the death of the petrodollar was finally noticed

8/9/2019 The Death of the Petrodollar Was Finally Noticed

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The Death Of The Petrodollar Was Finally Noticed

Submitted by Tyler Durden on 02/07/2015 19:09 -0500

Three months ago, we wrote "How The Petrodollar Quietly Died, And Nobody Noticed", in

which we explained in painful detail why far from the simple macroeconomic dogma which

immediately prompted the macro tourists to scream that "oil prices dropping are good for

US consumers", the collapse in the price of crude is not only a disaster for oil exporting

nations - one which will lead to a series of violent "Arab Springs" across the oil-producing

developed world - but far more importantly, have a massive impact on capital markets as a

result of the plunge in the most financialized commodity in history.

On the death of the Petrodollar we commented that unlike previously, when petrodollar

recycling funneled the proceeds from oil-exports into financial markets, helping to boost

asset prices and keep the cost of borrowing down, henceforth "oil producers will effectively

import capital amounting to $7.6 billion." We added that "oil exporters are now pullingliquidity out of financial markets rather than putting money in. That could result in

higher borrowing costs for governments, companies, and ultimately, consumers as money

becomes scarcer."

The conclusion was simple: "net capital flows will be negative for EM, representing the

first net inflow of capital (USD8bn) for the first time in eighteen years. This

compares with USD60bn last year, which itself was down from USD248bn in 2012. At its

peak, recycled EM petro dollars amounted to USD511bn back in 2006. The declines seen

since 2006 not only reflect the changed global environment, but also the propensity of

underlying exporters to begin investing the money domestically rather than save. Theimplications for financial markets liquidity - not to mention related downward

pressure on US Treasury yields – is negative."

In retrospect, it probably was not "simple enough", because even three months ago

everyone was confident that both higher yields and an increase in market liquidity are

imminent. Since then not only has the yield on the 10 Year plunged to near record low

levels (while 16% of global government debt now trades at negative yields), but judging by

the absolute liquidity devastation in the E-Mini, in Trasurys and virtually every other asset

class, few actually grasped the implications of what plunging oil really means in a world in

which this most financialized of commodities plays a massive role in both the global

economy and capital markets, not to mention in geopolitics, with implications far, far

greater than the amateurish "yes, but gas is now cheaper " retort.

So, three months later, we are happy to report that somebody finally noticed that the

Petrodollar has indeed finally died, and more importantly, has attempted to put together an

analysis of what we said in early November, reaching the conclusion that plunging oil just

may not be all that financial comedy TV has it cracked up to be.

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Did we say somebody? We meant everyone!

Below are extensive, in-depth, and long overdue questions on petrodollar recycling, or

rather its halt, and its implications from virtually every single Bank of America economist

and strategist who after months of stalling, have finally been forced to confront this most

critical of topics head on.

From Bank of America

Q&A on petrodollar recycling

We explore the economic, financial, and geopolitical implications that will result from

the collapse in oil prices and the reduction in petro-dollar flows.

We see a limited impact on UST yields or the USD. In recent years, the UK, Euro

area and EEMEA have benefitted from reserve diversification away from the USD. A

drying-out of petrodollar flows will reduce funding availability for current account

deficit countries, particularly the UK, and may hurt London’s real estate sector.

Venezuela’s debtors such as Cuba, which benefitted from Petrocaribe loans, as well

as left-leaning regimes in LatAm, will feel the pressure. Russia could lose regional

influence, although Ukraine’s dependence on its gas is still very high. Lower oil prices

should diminish the ability of Iran to project regional power. Growth model

limitations could eventually accentuate GCC social pressures, in our view.

The oil market outlook

Alberto Ades, co-head of Global Economics: Sabine, the natural starting point to a

discussion of petrodollar recycling is an assessment of the oil market. What is your readingof OPEC’s policy shift?

