Dollar is at 20-year high. That’s bad news for Bitcoin.

Key receivers

The dollar index rose to a 20-year high above 112 amid the Federal Reserve's tightening policy. While the dollar is on the rise, Bitcoin and other cryptocurrencies are struggling due to the Fed's interest rate hikes. The dollar is currently weak compared to other currencies, inflation or the European energy crisis could stimulate demand for risk assets.

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Bitcoin and the broader crypto market are struggling to hold above June lows due to renewed strength from the dollar.

BTC Down as DXY Rally

Bitcoin is fighting the dollar — and 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 new 20-year high on Friday, sending other global currencies and risk assets lower. The DXY, which measures the value of the dollar against a basket of other currencies, rose by 112 this morning. It is trading around 112.8 at press time, according to TradingView data.

The crypto market has been hit hard by the strength of the greenback in recent weeks. In August, Bitcoin enjoyed a brief rally to $25,200 as the dollar rebounded from its July highs. However, since then crypto assets have been crushed by the increasing weight of the dollar. Bitcoin now appears locked below $20,000 as the dollar continues to retreat, trading around $18,810 at press time.

Much of the dollar's positive price action can be attributed to the Federal Reserve raising interest rates. As the Fed raises rates to fight inflation, it strengthens US dollar liquidity. By making it more expensive to borrow money, this should help push inflation back down and reduce demand. However, one side effect of such a policy is that it makes the dollar a more attractive investment.

A weaker dollar means market participants have less money to invest in riskier assets like cryptocurrencies and stocks. In turn, this reduces demand, causing asset prices to fall. The Federal Reserve has ended its tightening policy of buying US Treasury bonds. This caused US bond yields to rise, which in turn increased the value of the dollar as more investors bought these bonds.

Dollar Milkshake Theory

It's not just crypto and stocks that suffer from a high US dollar. Liquidity from the global economy is flowing into the US dollar at a faster rate as the Fed begins to raise rates before other countries to fight inflation, and the rate increases.

This effect was created by Brent Johnson, CEO of Santiago Capital, “Dollar Milkshake Theory”. Johnson's theory shows that when the Fed stops printing the world's reserves, the dollar will absorb the flow of money from other currencies and countries.

Since the U.S. Reserve Bank turned off its money printing and began tightening monetary policy in March, the dollar milkshake theory appears to be playing out. The euro, which receives the heaviest weighting against the dollar in the DXY, has declined throughout 2022, recently hitting a 20-year low of 0.9780 against the dollar.

Other world currencies are not much better. The Japanese yen fell to a 24-year low Thursday, prompting government intervention to help prop up the weakening currency. While the European Central Bank has responded to the weakened euro by raising interest rates, the Bank of Japan has so far refused to do so. This is because they actively engaged in yield curve manipulation and kept interest rates at -0.1% by buying unlimited 10-year government bonds to keep yields at 0.25%.

As things stand, it's looking increasingly difficult for assets like cryptocurrencies to gain traction amid the global economic downturn. However, there are several signs that investors can watch for the end of the dollar's hegemony and its consequences. If next month's consumer price index shows a significant decline, investors may return to riskier assets on the expectation that the Fed will raise interest rates. Elsewhere, a solution to the current Russo-Ukraine war could help ease the global energy crisis by reducing oil and gas costs. Still, for the time being, the dollar's rise is showing no signs of slowing down — and this could keep the crypto at annual lows.

Disclosure: The author owns ETH, BTC and many other cryptocurrencies at the time of writing this piece.

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