Bracing for the second wave: The USD is at risk again, but February 1 might be better timing

Dollar hedging two: This time is different?

My inbox is full of USD hedging stories including this one about AUD:

And this one (Swedish language) about a Swedish pension fund (Alecta) which has sold the majority of its US government bonds due to increased risk and unpredictability in politics.

Meanwhile, my friend Steen Jacobsen, a macro mind who I have respected since at least 2005, is predicting that 2026 will be the year where pension funds and asset managers will face political pressure and be pushed toward domestic alignment. He says to expect repatriation flows as capital will prefer “home” vs. “away”. We have seen a 10-year plus trend of global savings piling into US assets, and so there is obviously reason to be concerned if that trend reverses. It’s tempting to pooh pooh the dollar bear story reflexively because of the dollar-bearish pension-hedging strategist hysteria in Q2 2025—and the failure of the dollar to follow through afterwards. But then again, the DXY hasn’t exactly skyrocketed since then, right?

The issue with selling USD right now is that this Greenland tariff gambit could be another maximalist demand that will be yanked as the February 1 deadline approaches. If those tariffs are enacted, the trade will be to sell USD and sell EUR and figure out what the heck you want to buy. For now, I think the risk of a TACO is too high to get super excited about short USD but the distribution of 2026 returns for the USD must almost certainly be heavily-skewed to the downside at this point as the world is realizing that the US policy nightmare is not over.

Japan

The JGB collapse took a night off last night as Japanese yields retraced. The JPY is not trading the same as it was in prior months and it’s looking more and more like the weak JPY trade is exhausted. The market has it on in pretty decent size, the election is known and priced in, there is some hawkish risk from BOJ, and upside price action in USDJPY has lost momentum. The risk of intervention capped things at 159.20/50 and now we await the next leg of the Japan fiscal fear trade.

The problem Japan faces is that if the BOJ tries to stabilize the bond market by buying bonds, that will be viewed as QE and the market will sell the JPY, which Japan does not want. If the BOJ sounds hawkish or hikes unexpectedly, it might stabilize the back end by reestablishing credibility on inflation… Or it might just trigger another massive leg lower in bonds as the BOJ ratifies the market’s view that yields should be way, way higher. It’s tricky. A one-off hike isn’t a game changer, so unless the BOJ goes mini-Volcker by hiking and announcing a stronger commitment to fight inflation, the result could be unappealing.

There is a solution that ticks every box, and I am not sure why they have not used it yet. Perhaps they have made a tactical decision to wait until after the election, or perhaps they are just not as worried about JGBs as financial people are. I’m not sure. But the clear solution is for GPIF to sell foreign bonds and buy JGBs. They would announce something like this:

Due to a significant rise in domestic bond yields, GPIF will reduce the allocation to foreign bonds and purchase Japanese government bonds in recognition of the relatively more attractive domestic yield. We will move to gradually return from the current foreign bond allocation of 25% to the 2015 target allocation level of 10%-15%.

It would sound more technical than that, but that should be the gist. GPIF’s allocation to foreign bonds was 11% in 2015 and that was upped over time to its current level around 25%. GPIF is absolutely huge, they have more than $1.7T under management. And the other big pension institutions in Japan, which are generally risk averse, will follow whatever GPIF does. GPIF currently holds around $400B of foreign bonds and a change in allocation there would send a strong signal for the start of a Japanese repatriation theme.

This would be enormously bullish JGBs and JPY at the same time. It would not crush the Nikkei the way more rate hikes might. It would serve a domestic policy purpose and allow them to reverse a 10-year rotation that was mostly enacted because of the huge spread between Japanese yields (low) and foreign yields (way higher). It would make sense from every angle and would also fit with a potential global repatriation vibe.

Recall that the GPIF announcements in 2015 were absolutely epic for the JPY (bullish USDJPY) and Nikkei. See this article, for example. GPIF’s movements were a key component of the market reaction to the Abenomics platform and drove the JPY weaker for two full years. So, if GPIF makes an announcement of this sort… Get on board quickly. The lifers will follow and it will be a trend that could last a year or more.

To be clear, I am not predicting this is imminent. I’m saying be ready just in case. I do think it’s the most logical and clean solution to the weak JPY and weak JGB problem and the odds of it happening after the election are way above zero. Tactically, they would most likely not want to do a market intervention play of this sort before the election, because it’s safer to let the market react to the election first, then do the GPIF announcement.

Final thoughts

1. Mark Carney’s “Love Actually” moment… Proud to be a Canadian today.There is an obvious tradeoff now where countries need to decide whether to take a massive economic risk and maintain a spine or capitulate to the Thucydidean idea where the weak accept that they must suffer the will of the strong. We saw mostly capitulation in Year One, but Year Two is starting to look a bit different. Europe has much to lose and is a mix of many leadership styles and priorities, so it’s very hard for them to stand up to threats and coercion. But they might?

2. This tweet from John Arnold about his first-ever visit to China is absolutely excellent. He focuses on robotics, manufacturing, and energy. If you have never been to China (I have not) it’s a good primer.

3. The phone call from the Deutsche CEO to Scott Bessent is reminiscent of how banks that rely on China and know what’s best only publish bullish reports on China. As my grandmother used to say: If you don’t have anything positive to say, don’t say anything at all.

4. In June 2008, I bought ten ZWD 100,000,000,000,000 bills as collectibles for $6 each. They are trading at $40 on eBay now. Here are some random comps, sorted by performance.

5. ICYMI, a short essay about my 5-day silent meditation retreat here: Recreational Buddhism. 9-minute read.