Sabine Schels, commodity strategist: Before the recent oil rebound, Brent crude oil

prices came off almost in a straight line from $115 to $50/bbl, making three very brief stops

at $85, $80 and $60. That marks the second steepest six-month decline in the oil

market’s history. In a dramatic policy shift, OPEC supply has kept increasing in recent

quarters despite falling prices, as Saudi Arabia seems intent on increasing its market share,

irrespective of the impact on price. Saudi Arabia has pledged not to take out supply even if

the price drops to $40, $30 or even $20 per barrel, suggesting curtailments will have to

come from high cost non-OPEC producers.


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The sharp price decline is delivering a windfall-tax to consumers globally while giving a

major blow to producers. For GCC alone, it is equivalent to $440bn in foregone revenues. In

our view, OPEC’s decision to give up on its traditional role of keeping supply and demand in

check will have far-reaching consequences across all asset classes as the flow of

OPEC petrodollars is drying up. In the absence of a quick and sharp rebound in oil

prices, this may drain liquidity from global asset markets, at least for the

remainder of 2015.

Alberto Ades: Recently, you cut your oil price forecasts significantly. What drives your

bearish view on oil prices for the next few months?

Sabine Schels: Basically, supply keeps running above demand. The term structure of

Brent, which preceded the collapse in prices, continues to weaken across the next 12

months as inventories are building at an alarming speed, setting the stage for lower, not

higher prices.

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Inventories typically build because supply exceeds demand in any given market. But in

some markets, like oil or gas, storage capacity is a finite number and price declines can

accelerate as inventories build. In previous oil price downturns, OPEC would reduce supply

as stocks built up to prevent a collapse in the term structure of prices. After all, when the

price of storage soars, storage operators benefit and oil producers suffer

However, this new OPEC policy will likely create a large inventory overhang, suggesting

further downside risks to oil prices. In fact, we see floating storage coming into play over

the coming months with roughly 55 million barrels building on ships by the end of

2Q15 as land-based inventories across North America, Europe and Asia fill up. But

even floating storage is limited by its very nature. If crude vessels fill up, shipping rates will

spike; and that is unlikely to help any oil producer in the world.

Alberto Ades: Given this new OPEC policy, couldn’t non-OPEC producers simply turn off

supply to stabilize prices? Are these producers large enough to influence the market

significantly?

Sabine Schels: To restore equilibrium in the oil market, we would need a sizeable supply

cut of at least 1 million b/d. In our view, it is not reasonable to expect non-cartelized

production to shut down immediately as prices fall because many producers are

well hedged, face very low cash costs, are partially protected by falling domestic

currencies or tax breaks, or are notoriously slow to react. According to our estimates,

with the exception of shale oil, which is cash flow intensive and thus dependent on price

(current or forward), non-cartelized crude oil output in many parts of the world is

not price sensitive at all, particularly in the first 12 months.

In the absence of a moderating agent like Saudi Arabia, this means prices have to fall below

operating cash costs (non-shale) or well below cash flow breakevens (shale) for

marginal producers. In our view, non-OPEC oil supply cuts will not come easy in the short

run, as operating cash costs sit below $40/bbl. True, investments will be put on hold as

some of the world’s output is challenged below $70/bbl in the long run. However,

production guidance continues to point up in 2015 for most listed companies. Unless

production guidance for 2015 goes negative or Saudi Arabia changes its policy, the market

could become more disorderly as oil prices find a floor around operating cash costs.

As a result, we now expect oil prices to spiral down toward the end of 1Q and

target Brent at $31/bbl and WTI at $32/bbl.

Alberto Ades: Since you expect no significant price bounce in the near future, do you see a

risk of the flow of petrodollars drying up in the longer term?

Sabine Schels: We have argued that once spending cuts by non-OPEC producers, most

likely US shale oil, are in place, Brent crude prices should start to recover. This will likely

happen in the second half of this year, to a year-end target of $57/bbl. For 2016, we


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forecast Brent crude oil prices averaging $58/bbl. All else equal, this should increase the

flow of petrodollars to the global economy, though to levels much lower than when oil was

in the $100+/bbl environment. However, there is a risk to our base case. This assumption

relies heavily on Saudi Arabian production staying at around the current level of 9.7 million

b/d. While the kingdom pledges not to cut output to prevent prices from falling, this new

OPEC policy could imply raising output, thus cutting into effective spare capacity.

