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Bitcoin Struggles as the Dollar Hits a 20-Year High

Bitcoin Struggles as the Dollar Hits a 20-Year High

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Key takeaways

  • The dollar index has jumped to 20-year highs thanks to more than 112 Federal Reserve economic tightening policies.
  • As the dollar soars, Bitcoin and other cryptocurrencies are struggling due to Fed rate hikes.
  • Although the dollar is currently rising against other currencies, a slowdown in inflation or the end of the European energy crisis could spark interest in risky assets.

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Bitcoin and the broader crypto market are struggling to stay above their June lows due to a stronger dollar.

Bitcoin down as dollar rallies

Bitcoin is fighting the dollar – and it’s losing.

The dollar index (DXY), a financial instrument that measures the price of the U.S. dollar against other currencies, hit a new 20-year high on Friday, pushing other global currencies and risk assets lower. The DXY, which measures the value of the dollar against other currencies, rose above 112 earlier this morning. It is trading at around 112.8 at press time, according to TradingView data.

The crypto market has been hit particularly hard in recent weeks due to the strengthening of the dollar. In August, Bitcoin enjoyed a brief rally to $25,200 as the dollar rallied from its July highs. Since then, however, the crypto asset has been crushed under the weight of a rising dollar. Bitcoin now appears to have fallen below $20,000, while the dollar continues to rise, trading at around $18,810 at press time, according to data from CoinGecko.

DXY (blue) and BTC/USD (orange) chart (Source: TradingView)

A large part of the positive price development of the dollar can be traced to the rise in interest rates by the Federal Reserve. When the Fed raises interest rates to fight inflation, it tightens the liquidity of the US dollar. This should help slow inflation by making it more expensive to borrow money, which reduces demand. However, one side effect of such a system is that it makes the dollar a much more attractive investment.

The tightening of dollar liquidity means that market participants have less money to invest in riskier assets such as cryptocurrencies and stocks. This in turn reduces demand, causing asset prices to fall. The Federal Reserve has also stopped buying US government bonds as part of its tightening policy. This has caused US bond yields to rise, helping the dollar rise as more investors buy these bonds.

Dollar shake theory

It’s not just crypto and stocks that are suffering from the sharp rise in the US dollar. As the Fed began raising interest rates to fight inflation before other countries and has been increasingly aggressive in its hikes, global liquidity is flowing into US dollars at a record pace.

This effect was coined by Brent Johnson, CEO of Santiago Capital, in the “Milkshake Theory of the Dollar”. It assumes that the dollar will absorb liquidity from other currencies and countries worldwide whenever the Fed stops printing because it is the world’s reserve currency.

Since the U.S. Reserve Bank shut down its money printer and began tightening liquidity in March, the dollar shake theory seems to be coming true. The euro, the currency that gets the most weight against the dollar on the DXY, has been falling throughout 2022 and recently hit a new 20-year low of $0.9780 against the dollar.

Other world currencies are not doing much better. Japan’s yen fell to a 24-year low on Thursday, prompting government intervention to shore up the currency. Although 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 raise them. That’s because it actively engages in yield curve management, keeping rates at -0.1% while buying unlimited 10-year Treasuries to keep the yield target at 0.25%.

In the current situation, it is increasingly difficult for assets such as cryptocurrencies to find strength amid a weakening global economy. However, there are several signs that investors can watch out for that could point to the end of the dollar’s dominance and its attendant effects. If next month’s CPI data falls significantly, investors may turn to riskier assets in the hope that the Fed will moderate its rate hikes. Elsewhere, a resolution to the current Russia-Ukraine war could help alleviate the global energy crisis by lowering oil and gas costs. Still, for now, the dollar’s rally shows no signs of slowing down — and this could keep the crypto trapped near its annual lows.

Disclosure: At the time of writing this article, the author owned ETH, BTC and several other cryptocurrencies.

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