This time, why hasn't the US dollar strengthened significantly? -- A "dramatic shift" in global capital flow patterns

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In the current intertwining of global energy crises and geopolitical conflicts, the United States, as a major energy producer, should be a beneficiary, but the US dollar has not rebounded sharply.

On March 20, Deutsche Bank released two research reports, deeply analyzing the profound changes in the current foreign exchange market and global capital flows. Strategists George Saravelos and Oliver Harvey pointed out that the nature of the current shock and the transmission channels of capital flows are completely different from those in 2022, and global capital flow patterns are undergoing a “major transformation,” which directly suppresses the upward space for the US dollar.

(The current US dollar fluctuates near the 100 level, still noticeably lower than the 2022 level above 110)

Interest Rate Advantage Gone, Global Central Banks "Change Face" Together

During the Russia-Ukraine crisis of 2022, the Federal Reserve’s aggressive rate hikes made the US dollar stand out. But this time, things have changed.

Deutsche Bank points out that changes in interest rate differentials are not moving in favor of the US dollar. Major global central banks are shifting to a hawkish stance at a faster pace. This week, the Bank of England, Bank of Japan, Riksbank, and European Central Bank all released strong hawkish signals in press conferences. Deutsche Bank economists even expect the ECB to raise rates twice this year.

This means the US is no longer the only high-yield safe haven. When other major economies also tighten monetary policy, the dollar’s interest rate advantage is sharply diminished, and capital no longer rushes blindly into the US.

"Selling Dollars" as the Optimal Solution, Foreign Capital Stops Buying US Assets

Faced with high energy import bills, Asian and Middle Eastern countries are adopting a new strategy: consuming dollar reserves.

Deutsche Bank believes that for these countries, using dollar-denominated foreign exchange reserves and excess savings to pay import bills is currently the most rational policy response. This not only prevents currency depreciation, thereby mitigating imported inflation, but also preserves domestic fiscal space.

However, a side effect of this strategy is a direct reduction in demand for US assets. Deutsche Bank’s high-frequency ETF monitoring data shows a sharp slowdown in foreign private purchases of US assets, in stark contrast to the continuous inflows observed in 2022.

“Many Asian central banks have already intervened actively in the market.” Deutsche Bank stresses that this intervention isn’t restricted to official reserves, but extends to private capital. When global buyers no longer pay for US assets, the impetus driving the dollar upwards naturally weakens.

Petrodollar Flows Blocked, Middle Eastern "Moneybags" No Longer Generous

Aside from Asia, the world’s largest petrodollar “reservoir” in the Middle East is also showing movement.

Historically, Gulf economies have been among the world’s largest savers. Just the net international investment positions of the UAE and Saudi Arabia are close to $2 trillion. Among the world’s top ten sovereign wealth funds, four are in the Middle East. This enormous wealth accumulated from petrodollars used to frequently flow back into US financial markets, supporting dollar hegemony.

But the Iran conflict may disrupt this cycle. Deutsche Bank notes that although there is not widespread financial pressure in the region yet, if the conflict persists, it will impact oil prices, as well as energy flows and hydrocarbon exports.

To cope with domestic deficits, Middle Eastern countries may have to tap into their foreign exchange savings. “From a policy perspective, when global geopolitical shifts cause domestic financing needs to increase, should petrodollars continue to pay for America’s deficit?” Deutsche Bank raises a soul-searching question.

When neither Asia nor the Middle East is willing to pay for America’s deficit anymore, the strong foundation of the US dollar is quietly being eroded.

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