If this occurs, oil prices may stay low for longer, depressing the flow of

petrodollars for years to come. This would allow them to increase their market share as

oil prices recover, rather than allow shale producers in the US to reenter the market.

In this context, it is important to note that Saudi production is close to a record high in

terms of total output, but not in terms of its share of the global market. So the question

remains whether the Saudis want to put their spare capacity to work in coming years and

increase output beyond 12 million b/d as oil prices start to recover. In that scenario, we

estimate the fiscal budget breakeven price for the Kingdom would fall quickly, by $22/bbl

from $94/bbl currently, meaning much-trumpeted reserves would last even longer to

sustain this new policy.

Alberto Ades: Could a rebound in global economic activity support an oil price recovery,

even under the new OPEC policy?

Sabine Schels: Our models suggest a six-month lag before lower prices start to impact

consumption positively. Assuming the lower prices create no spiraling effect in emerging

markets, this means global consumption should accelerate meaningfully in the second half

of this year and into 2016.

Global oil demand is driven by net oil importing countries and large oil producers.

Incrementally, we still expect China and India to deliver the bulk of the global consumption

increase in 2015, although we do not expect China’s oil demand to grow nearly as fast as it

did between 2004 and 2010, given domestic housing woes and an expensive currency.

While large importing countries like the US, China and India will likely see a bounce in

consumption in 2015 and 2016, demand in oil-producing countries could be meaningfully

slower next year as recession bites in Russia and lower oil prices negatively impact Middle

East economies. After all, many oil producers had

their cake and ate it too for years as oil prices rose.

As a result, we remain very concerned that slower demand from oil-producing

countries could come back to haunt the market. We estimate 50% of the growth in

demand in the last 10 years has come from oil-producing countries, a clear downside risk

to prices, and the flow of petrodollars, from here.

GCC: a possible tectonic shift in petrodollar recycling


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Alberto Ades: Jean-Michel, let’s turn to the regional impact of the petrodollar recycling

dry-up for the countries in the Gulf Cooperation Council (GCC). How did these countries

recycle petrodollars during the oil boom years?

Jean-Michel Saliba, Middle East and North Africa economist: GCC oil export earnings totaled

roughly US$1.04tn in 2014, for a cumulative US$10.8tn since 1970. These revenues havebeen recycled through two main channels, the absorption and financial account

channels. The former refers to the use of oil export receipts to finance imports of goods

and services. Through the second channel, current account surpluses translate into net

financial investments in the rest of the world. The split in these flows comes from the

sovereign’s intertemporal allocation decision between spending under the absorption

channel and saving under the financial account channel. The latter also involves an asset

allocation decision.

Alberto Ades: Let’s first discuss the absorption channel. How has i t evolved since the

1970s?

Jean-Michel Saliba: GCC absorption capacity has increased steadily with the launch of

large diversification and infrastructure spending programs. We estimate that around half of

the GCC oil export earnings were spent and recycled through imports between 2003 and

2014. In comparison, during the oil boom of the 1970s and 1980s, the ratio of imports to

exports increased rapidly from 0.3 to 0.6 on average in the 1980s and then remained fairly

elevated on large domestic development plans and declining oil prices. After peaking at 0.8

in 1986, the ratio has declined gradually after the spending drop of the 1990s. This

suggests the absorption channel has diminished in importance for GCC this time around.

Also, in the past, higher GCC imports lent support to global demand and mitigated the

widening of DM current account deficits due to higher oil prices. In other words, imports

were sourced back from developed markets. Over time, this channel has become somewhat

USD-negative as trade links with the US decreased at the expense of the rise in the share of

Asia.

Alberto Ades: Is it safe then to conclude that the financial account channel has recently

gained importance for the GCC?

Jean-Michel Saliba: Yes, and this is probably the reason why this is the channel people

tend to focus on when speaking of petrodollar recycling. Current account data suggest the

GCC has accumulated $2.7tn in net foreign assets since the 1970s1, $2.4tn of which has

likely come during the most recent oil boom that started in 2004


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Saving GCC petrodollars in the form of foreign assets held abroad has occurred largely

through the official sector. In turn, the GCC official sector’s outward investment has helped

sterilize oil receipts. This has shielded the domestic economies from excessive or volatile

liquidity, albeit only incompletely given the presence of currency pegs and robust fiscal

expansion.

