- The dollar index jumped to a 20-year high above 112 thanks to the Federal Reserve’s tightening policy.
- While the dollar is bullish, Bitcoin and other cryptocurrencies are struggling with the Fed’s interest rate hikes.
- While the dollar is currently up against other currencies, a decline in inflation or the end of the European energy crisis could revive interest in risky assets.
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Bitcoin and the broader cryptocurrency market are struggling to stay above June lows due to the dollar’s renewed strength.
BTC down as DXY rally
Bitcoin is fighting against the dollar and losing.
The dollar index (DXY), a financial instrument that measures the price of the US dollar against a basket of other currencies, hit a new 20-year high on Friday, pushing other world currencies and risk assets down. DXY, which measures the dollar’s value against a basket of other currencies, broke through 112 this morning. It is trading around 112.8 at press time, according to data from TradingView.
The cryptocurrency market has been particularly hit in recent weeks due to the renewed strength of the greenback. Bitcoin rallied briefly to $ 25,200 in August as the dollar returned from its July highs. However, since then, cryptocurrencies have been squeezed under the weight of the rising dollar. Bitcoin now appears to be stuck below $ 20,000 as the dollar continues to rise, trading at around $ 18,810 at press time, according to data from CoinGecko.
Much of the positive action on dollar prices can be traced back to the Federal Reserve’s rising interest rates. As the Fed raises 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, a side effect of this scheme is that it makes the dollar a much more attractive investment.
Tightening dollar liquidity means market participants have less liquidity to invest in riskier assets like cryptocurrencies and stocks. In turn, this reduces demand, causing asset prices to drop. The Federal Reserve also stopped buying US Treasuries as part of its tightening policy. This has caused U.S. bond yields to rise, which helps the dollar’s value rise as more investors buy these bonds.
The dollar milkshake theory
It’s not just cryptocurrencies and stocks that are suffering from the US dollar’s surge. As the Fed began raising rates to fight inflation earlier than other nations and has been increasingly aggressive in the magnitude of its increases, the liquidity of the global economy is flowing into US dollars at a record pace.
This effect was coined “Dollar Milkshake Theory” by Santiago Capital CEO Brent Johnson. It assumes that the dollar will absorb liquidity from other currencies and countries around the world whenever the Fed stops printing due to its place as the world’s reserve currency.
Ever since the US reserve bank shut down its money printer and started squeezing liquidity in March, the dollar milkshake theory appears to be working. The euro, the highest weighted currency against the dollar in the DXY, plummeted throughout 2022, recently hitting a new 20-year low of 0.9780 against the dollar.
The other world currencies are not doing much better. The Japanese yen tumbled to a 24-year low on Thursday, prompting government intervention to help support the currency. While the European Central Bank has responded to the weakening of the euro by raising interest rates, the Bank of Japan has so far refused to do so. This is because it is actively engaged in controlling the yield curve, keeping interest rates at -0.1% and buying an unlimited amount of 10-year government bonds in order to keep yields 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 indicate the end of the dollar’s dominance and its ripple effects. If next month’s Consumer Price Index data falls sharply, investors could turn to riskier assets in hopes that the Fed will moderate its interest rate hikes. Elsewhere, a resolution of the current Russian-Ukrainian war could help alleviate the global energy crisis by reducing the cost of oil and gas. However, for the time being, the dollar’s rise shows no signs of slowing and that could keep cryptocurrencies trapped near annual lows.
Disclosure: At the time of writing this piece, the author owned ETH, BTC, and many other cryptocurrencies.