategy to artificially suppress interest rates), and its government bonds now offer Japanese investors 100 basis points more yield than in January 2024. Therefore, Japanese government bonds can compete with international capital, and as McNair points out, their rising yields are pulling US Treasury yields higher. Term premium risk, the extra return investors demand for holding longer-term investments, has become a feature of the entire fixed income market in 2025.

McNair believes that lowering the federal funds rate would narrow the interest rate differential between the US and Japan (and other regions), "and that narrowing means cheaper hedging."

Cheaper hedging can improve after-hedge returns, perhaps enticing international buyers to return to US long-dated assets.


Risk Warning and Disclaimer: This article represents only the author’s views and is for reference only. It does not constitute investment advice or financial guidance, nor does it represent the stance of the Markets.com platform. Trading Contracts for Difference (CFDs) involves high leverage and significant risks. Before making any trading decisions, we recommend consulting a professional financial advisor to assess your financial situation and risk tolerance. Any trading decisions based on this article are at your own risk.

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