Over time, the role of the GCC monetary authorities, except for the Saudi Arabia Monetary

Agency (SAMA), has been eclipsed by the rise of sovereign wealth funds. This likely implies

a less risk-averse asset allocation by GCC.

Alberto Ades: You bring up an important new player, namely the SWFs. Their relative size

and influence over global markets has increased sharply since the

1980s. What are the implications of this?

Jean-Michel Saliba: For one thing, the growing relevance of the financial account channel

and the rise of SWFs have made it more difficult to track the flows accurately. Through our

work, we have been able to account for the geographical destination of only about 50% of

the accumulated GCC net foreign investment.

Previously, tracking was simpler because the bulk of financial flows passed through DM

banks or DM securities markets. The GCC current account surpluses could broadly be

explained by increases in FX reserves and bank deposits in the US and Bank of International

Settlements (BIS) reporting countries. For example, between 1974 and 1979, 47% of total

identified investments were deposited in bank accounts in developed economies or used to

purchase UK or US money market instruments. The rest were simply used for long-term

lending, mainly to developing economies through international banks. These patterns

actually planted the seeds of the 1980s debt crises when flows dried out.

This time, financial account flows appear to have gained in sophistication, with

diversification across a larger set of asset classes and geographies, including regional and

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domestic ones. This likely implies a potentially less risk averse asset allocation by the GCC

countries

Alberto Ades: Of what you have been able to track, what are the geographical destinations

of GCC petrodollar investment flows?

Jean-Michel Saliba: We believe the bulk of petrodollars recycled through the

financial channel ended, either directly or indirectly, in the deep and liquid US

financial markets. After all, the rise in the GCC current account surpluses was mirrored by

the widening of the US current account deficit, whereas Emerging Asia has run surpluses

and the Eurozone has kept relatively flat external balances. Therefore, these flows ended up

financing the US, for the most part. Petrodollars may have funded an increase in domestic

and regional investment on a relative basis as well, but this remains hard to quantify. That

said, the Abu Dhabi Investment Authority (ADIA) allocation could be used as a very rough

guide on investment flows. Long-term neutral EM benchmark exposure for ADIA consists of

between 15% and 25% of assets under management. This contrasts with 35-50% for NorthAmerica, 20-35% for Europe and 10-20% for Developed Asia. Note that around 75% of

ADIA’s assets are managed externally and some 55% of ADIA’s assets are invested in

index-replicating strategies.

In terms of the cumulative stock of identified GCC foreign asset holdings, most of it is

concentrated in foreign direct investments in Europe, Asia, and the US, BIS offshore bank

deposits and US equities


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Alberto Ades: What would be the main implications of the dry-up in petrodollar recycling

likely to happen in a lower oil price environment?

Jean-Michel Saliba: Lower oil prices for longer should imply material shifts in the size

and direction of petrodollar recycling flows. Every $10/bbl drop in oil prices shaves off

4.2% of GDP from GCC current account balances. The move in oil prices between

US$115/bbl and US$52/bbl would therefore shave off US$440bn in export revenues

annually. The GCC external current account breakeven oil price is at approximately

$65/bbl, which would only make the region a net external creditor if oil prices rebound

sharply this year. The regional fiscal breakeven oil price is at $85/bbl, suggesting the GCC is

set to run a fiscal deficit on aggregate, the bulk of which is likely to be financed through a

drawdown of foreign assets currently held abroad.

History suggests GCC’s fiscal adjustment occurs with a lag. This would imply a sticky

absorption channel through still elevated imports in the near term. During the first year or

so of low oil prices, a country such as Saudi Arabia would draw down its official reserves to

finance the balance of payments gap. These assets are most likely invested in foreign



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deposits and liquid US securities, which would take a hit. Later, financial account flows,

which in the era of high oil prices were invested abroad to sterilize oil receipts, would likely

reverse their direction. This would leave a more manageable drawdown of official central

bank assets. Petrodollar shifts could reshape the geopolitical landscape

Alberto Ades: Jean-Michel, let’s conclude by discussing the changing geopolitics. Whatimpact do you expect for the Middle Eastern conflicts?

