Three mechanisms that prevent the US dollar from depreciating – Natixis

The dollar has not depreciated in the recent period despite the United States' large external deficit and its large accumulation of external debt. Three mechanisms can be put forward to explain this lack of depreciation of the dollar, analysts at Natixis report.

Size of bond capital flows heading to the US while leaving the eurozone

“International bond capital is flowing into the United States, in significant quantities and sufficient to finance the US external deficit, while it is flowing out of the eurozone on average.”

Prospect of earlier exit from expansionary monetary policy in the US than in the eurozone

“The faster recovery in activity in the US has led to expectations of a faster exit from expansionary monetary policy in the US than in the eurozone (stabilisation of the Federal Reserve’s balance sheet in 2022, rather than 2023 in the eurozone, start of the hike in short-term interest rates in 2023 in the US, rather than 2024 in the eurozone).”

The attractiveness of the US equity market

“The faster growth in stock market indices in the US attracts international investors more to US equities than to European equities, which is obviously positive for the dollar. There may even be an offsetting effect between bonds and equities: when risk aversion rises, which has been the case in the most recent period, there are fewer buyers of US equities, but more buyers of US bonds.”

What would it take for the US external debt to lead to a depreciation of the USD?

“US external debt could lead to a depreciation of the dollar only if: The ECB announced an exit from its highly expansionary monetary policy; The European bond market became more attractive for non-residents.”