There’s one macro variable that single-handedly accounts for over 50% of crypto price swings.

What it means for the value of your token bag 👇

The variable I’m referring to is the US DOLLAR.

I fitted BTC price & crypto mkt cap against a laundry basket of macro factors. The value of USD (proxied by DXY index) has most significant correlation w/ crypto.

54% of y-o-y BTC price change can be explained by DXY alone.

DXY up—> crypto down. Vice versa.

Onset of last crypto winter in 2018 coincided w/ major $ trend reversal, while as $ began dropping in early 2019, BTC rose from dead. Makes you wonder is crypto driven by BTC halving like they make you believe, or by dollar valuation cycle?

You say, crypto prices are denominated in USD. So if dollar goes up, ofc crypto go down. Or maybe you think, crypto is risk-on asset, USD is risk-off asset. They should ofc be negatively correlated.

So what’s the big deal Tascha?

Indeed there’s also negative correlation btw DXY & commodities, which are mostly traded in USD, and btw DXY & stock mkt, which is risk-on asset.

But DXY explains only 24% of gold price changes & 7% of S&P 500 changes— its correlation w/ crypto is an order of magnitude bigger.

Why?

It’s a combination of factors. Mechanically, as USD goes up, onramp via stablecoins from other fiats becomes more costly, reducing demand for crypto.

But more importantly, dollar value is bellwether of many macro factors from global risk appetite to monetary conditions to growth outlook to central bank action, all of which affect crypto.

In other words even if DXY in itself doesn’t “cause” crypto price changes, it’s a great summary indicator of many other factors that do. ‘Tis similar idea to “dimensionality reduction” in data science if you will.

So if you want to know how your crypto bag may perform short-to-mid term, it’s useful to look at dollar valuation trend & its drivers 🔮

Driver 1: US current account

Your college econ textbook says if a country imports more than it exports (i.e. current account deficit, roughly), its currency value should go down.

Indeed US current account has worsened since Covid, while $ value dropped.

But post-Covid economic recovery is slowing & gov spending shrinking–> lower import demand—> lower current account deficit this yr—> supports $ value.

So,

Team dollar-bull: score 1

Team dollar-bear: score 0

But in reality current account impact on $ is small compared to other fiats as many commodities are priced in $. In a world of hyper-financialization, financial mkts have bigger impact on $ value, which brings me to:

Driver 2: US capital inflow

US is net recipient of portfolio investment inflow. Money coming in to buy US assets—> shores up $ demand.

A bigger & bigger share of this money has gone into US stock mkt, which has outperformed most other stock mkts by a mile & attracted investors world-wide.

But as you know, w/ Fed tightening coming & economic slowdown likely already underway, stocks’ been hard hit. A lengthy bear mkt prompts investors to seek greener pastures—> money leaving US mkts—> $ demand down—> $ value down.

Whether we’ll see extensive downturn in stocks is debatable. But to give it benefit of doubt, let’s say we will. We now have:

Team dollar-bull: score 1

Team dollar-bear: score 1

Driver 3: Fed rate hikes

Perpetual low-rate environment in US has spurred carry trades of all sorts— borrow in USD w/ low interest rates to buy foreign assets that offer higher yields. It’s a big driver of growing foreign asset holdings of US banks & other financial entities.

It’s foolproof investment until your $ funding cost goes up. Rate hike—> carry trades less profitable—> less portfolio outflow from US—> $ demand goes up—> $ value goes up—> carry trades even less profitable—> a reflexive cycle that self-reinforces.

’Tis only one of many ways that rate hikes boost $. But as you see from chart below, which estimates response of DXY to interest rate shocks (data from 2010 to 2021), rate hike (left chart) has weaker effect on $ appreciation than rate drop (right chart) on $ depreciation.

I.e. the impact is escalator up & elevator down. This contrasts the impact of quantitative easing/tightening as you’ll see in a sec.