Jean-Michel Saliba: Over a longer time frame, we would expect lower financial support to

regional proxy armed groups to weaken some of the geopolitical dynamics on the ground.

However, this can be moderated by various factors. First, in the local press, the Iranian

leadership has expressed its belief that the new Saudi oil policy regime has clear geopolitical

motives. The closest analogy is perhaps the 1985 Saudi oil policy regime shift, which sent

oil prices tumbling and weighed on the conduct of the Iran-Iraq war. Iranian Foreign

Minister Zarif recently suggested that lower oil prices diminish the possible gains of the

Iranian regime concluding a nuclear deal with the P5+1 countries. Also, we note the Iranianmacro adjustment could make the threat of further sanctions less potent.

Second, the resurgent Houthi military gains in Yemen, continued engagement in the Syrian

conflict and recent Hezbollah-Israeli hostilities suggest Iranian regional ideological

involvement is unlikely to alter course materially in the near term given the elevated stakes.

In addition, a number of regional proxy armed groups were founded in the mid-1980s and

appear to have developed alternative financing mechanisms.

Finally, in some instances, lower oil prices could accentuate sectarian conflicts in the Middle

East. We suggested a risk to the colonial Sykes-Picot borders in Iraq, which has been

addressed imperfectly through US external intervention and the recent budgetary

agreement between Baghdad and the Kurdistan Regional Government. However, low oil

prices challenge the economics of the deal and deepen Iraq’s fiscal strains and liquidity

crunch.

Alberto Ades: Venezuela is another oil exporter that will also be directly impacted.

Francisco, how did Venezuela recycle petrodollars during the previous oil boom? I get the

sense that geopolitical trends in the region can’t be understood without a reference to

Venezuela and the “grants” it distributed to countries with shared political affinities. Is this

correct?

Francisco Rodríguez, Andean economist: Definitely. High oil prices in recent years

allowed Venezuela to expand its influence in the region. The cost of this was very large for

the country. We estimate the stock of loans to regional allies currently outstanding totals

$25bn. This is larger than the current Venezuelan international reserves. In other words,

the opportunity cost of Venezuelan foreign policy was not building a stabilization fund that

would have enabled it to smooth out the adjustment during periods of declining oil prices.


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These policies are unsustainable at current oil prices. In fact, the data already show a

notable decline in trade credits and other public sector investment assets, two capital

account items that essentially capture the change of liabilities of other countries with

Venezuela generated as a result of Petrocaribe and other cooperation agreements. Net

lending to other countries, as captured by the sum of these lines, fell to $1.9bn in the first

three quarters of 2014 from $5.9bn and $11.2bn for comparable periods in 2013 and 2012,

respectively.

Alberto Ades: And are we already seeing some of the effects of these drying out?

Francisco Rodríguez: Absolutely, the restoration of full diplomatic relations between the

United States and Cuba is an important byproduct of this decline in Venezuela’s influence.

From Cuba’s vantage point, the need to change its sources of external income is evident. As

of 2013, it received oil shipments from Venezuela totaling 98mbd. In our view, the

implications of this important announcement reach beyond Cuba’s borders, as it can help

reshape the relationships between the US and Latin America, a region where a large fractionof governments is headed by leftist parties.

Alberto Ades: We cannot discuss geopolitics of oil without discussing Russia. Every day we

hear that Russia will not only be affected economically but also politically, and even socially.

Vladimir, overall, how important is oil for Russia?

Vladimir Osakovskiy, Russia and CIS economist: We believe the impact of oil prices

goes well beyond the economy and deeper into Russian society. This dependence goes all

the way back to the late 1970s, when the then USSR became one of the major energy

exporters and an important player on the global energy markets. In periods of relatively

high oil prices, the abundant inflow of capital tended to create strong momentum in the

economy, which also coincided with periods of a very assertive foreign and domestic policy


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For example, historically high oil prices between the late 1970s and early 1980s correlated

with the peak of the tensions between the US and the USSR in various parts of the world.

