The US Dollar Index (DXY), which tracks the value of the Dollar against major currencies, is under pressure this week and could continue to lose ground in the short term.
While dollar reversals are historically bullish for bitcoin, things could be different this time around.
The reason for this expected divergence is because the decline in DXY will likely result from the likes of the European Central Bank (ECB) following the lead of the Federal Reserve (Fed) in fighting inflation with interest rate hikes. And bitcoin, a liquidity-sensitive risky asset, may struggle to benefit from dollar weakness resulting from currency traders buying the euro and other currencies in the expected global tightening.
The dollar’s previous downtrend dated 2020 and early 2021, which boosted rallies in risky assets including bitcoin, resulted from the Fed printing trillions of dollars to cushion the economy from the negative impact of the coronavirus pandemic. The Fed started turning off the liquidity tap earlier this year and now other central banks are expected to follow suit.
According to a group of 48 economists polled by Reuters from May 10 to 16, the ECB is likely to raise the deposit rate in July and raise it above zero by the end of September. The central bank deposit rate is currently at -0.5%.
Yes, you read that right. Over the past decade, interest rates in Europe and Japan have turned negative as central banks struggled to boost the economy. In layman’s terms, a negative interest rate setting essentially means that the lender is charged for lending money. The unnatural phenomenon has sparked debate over whether the financial system is close to collapsing and has strengthened the case for exploring alternatives such as cryptocurrencies. Therefore, the imminent reversal of negative rates could put pressure on cryptocurrency markets.
ECB council member Klaas Knot said on Tuesday that he supported a 0.25 percentage point increase in July. Earlier this month, Knot’s colleague Isabel Schnabel said the central bank was “closely monitoring” the inflationary effects of a weaker euro. Andrea Maechler, a board member at the Swiss National Bank, said the strong Swiss franc helped stave off inflation. These comments indicate that policymakers around the world are considering a retaliatory tightening to strengthen their currencies and keep a check on inflation.
The EUR/USD pair is up nearly 1% this week, while the dollar index is down 0.7%. Despite weakness in DXY, bitcoin is down 4%.
Historically, major tops and bottoms of bitcoin prices have coincided with bullish/low reversals in the dollar index.
Bitcoin has seen a 15-fold rally to over $60,000 in a year after the coronavirus-induced dip in March 2020. During that time, DXY has dropped more than 12% to 89.50. The inverse correlation resulted from the Fed’s unprecedented money printing. Other central bankers did the same, which fueled exceptional risk-taking in financial markets.
DXY may feel the pull of gravity again, but mostly due to retaliatory tightening from other central banks. Thus, the likelihood of bitcoin taking hints of a weak dollar and plotting a rally similar to that of 2020-21 looks low.
From a technical analysis standpoint, bitcoin could see a rally of relief if the bears again fail to establish a position below the June 2021 low of $28,800. Sellers penetrated the main support last Thursday, but failed to secure a weekly close (Sunday, UTC) below the support line.
Immediate resistance is at $31,293 (weekly high), above which the cryptocurrency could revisit the 100-week simple moving average, currently at $36,650. Acceptance below $28,800 would expose recent lows close to $25,000.