Europe Will Not Use the Exit from U.S. Treasury Bonds as a Weapon

SadaNews - The deterioration of transatlantic relations, recently fueled by U.S. President Donald Trump's attempt to acquire Greenland, may lead to a gradual redistribution of capital. However, using Europe's holdings of U.S. Treasury bonds, valued at around $3.5 trillion, as a weapon would be difficult to execute and is likely to yield counterproductive results.

The "Sell America" strategy is not in Europe's interest: the financial consequences would be severe, given the region's significant reliance on U.S. dollar funding.

While a sudden exit from U.S. Treasury bonds at low prices is unlikely, changes in transatlantic relations are not neutral regarding capital flows. This impact is already evident in foreign exchange markets, where the euro has risen by more than 10% against the dollar since the trade shock that occurred in April.

The ongoing dispute over Greenland and the general deterioration of relationships may gradually shift European investors away from U.S. assets, increasing upward pressure on the euro - gains that will negatively affect economic activity and complicate inflation forecasts.

Europe Will Not Do What China Does

China has never taken a step in this direction for the same reason we believe Europe won't: selling Treasury bonds at low prices would be like a fire that burns everyone.

The deterioration of relations between Europe and the United States is starting to cast shadows over financial markets. After the recent escalation in the Greenland dispute, the discussion shifted towards using Europe's Treasury bond holdings as leverage against Washington. As it is said, targeting capital rather than trade flows would have a more significant impact on markets.

European investors hold nearly $3.5 trillion in U.S. Treasury bonds, which represents about 40% of the total U.S. government debt held abroad, surpassing Asia last year. Theoretically, this concentration highlights America's dependence on European capital and suggests that these holdings offer considerable leverage.

But does this really mean that Europe can turn its Treasury bond portfolio into a geopolitical weapon? And are markets really at risk of selling them at low prices? In short, no, for several reasons:

The proportion of Treasury bond holdings by European public sector investors that could be mobilized for a coordinated sale is minimal. More importantly, the financial repercussions would be severe, including for Europe itself.

European Dependency That Is Hard to Shed Anytime Soon

The financial system in the region remains heavily reliant on U.S. dollar funding. Holdings of dollar-denominated debt securities, including Treasury bonds and mortgage-backed securities from government agencies, are a key component of the high-quality liquid assets for eurozone banks, supporting short-term funding and helping meet regulatory liquidity requirements.

A study by staff at the European Central Bank indicates that the value of eurozone banks' dollar-denominated loans is at least €700 billion, which equals 9.2% of total loans.

Any random selling would lead to sharp asset value erosion and exacerbate financial pressures on both sides of the Atlantic. There is no doubt that a financial collapse is not in anyone's interest.

For European policymakers, the pursuit of greater strategic independence using U.S. Treasury bonds as a geopolitical tool is unlikely to be achieved. The more fruitful path lies in strengthening the European financial system itself: deepening capital markets, increasing the depth and liquidity of euro-denominated assets, and expanding payment and settlement infrastructure to reduce dependence on dollar channels.

Over time, these steps - rather than coercive financial methods - will contribute further to enhancing Europe's financial resilience and the role of its single currency internationally.

Are You Ready for a Stronger Euro?

A sale of U.S. Treasury bonds at low prices is unlikely. However, this does not mean that changes in transatlantic relations will be neutral regarding capital flows. A clear example is already manifesting in foreign exchange markets: the euro has risen by more than 10% against the dollar since the trade shock in the second quarter of last year, rising by about 7% in real terms.

Our model, which analyzes daily movements in the euro to dollar exchange rate to reveal its main drivers, indicates that shifts in global risk sentiment were a primary driving force behind this rise, as investors sought to diversify their investments away from the traditional safe-haven role of the dollar towards other currencies, particularly the euro. Changes in perceptions of relative monetary policy stances have reinforced this trend.

In summary, using capital as a weapon would have very destructive effects, particularly on Europe itself. This does not rule out the continued market-driven decline of dollar-denominated assets if doubts about their safe-haven status grow and concerns about the financial outlook for the U.S. persist.

As with trade, shifts in transatlantic relations increasingly affect capital flows, with the resulting gradual yet significant market consequences.