More recently, record high oil prices in mid-2008 and between 2011 and early 2014

coincided with a brief war with Georgia in August 2008 and the political crisis in Ukraine. On

the contrary, periods of low and falling oil prices have coincided with times when Russia’s

relations with the West tended to improve. We can say that with respect to the entire

Perestroika in 1987 and the US-Russia reset in early 2009.

Also, there are numerous ways in which such high oil revenues have been converted into

political capital. Obviously, more abundant capital gave the government a greater ability to

increase spending on such a political item as defense, which gave it more tools for an

independent foreign policy on the international agenda. Russia's defense spending reached

peaks in the mid-1980s and in 2014.

Similar to what Francisco described for Venezuela, abundant and expansive energyresources also provide a lot of “soft power” that can be converted easily into political

benefits through discounted gas shipments, direct financial support to loyal governments,

etc. Over the past 5-10 years Russia has been quite active in supporting loyal governments

in Belarus, Armenia and Ukraine. However, the capacity for such soft power is declining with

lower oil prices and, even more importantly, the value of energy concessions that Russia

can offer is falling as well.



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Alberto Ades: Vadim, with all this background that Vladimir outlined, can we expect easing

of the geopolitical tensions in Ukraine as a result?

Vadim Khramov, Ukraine and CEE economist: From the geopolitical standpoint, there is

an argument that Russia would have to take a softer stance on Ukraine, as falling oil prices

and western sanctions hurt the Russian economy. For now, the conflict in eastern Ukraine isstill ongoing and at the end of 2014, there was even some escalation of tensions. Therefore,

it is hard to say that Russia is taking a softer stance on Ukraine for now. However, we do

not know the counterfactual on the situation had oil prices stayed high.

One major issue is related to Ukraine energy imports from Russia. As you know, Ukraine is

an energy importer. According to our estimates, the recent drop in oil prices will allow it to

save about $4bn on the imported gas bill as well as $3-4bn on petroleum-related imports.

Also, Ukraine’s energy dependence on Russia has reduced not only in price but also in

volume terms. This limits Russia’s ability to add more pressures on Ukraine.

That being said, our estimates show that Ukraine still will have to buy almost half of its gas

imports from Russia in the next few years, as large gas substitution from Europe is unlikely.

Therefore, even under a situation with low energy prices, Russia can add pressure on

Ukraine along the energy lines. For this reason, in my view, the short-term impact of low

energy prices on the Ukraine conflict overall is still limited.

Alberto Ades: Let’s briefly discuss potential impacts on domestic policies in Russia.

Vladimir, are these affected as much as foreign policies?

Vladimir Osakovskiy: Sure. In the past, discussions about reforms in Russia have

occurred during periods of low oil prices. For example, the USSR started democratizationand its move away from the planned economy in the late 1980s when it was facing massive

resource constraints due to a sharp decline in oil prices. After oil prices dipped below

$10/bbl, Russia was pushed to accept the IMF program in 1998, even though it did not help

to avert the default.

Conversely, the intensity of Russia's reforms fell quickly and the government increased its

assertive control over society as oil prices started to rise at the beginning of the century.

The reformist and democratic agenda had a tentative recovery in 2009 when the oil price

dropped below $30/bbl. However, this period faded quickly, just as oil prices recovered

quickly.

* * *

Strategy impact will be larger for FX than for rates

Alberto Ades: Gustavo, let’s switch away from regional geopolitics and back into global

economics and strategy. As petrodollar recycling dries out, will this hit global liquidity

conditions?


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Gustavo Reis, global economist: Jean-Michel noted petrodollar flows likely ended up in

liquid US financial markets; therefore, a consequent effect would be diminished

support for US asset prices. There are other adjustments that can override this,

however. Unlike in the 1970s, when oil revenues were mostly recycled through banking

channels, the ongoing adjustment in global rates and exchange rates is key to

understanding how petrodollar flows will ultimately affect overall financial conditions.

