- The dollar index rose to a 20-year high above 112 thanks to the Federal Reserve’s economic tightening policy.
- As the dollar rises, Bitcoin and other cryptocurrencies struggle due to Fed rate hikes.
- Although the dollar is currently appreciating against other currencies, a decline in inflation or an end to 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 as the dollar strengthens again.
Bitcoin falls as dollar rallies
Bitcoin is fighting against the dollar and it is losing.
The Dollar Index (DXY), a financial instrument that measures the value of the U.S. dollar against a basket of other currencies, hit a 20-year high on Friday, undercutting other world currencies and riskier assets. DXY, which measures the value of the dollar against a basket of other currencies, crossed 112 this morning. It is trading around 112.8 at press time, according to TradingView data.
The cryptocurrency market has been hit particularly hard in recent weeks due to the renewed strength of the dollar. In August, Bitcoin experienced a brief rally to $25,200 as the dollar retreated from its July high. However, since then, crypto assets have been crushed under the weight of a rising dollar. Bitcoin now appears to have stabilized below $20,000, trading around $18,810 at press time, according to CoinGecko data, while the dollar continues to climb.
Much of the dollar’s positive price action can be traced to the Federal Reserve’s rising interest rates. The Fed is tightening US dollar liquidity as it raises rates to fight inflation. This should help lower inflation by making debt more expensive, thereby reducing demand. However, one side effect of such a regime is that it makes the dollar a more attractive investment.
Tightening dollar liquidity means market participants have less money to invest in riskier assets like cryptocurrencies and stocks. This, in turn, reduces demand and causes asset prices to fall. The Federal Reserve has also stopped buying US Treasury bonds as part of its tightening policy. This has led to an increase in the yield on US bonds, which helps the value of the dollar to increase as more investors buy these bonds.
The Dollar Milkshake Theory
It’s not just cryptocurrencies and stocks suffering from the appreciation of the US dollar. Liquidity from the global economy is flowing into the U.S. dollar at a record pace as the Fed begins to raise rates before other nations to fight inflation and is increasingly aggressive in the size of its hikes.
This effect was coined by the “Dollar Milkshake Theory” by Brent Johnson, CEO of Santiago Capital. He claims that when the Fed stops printing because it is the world’s reserve currency, the dollar will draw liquidity from other currencies and countries around the world.
The Dollar Milkshake theory seems to have worked as the US Reserve Bank turned off the money printer and began tightening liquidity in March. The euro, the currency with the largest weighting against the dollar on the DXY, has fallen sharply during 2022, reaching a 20-year low of $0.9780.
The situation of other world currencies is not so good. The Japanese yen fell to a 24-year low on Thursday, prompting government intervention to help prop up the currency. While the European Central Bank has responded to the euro’s weakening by raising interest rates, the Bank of Japan has so far refused to do so. That’s because it actively engages in Yield Curve Control, keeping interest rates at -0.1% while buying an unlimited amount of 10-year Treasuries to keep yields at a target of 0.25%.
As the global economy deteriorates, assets such as cryptocurrencies are increasingly difficult to gain traction. However, there are several signs that investors can look out for that could signal the end of the dollar’s dominance and its impact. If next month’s Consumer Price Index data shows a significant decline, investors may turn to riskier assets in the hope that the Fed will calm down on rate hikes. Elsewhere, a resolution to the current Russia-Ukraine war could help ease the global energy crisis by lowering the cost of oil and gas. Still, for now, the dollar’s appreciation shows no signs of slowing down, which could keep the cryptocurrency near annual lows.
Disclosure: The author owned ETH, BTC and several other cryptocurrencies at the time of writing this piece.