So long to Saudi petrodollar recycling
Saudi Arabia’s shift away from being a major player in petrodollar recycling into credit markets appears confirmed by today’s US Treasury data. The steady increase in holdings of US Treasuries (UST), both outright and relative to overall reserves, is mirrored in bank deposits, with the decline in reserve assets hitting other allocations.
The shift in composition represents an important shift of style, in favour of liquidity and reducing the risk profile of reserve assets. The cause would appear to be the on-going challenge of low oil prices, with government deposits at the Saudi Arabian Monetary Authority (SAMA) declining steadily as a lagged response to falling crude oil prices. Unless Saudi crude oil prices rebound to around $100/bbl, this decline will continue unabated.
SAMA’s behaviour raises an important broader point: the compositional impact of a decline in excess reserves. Central banks globally are major holders of higher-rated government bonds, particularly US Treasuries (with a USD peg, Saudi Arabia’s reserves should be even more skewed towards UST). It’s natural then to think that a decline in reserve assets should affect holdings of UST proportionally.
As a first response, this should be the case; UST are held precisely because they are more liquid instruments. When the demand for liquidity first appears, these are the assets that should be sold first. However, if the decline is seen as a more permanent shock, the medium- to long-term impact should be a restocking of UST holdings and rotation out of riskier assets.
Whether compositional effects dominate will depend both on the starting point for the mixture of assets, as well as the pace of decline. In Saudi Arabia’s case, the portfolio mix was riskier (again, with a USD peg, there should be a far greater allocation to UST than appears to have been the case), with the adjustment coming through allocations to other assets; while reserves fell by US$147bn over the past two years, the decline ex-UST and bank deposits was a much larger amount, US$188bn. It’s unlikely that these ‘other securities’ were Bunds, JGBs, and so on, as it would be at least as easy for SAMA to transact UST as these other markets. The likelihood is that these allocations were into external allocations.
For asset managers, those with mandates from SAMA are likely to see continued withdrawals, squeezed by a compositional shift towards UST and deposits on one side, and a decline in reserve assets on the other. The days of petrodollar recycling into credit markets for this major player appear to be receding ever further into the rear view mirror.