Our Global Liquidity Tracker shows the recent oil price drop coincides with a moderate

tightening in global liquidity conditions. The higher market volatility and diminished risk

appetite have offset the drop in global bond yields. Much of this reflects global growth

concerns, which have also been weighing on oil prices. Moreover, monetary policy in the

Euro area and Japan will probably deviate from the playbook of looking through oil price

changes by responding assertively to increased deflation risks.

Despite the uncertainty on recycling routes, my view is that petrodollar flows will be of

second-order importance to global liquidity in 2015. Estimating the impact of petrodollarflows on global market conditions a decade ago, the International Monetary Fund found

them to be limited. A more patient Federal Reserve, additional easing by the

European Central Bank and Bank of Japan, as well as the decline in long-term

global inflation expectations, will likely dominate. This suggests a contained

potential impact of petrodollar flows over and above the market gyrations

associated with the oil price plunge.

Alberto Ades: Shyam, in terms of strategy, given the GCC’s sizable holdings of US fixed

income assets, what will be the impact on US rates? Should we expect a sell-off of US

Treasuries?

Shyam Rajan, rates strategist: As Jean-Michel mentioned, there is definitely a risk that

countries like Saudi Arabia will draw down liquid US securities to finance any balance of

payments gap. After all, according to the latest TIC holdings data, OPEC nations hold about

$280bn of UST, with another $200bn held by Russia and Norway.

However, we are less concerned about the impact of this flow on the rates market for two

reasons. First, corporate bond and stock holdings of Middle East oil-exporting

nations have increased by almost twice that of UST over the last four years (up about

$70bn since 2010). This increased preference for higher-yielding and higher-risk assets

likely explains why the relationship between UST flows from this region and oil prices hasweakened substantially recently. This is consistent with Jean-Michel’s intuition that the

emergence of SWFs has probably led to a less risk averse allocation by GCC.

Second, sales by these countries are usually more than offset by other flows. It is important

to remember that the top four oil importers excluding the US (China, Japan, India and

South Korea) own five times the amount of UST held by the oil exporters. Increased buying

from these countries could therefore easily offset any sales. In addition, a further drop in


15/15

oil prices as envisioned by Sabine would probably increase risk aversion and safe

haven flows into the UST market.

Alberto Ades: Talk of UST yields and inflation may have implications for Fed action. Mike,

could the shift in petrodollar recycling influence the Fed’s monetary policy during 2015?

Michael Hanson, United States economist: Not in my view. For the Fed, the decision on

when to begin the tightening cycle will depend on how it assesses the progress toward

maximum employment and price stability in the dual mandate. But as the January FOMC

statement revealed, financial and international developments will also play a role. If the

shedding of US assets by oil-exporting economies results in an appreciable

tightening of US financial conditions, the Fed may move later or more gradually in

its exit strategy.

* * *

In other words, from irrelevant, to "unambiguously good" if only for those who have zerounderstanding of what it means, suddenly the end of the Petrodollar recycling chain is said

to impact everything from Russian geopolitics, to global capital market liquidity, to safe-

haven demand for Treasurys, to social tensions in developing nations, to the Fed's exit

strategy.

Or said otherwise, we now know why the Fed felt like adding the word "international

developments" in its latest statement.
http://www.zerohedge.com/news/2015-01-28/unanimous-fed-remains-patient-target-normalize-rates-expects-lower-inflationhttp://www.zerohedge.com/news/2015-01-28/unanimous-fed-remains-patient-target-normalize-rates-expects-lower-inflationhttp://www.zerohedge.com/news/2015-01-28/unanimous-fed-remains-patient-target-normalize-rates-expects-lower-inflationhttp://www.zerohedge.com/news/2015-01-28/unanimous-fed-remains-patient-target-normalize-rates-expects-lower-inflationhttp://www.zerohedge.com/news/2015-01-28/unanimous-fed-remains-patient-target-normalize-rates-expects-lower-inflationhttp://www.zerohedge.com/news/2015-01-28/unanimous-fed-remains-patient-target-normalize-rates-expects-lower-inflation

the death of the petrodollar was finally noticed

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