Should credit investors worry about foreign central banks’ gradual exodus from USD-denominated assets? Absolutely.

Central bank reserves are a vital anchor for the stability of commercial banks and the broader financial system. By ensuring that transactions can be settled smoothly, they play a central role in maintaining financial stability.

By holding USD-denominated assets, foreign central banks also help finance the sizable U.S. federal budget deficit.

However, the share of global foreign exchange reserves held in U.S. dollars has been trending downward over the past 25 years, falling from 72% in 2001 to just 57% today. Worryingly, this trend — often referred to as de-dollarization — appears to have accelerated in recent years, driven by several factors, including:

·        Western sanctions, which have encouraged Russian oil products to be traded in the local currencies of buyers

·        China’s strategic push to reduce its reliance on the U.S. dollar and lessen exposure to U.S. influence

·        An increasingly unpredictable U.S. foreign policy, which may be reducing global demand for dollar assets

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At the current rate of decline, the share of USD-denominated foreign exchange reserves could fall below 50% within the next decade — a level last seen in the early 1990s, following a turbulent period marked by high U.S.inflation, repeated recessions, and a loss of confidence in the dollar.

For credit investors, the implications are meaningful. According to estimates from J.P. Morgan Research, every $300 billion decline in foreign holdings would push U.S. yields higher by more than 33 basis points. On that basis, if the current trend continues, U.S. interest rates could rise by more than 60 basis points over the coming decade.

Any further rise in rates would clearly be problematic for credit investors.

In our view, the U.S. administration is playing a dangerous game: weaponizing the dollar may deliver short-term geopolitical leverage, but the long-term economic costs could be severe.

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