Analysis – As sanctions ‘arm’ the US dollar, some Treasury buyers may back off

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© . FILE PHOTO: US dollar banknotes are shown in this image, taken Feb. 14, 2022. REUTERS/Dado Ruvic/Illustration

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By Karen Brettell () – US sanctions against Russia should hasten a move by some countries to reduce their reliance on the US dollar, which could also dampen demand for treasury bills, much like the Federal Reserve, the largest holder of US dollars. debt, appears to be cutting his bond holdings. The United States and other Western countries have imposed widespread economic sanctions on Russia in response to the invasion of Ukraine, which effectively cut off the Russian central bank, its sovereign wealth fund, banks and certain individuals from engaging in US dollar transactions. The dollar is the main reserve currency in the world. Analysts say using it as a financial weapon is likely to accelerate a move already underway by many countries to diversify investment in alternative currencies. “The more we use it, the more other countries are going to diversify for geopolitical reasons,” said Zongyuan Zoe Liu, a fellow for international political economy at the Council on Foreign Relations. The dollar’s reserve status stimulates demand for US assets, including government bonds, and allows the government to issue more debt at lower rates than would otherwise be possible. Treasuries are also attractive to investors because the market is larger and more liquid than others. However, if Treasuries are less attractive to some investors, just as more supply enters the market, the result could be higher yields. The Fed is expected to begin maturing government bonds in the coming months without replacing its $8.9 trillion balance sheet, in addition to aggressive rate hikes to tackle rising inflation. 10-year benchmark returns hit 2.56% on Monday, the highest level since May 2019. While the dollar is unlikely to be replaced as a reserve currency any time soon, a steady shift in the greenback could lead to a more fragmented global economy where payments more evenly distributed between currencies, including the dollar, euro and yuan. “The depreciation of the US dollar (is the) final result as the dollar is weaponized in a new era of sanctions,” analysts at the Bank of America (NYSE:) led by Michael Hartnett said in a report released Thursday. In a sign that the shift is already gaining momentum, The Wall Street Journal said this month that Saudi Arabia was in talks to price the crude it sells to China in yuan. Russia has phased out its dollar holdings since imposing Western sanctions following Moscow’s annexation of Crimea in 2014. In 2021, it said it would ditch all US dollar assets in its National Wealth Fund and increase holdings in euros and gold. . According to data from Treasury International Capital (TIC), Russian government bonds have fallen to negligible levels in mid-2018, falling from about $150 billion a decade ago. Other countries have also reduced their bond holdings. China held $1.1 trillion in Treasures in January, making it the second largest foreign owner after Japan, up from about $1.3 trillion in 2013. $12 trillion over this period. Saudi Arabia had $119 billion in government bonds in January 2022, down from $185 billion in February 2020. Demand for bonds by oil producers in the mid-2000s was seen as key to keeping interest rates low, even as the Fed undertook a two-year hike cycle. This time, oil producers will be less likely to intervene, even as they benefit from rising oil prices, said Thomas Mathews, a market economist at Capital Economics. “The sanctions against Russia will be a bit alarming for many of the major oil exporters who hold large amounts of government bonds (and US assets in general) and could expedite some diversification plans. That could mean that some of the support for treasury bills from foreign savings, as we saw in the mid-2000s, could be absent during this tightening cycle,” Mathews said. That said, even if these countries continue to reduce their purchases of government bonds, they are not expected to launch major sales of the bonds. There may also be limits to the extent to which countries can reduce their holdings, as there are few alternatives in terms of security and liquidity. If yields continue to rise, bonds can attract alternative buyers. “As interest rates get higher and the prospects of an economic slowdown continue to grow, there will be a diversification from risky assets into Treasuries so yields may become a little more stable themselves,” said Thomas Simons, a money market economist at Jefferies. “I think it’s more of a risk to risky assets in this environment than Treasuries.”

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