Dollar: Fragmentation Risk and Reserve Diversification — MUFG

MUFG analyst Michael Wan recently noted that U.S. threats to penalize countries with economic ties to Iran, along with new sanctions on over 60 entities, are intensifying fragmentation risks in the global financial system and accelerating central banks' diversification of foreign exchange reserves.

**Sanctions threats shake confidence in dollar reserves**

The recent U.S. secondary sanction threats against Iran have directly impacted some countries' willingness to continue holding the dollar as a primary reserve asset. Market signals indicate that this weaponization of the dollar system has raised concerns among multiple nations about their financial security, prompting them to seek reduced reliance on the dollar. MUFG analysts believe this is not a short-term market fluctuation but a structural shift that could persist for years.

**Reserve diversification trend accelerates**

Against this backdrop, global central banks' moves to increase gold holdings and explore bilateral local-currency settlements are expected to gain new momentum. Reports suggest some emerging market central banks have begun adjusting their foreign reserve compositions to hedge against potential sanction risks. If this trend continues, it could gradually erode the dollar's dominance in global reserve currencies and exert long-term downward pressure on the dollar exchange rate.

**Dollar faces multiple near-term pressures**

As of press time, the dollar index was trading near 99.02, in a multi-year low territory. Beyond geopolitical structural concerns, market repricing of Fed policy paths is also weighing on the dollar. MUFG's view provides new medium-to-long-term logic for a bearish dollar outlook, namely that the unpredictability of U.S. foreign policy itself is becoming an additional risk premium on dollar assets.