Bitcoin Traders Shouldn’t Rely Too Much On Dollar Strength Index (DXY) — Here’s Why
Bitcoin investors count on a number of trackers and indicators to get an overview of the market. It seems to make sense to look at the strength of the US dollar for this purpose, but does the data warrant it?
DXY vs. BTC: A Misplaced Correlation?
You may have noticed that the USD’s purchasing power is steadily declining by 1% every 30 days. However, the USD Dollar Index (DXY) is a measure of how strong the USD is against the following six major currencies:
Because Bitcoin’s price relies on incoming cash flow to rise in value, it then follows that the DXY would affect BTC. In fact, among crypto analysts, it is a commonly held belief that DXY is Bitcoin’s biggest influencer. For example, Financial Innovation study at EconStor, used a VEC (Vector Error Correction) model to conclude that:
- The price of gold has no influence on Bitcoin in the long run.
- CPI (Consumer Price Index) has some causality in the short term.
- DXY has the strongest influence on Bitcoin across variables.
In turn, if the USD Dollar Index (DXY) is low, Bitcoin should be stronger and vice-versa. In other words, the relationship between BTC and DXY should be inversely proportional. However, is that really the case?
Counter-Narrative to DXY vs. BTC Correlation
If Bitcoin is influenced by DXY, what is influencing DXY strength? Because it relies on a weighted basket of currencies, the euro in particular, it is largely impacted by divergent macroeconomic policies. Case in point, between 2015 and 2020, the European Central Bank (ECB) was on an asset purchasing spree. At the same time, the Federal Reserve was maintaining its balance sheet.
This resulted in DXY getting ahead of the euro by 15 points.
Aside from monetary policies, DXY is influenced by the labor environment, inflation, trade balance, and relative deficits.
However, if such a discrepancy in monetary policies affects DXY, how does DXY exert influence over Bitcoin? When their relationship is lined up across two years, DXY sporadically influences Bitcoin’s short-term price, but not in the long run.
A strong dollar remains a safe haven as a global reserve currency. At the same time, Bitcoin is increasingly acting as a hedge against the dollar.
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How Strong Is The Dollar Now?
Based on the weighted basket of currencies, and how it performs against them, the DXY is 95.8 at press time. This means it reached a 16-month high against its sovereign competitors.
Last Friday, DXY hit a speed bump when the University of Michigan’s Consumer Sentiment Index went down to 66.8 from October’s 71.7, making it the lowest since November of 2011. This largely stems from supply chain and inflation concerns.
The rest of the world is not faring better, with Europe tackling a looming energy crunch, exacerbated by new viral fears. Interestingly, the saving rates are rising across the board, paving the road to deflationary Bitcoin against both EUR and USD.
Given the fact that the US has inherently far more resources than both Europe and China, the DXY is continuing its steep upward climb.
Kevin O’Leary recently put some of his cash into high-yield stablecoins due to inflation. Do you think it makes sense to hold fiat cash in banks any longer? Let us know in the comments below.