Key points to remember
- The dollar index jumped to 20-year highs above 112 on the back of the Federal Reserve’s economic tightening policy.
- As the dollar soars, Bitcoin and other cryptocurrencies are struggling due to Fed interest rate hikes.
- While the dollar is currently appreciating against other currencies, a drop in inflation or the exit from the European energy crisis could revive interest in risky assets.
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Bitcoin and the broader crypto market are struggling to stay above their June lows due to renewed dollar strength.
BTC Down as DXY Rally
Bitcoin fights against the dollar and loses.
The Dollar Index (DXY), a financial instrument that measures the price of the U.S. dollar against a basket of other currencies, hit a new 20-year high on Friday, sending other global currencies and assets lower. risk. DXY, which measures the value of the dollar against a basket of other currencies, rose above 112 earlier this morning. It is trading at around 112.8 at press time, according to data from TradingView.
The crypto market has been particularly hard hit in recent weeks due to the greenback’s renewed strength. In August, Bitcoin saw a brief rally to $25,200 as the dollar retreated from its July highs. However, since then, crypto assets have been crushed under the weight of the rising dollar. Bitcoin now appears pinned below $20,000 as the dollar continues to climb, trading at around $18,810 at press time, according to data from CoinGecko.
Much of the positive dollar price action can be attributed to the Federal Reserve’s interest rate hike. As the Fed hikes rates to fight inflation, it tightens US dollar liquidity. This should help bring inflation down by making it more expensive to borrow money, thereby reducing demand. However, one of the side effects of such a scheme is that it makes the dollar a much more attractive investment.
Tighter dollar liquidity means market participants have less cash to invest in riskier assets like cryptocurrencies and stocks. This, in turn, reduces demand, causing asset prices to fall. The Federal Reserve also stopped buying US Treasury bonds as part of its tightening policy. This has driven US bond yields higher, helping the dollar rise in value as more investors buy these bonds.
The Dollar Milkshake Theory
It’s not just crypto and stocks that are hurting from the surging US dollar. While the Fed started raising rates to fight inflation ahead of other countries and has been increasingly aggressive in the size of its hikes, liquidity from the global economy is flowing into the US dollar at a record pace.
This effect was coined the “milkshake dollar theory” by Santiago Capital CEO Brent Johnson. He postulates that the dollar will suck liquidity from other currencies and countries around the world whenever the Fed stops printing due to its place as the world’s reserve currency.
Since the U.S. Reserve Bank turned off its money printer and began tightening liquidity in March, the Dollar Milkshake theory seems to be coming to fruition. The Euro, the currency that receives the largest weighting against the Dollar in the DXY, has been falling throughout 2022, recently hitting a new 20-year low of 0.9780 against the Dollar.
The other world currencies are not faring much better. The Japanese yen fell to its lowest level in 24 years on Thursday, prompting the government to intervene to help prop up the currency. While the European Central Bank has responded to the weaker euro by raising interest rates, the Bank of Japan has so far refused to do so. Indeed, it is actively engaged in controlling the yield curve, keeping interest rates at -0.1% while buying unlimited 10-year government bonds to keep the yield at a target of 0.25%.
As things stand, it seems increasingly difficult for assets such as cryptocurrencies to find strength in a deteriorating global economy. However, there are several signs that investors can pay attention to that could signal the end of dollar dominance and its ripple effects. If next month’s consumer price index data registers a noticeable decline, investors could turn to riskier assets in the hope that the Fed will moderate its interest rate hikes. Elsewhere, a resolution to the current Russian-Ukrainian war could help ease the global energy crisis by reducing the cost of oil and gas. Yet, at the moment, the dollar’s rise shows no signs of slowing down, which could keep the crypto trapped near yearly lows.
Disclosure: At the time of writing this article, the author owned ETH, BTC, and several other cryptocurrencies.