The Rising Cost of Currency Hedging and Its Impact on Emerging Market Portfolios

Here’s the deal: Emerging market investors are facing a perfect storm of rising currency hedging costs and macroeconomic volatility. With the U.S. dollar’s dominance and trade policy shifts driving chaos, strategic asset allocation isn’t just a buzzword—it’s a lifeline. Let’s break it down.

The Hedging Cost Tsunami

Currency hedging costs in emerging markets have spiked due to a cocktail of factors. The U.S. dollar’s strength—driven by tariffs and Fed policy—has pushed EM currencies like the Brazilian real and Indian rupee down 4–5% year-to-date [1]. Meanwhile, U.S. tariffs on emerging markets have jumped from 2.4% in early 2024 to 16.5% today, creating a 76% average increase in hedging costs for firms [3]. “This isn’t just noise—it’s a structural shift,” says a report by Delphos. Investors are now paying a premium to protect against sudden swings, with 94% of firms reporting higher costs [3].

Strategic Allocation: The New Playbook

Institutional investors are rewriting the rules. Take WisdomTree’s dynamic hedging models, which use momentum-driven strategies to outperform static 50% hedges while cutting portfolio volatility [2]. These models adjust hedge ratios in real time, hitting 50% in March 2025 as geopolitical risks flared [2]. Similarly, Canadian pension funds are tailoring hedges to specific markets: unhedged in U.S. dollars, long in the yuan, and short in the real [3]. It’s a masterclass in precision.

For fixed income, full or over-hedging is the norm. A public pension plan partnered with PGIM to build a $1 billion multi-asset credit portfolio, swapping traditional high-yield bonds for alternative credit instruments to generate stable income [5]. This approach targets 150 basis points over benchmarks while managing risk—a bold move in a world where EM growth is slowing to 2.4% annualized [2].

Macro Events: The Wild Cards

Elections and trade policy shifts are the ultimate wild cards. Ahead of U.S. elections, firms are extending hedging durations from short-term forwards to multi-year contracts to lock in protection against policy-driven volatility [2]. The MSCI Emerging Markets Index, up 15.6% year-to-date, has outperformed the S&P 500, but post-debut volatility demands algorithmic rebalancing and sector diversification into tech and mining [4].

J.P. Morgan warns that trade policy shifts could trigger a global growth downshift and inflation rotation toward the U.S. [3]. That’s why investors are overweighting defensive sectors and inflation-linked bonds while underweighting credit risk [1]. It’s a balancing act between growth and protection.

The Bottom Line

Emerging markets aren’t dead—they’re just more complicated. With the dollar’s weakness making EM assets attractive, the key is to hedge smartly. Dynamic models, tailored strategies, and proactive rebalancing are non-negotiable. As one Delphos report puts it, “Currency risk isn’t a bug—it’s a feature in EM investing” [4].

Source:[1] FX Risk in Emerging Markets: Strategies for Success - Delphos [https://delphos.co/news/blog/foreign-exchange-risk-emerging-markets-smarter-strategies-for-capital-raising/][2] Bottom-Up Dynamic Currency Hedging Amid Uncertain US Policies - WisdomTree [https://www.wisdomtree.com/investments/blog/2025/04/07/bottom-up-dynamic-currency-hedging-amid-uncertain-us-policies][3] Tariff-driven Currency Volatility Hits North American Firms - Traders Magazine [https://www.tradersmagazine.com/am/tariff-driven-currency-volatility-hits-north-american-firms-profits-driving-surge-in-fx-hedging/][4] An Empirical Study of Emerging Markets - Global Risk Institute [https://globalriskinstitute.org/publication/currency-hedging-strategy-an-empirical-study-of-emerging-markets/][5] A Strategic Asset Allocation for Enhanced Income - PGIM [https://www.pgim.com/us/en/institutional/insights/annual-best-ideas/2025/case-studies/strategic-asset-allocation-for-enhanced-income]