Bitcoin’s Reaction to Dollar Index Will Not Be Ignored: Analyst

Bitcoin's Reaction to Dollar Index Will Not Be Ignored: Analyst

The Relationship Between Bitcoin and the U.S. Dollar Index

In recent weeks, Bitcoin (BTC) has shown a break in its negative correlation with the U.S. dollar index (DXY). While the greenback experienced a continued sell-off, Bitcoin struggled to gather upside traction. However, this situation may not last long, according to industry experts.

The dollar index measures the exchange rate of the U.S. dollar against major global fiat currencies. Last week, the index fell 2.26%, marking its worst performance since November. It dropped below 100.00, reaching its lowest level since April last year. Meanwhile, Bitcoin traded primarily between $30,000 and $32,000, extending its multi-week consolidation, even as equities, including meme stocks, rallied.

Acheson Acheson, author of the Crypto is Macro Now newsletter and former head of research at CoinDesk and Genesis, highlights the impact of the dollar index on global liquidity conditions and valuations in risk assets, including cryptocurrencies. As the dollar index gyrates, it influences global liquidity conditions, which can affect the value of cryptocurrencies. Acheson predicts that the negative relationship between the dollar index and Bitcoin will likely return.

To understand this relationship, it’s crucial to recognize the role of the U.S. dollar as a global reserve currency. The dollar plays an outsized role in global trade, international debt, and non-bank borrowing. When the dollar strengthens, those with dollar borrowings face higher debt servicing costs and reduce their exposure to risk assets. Conversely, a weaker dollar has the opposite effect.

Acheson explains that the relationship between Bitcoin and the dollar index is not just because the U.S. dollar is the denominator in the most-quoted pair for the crypto asset. When the denominator (dollar) decreases in value, the ratio (Bitcoin price) increases, all else being equal. Additionally, a weaker dollar boosts global liquidity by providing more breathing room for U.S. dollar debt holders worldwide.

To illustrate the significance of the dollar index, consider the chart showing the share of foreign currency debt issuance. The U.S. dollar is the preferred choice, with around 70% of debt denominated in the greenback since 2010. This chart demonstrates the widespread use and influence of the U.S. dollar globally.

Moreover, it’s worth noting that the strength or weakness of the dollar has historically had a significant impact on gold’s performance. During the bull run of the 2000s, the launch of spot-based exchange-traded funds (ETFs) and sustained periods of DXY weakness contributed to gold’s impressive performance.

The recent sell-off in the dollar index appears to have legs, according to Goldman Sachs. Factors such as cooler inflation and anticipation of a more patient stance from the Federal Reserve have contributed to the decline. Acheson shares this sentiment, pointing out that fundamentals indicate a continued slide for the dollar. Despite signs of strength in the U.S. consumer sector, inflation is decreasing rapidly. In fact, headline inflation in the U.S. on a year-on-year basis is now lower than that of Japan.

Traders are expecting the Federal Reserve to halt its tightening cycle after an anticipated 25 basis point interest rate hike. Since March 2022, the central bank has raised rates by 500 basis points, which partly contributed to last year’s crypto market crash.

In conclusion, the relationship between Bitcoin and the U.S. dollar index is complex and intertwined with global liquidity conditions and risk asset valuations. While the recent break in their negative correlation may be temporary, industry experts predict that the relationship will return. The ongoing decline in the dollar index, driven by factors such as inflation and Federal Reserve policies, could potentially boost Bitcoin’s prospects in the market.

Note: This article has been edited by Parikshit Mishra.

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