The US Dollar Index (DXY), which tracks the greenback's value against major currencies, has come under pressure this week and could continue to lose ground in the near term.
While reversals in the dollar are historically bullish for bitcoin, things could be different this time.
The reason for this expected divergence is because decline in the DXY is likely to stem from the likes of the European Central Bank (ECB) following the Federal Reserve's (Fed) lead in fighting inflation with interest rate hikes. And bitcoin, a liquidity-sensitive risk asset, may struggle to benefit from dollar weakness resulting from currency traders buying the euro and other currencies on expected global tightening.
The dollar's previous bearish trend dated 2020 and early 2021, which powered rallies in risk 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 began closing the liquidity tap early 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 May 16, the ECB will likely raise the deposit rate in July and push it above zero by the end of September. The central bank's deposit rate currently stands at -0.5%.
Yes, you read it right. In the last decade, interest rates across Europe and in Japan went negative as central banks struggled to jump-start the economy. In layman's terms, a negative interest rate setup essentially means the lender is charged for lending money. The unnatural phenomenon sparked debate about whether the financial system is close to collapsing and strengthened the case for exploring alternatives like crypto. So, the impending reversal of negative rates could pressure crypto markets.
The ECB governing council member Klaas Knot said Tuesday he supports a quarter-point increase in July. Early this month, Knot's colleague Isabel Schnabel said the central bank was "closely monitoring" the inflationary effects of a weaker euro. Andrea Maechler, a member of the Swiss National Bank's board, said the strong Swiss franc has helped ward off inflation. These comments indicate policymakers worldwide are considering retaliatory tightening to strengthen their currencies and keep a tab on inflation.
The EUR/USD pair has risen nearly 1% this week, while the dollar index is down 0.7%. Despite the weakness in the DXY, bitcoin is nursing a 4% loss.
Historically, bitcoin's major price tops and bottoms have coincided with bullish/bearish reversals in the dollar index.
Bitcoin charted a 15-fold rally to over $60,000 in a year following the coronavirus-induced crash of March 2020. During that time, the DXY collapsed by over 12% to 89.50. The inverse correlation resulted from Fed's unprecedented money printing. Other central bankers did the same, which stoked exceptional risk-taking in financial markets.
The DXY could feel the pull of gravity again, but mainly due to retaliatory tightening by other central banks. Thus, the probability of bitcoin taking cues from a weak dollar and charting a 2020-21-like rally appears low.
From a technical analysis standpoint, bitcoin could see a relief rally if the bears again fail to establish a foothold under the June 2021 low of $28,800. Sellers penetrated the key support last Thursday but could not secure a weekly (Sunday, UTC) close under the support line.
The 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 under $28,800 would expose recent lows near $25,000.