For now:

Team dollar-bull: score 2

Team dollar-bear: score 1

Driver 4: Fed quantitative tightening

Impact of Fed asset purchases is similar to rate hike: QT—> $ up, QE—> $ down. Except its effect is stronger b/c it directly affects liquidity in mkts & far end of yield curve.

Historical data shows the effect of QT (right chart) which leads to $ appreciation tends to be much stronger than that of QE (left chart) which leads to $ depreciation.

If you take the above estimation at face value, QT impact on $ lasts for ~10 mos b/f subsiding. That means if QT this yr starts in July, it’ll boost $ strength till May 2023.

(BTW, like this so far? I write about ideas on investment, macro and human potential. Subscribe to my newsletter for updates 👉 https://taschalabs.com/newsletter .)

Anyway now we have:

Team dollar-bull: score 3

Team dollar-bear: score 1

Dollar bull is winning & indeed has been since May last yr while crypto strength being chipped away. ($ up, crypto down, remember?)

Ukraine gave DXY another boost. At current rate the thing’s on its way to cross 100— a long-term resistance— in 6 mos.

But will its upward path be that smooth in next few mos? I doubt it.

Let’s not forget neither rate hike nor QT has started yet. Fed balance sheet growth, though slowing down majorly since last May, is still growing. Mkt is not lacking liquidity whatsoever.

And yet everyone’s trying to front run Fed. Nasdaq dropped 20% from Dec to this month’s low & crypto over 40%. These aren’t warranted, yet, by actual mkt conditions.

I expect strong mkt rebound at some point from now till July, which is when QT is supposed to start the latest. (Rate hike is small potato, QT is big potato, remember?)

That means BTC dominance may still take another leg down by June.

Depending on Ukraine situation, QT schedule may change. If it gets delayed to cushion oil price blow on economy, mkts will rejoice but prob won’t last long.

Regardless, my baseline is short-to-mid term mkt rebound w/ heightened volatility, but by end of this yr, QT well on its way, DXY further up, crypto further down.

But all said, let’s not lose the big picture. $ has been on a long-run downtrend for past 30+ yrs. Why so?

Many reasons but end of day it’s simply supply & demand. If supply of $ outgrows demand, price is bound to drop. I’m not just talking abt supply of $ itself, but also supply of other things that are de-facto dollar substitutes, for example, US gov securities.

US treasuries & other debt securities are increasingly being treated by investors like money, i.e. a medium of exchange & store of value. The trend is underwritten by volatility suppression from central bank, which helped to make the values of these “quasi money” very stable.

That means actual money supply should be whatever gets counted in stats for M1, M2 etc, plus public debt stock in circulation. W/ increasing indebtedness of US gov, this actual money supply now doubles the official M2 & grows faster too.

Assuming money demand holds steady, to see which way $ value will go in long term, you only need to ask yourself 1) is the trend in public debt going to reverse? 2) will there be more & more things other than USD that people can use as global money?

My answer is 1) no, 2) yes. W/ demographic aging & automation, gov expenditure has to go up, which means more debt, i.e. more quasi money issuance. As for global money, idk but I heard there’s this thing called crypto 😉

TLDR:

1/ there’s tight correlation btw dollar value & crypto, $ up–> crypto down

2/ $ should appreciate this yr

3/ QT-led $ appreciation lasts abt 10 mos

4/ Expect short-mid term mkt rebound but proper bear mkt later 2022

5/ Long-term $ weakness in the cards

5 Comments

  1. Nice post and super timely also. One of your last posts about crypto inflows being less was really awesome too. It’s so easy to get caught up in micro level btc price action. There’s no shortage of onchain analysts giving reasons why we’re about to go to moon, but there’s simply no sense begin their tech analysis. It’s hollow. I was always thinking, if rates up and QT then dollar up and the moon calls never squared with my own personal rationale. This DXY BTC relationship I’ve been thinking about a a while now, albeit on a more simplistic level so to see this pop up in my emails on a Sunday when there’s actually time to read is a dream come true 🙂
    It seems like your longer term base case for the dollar going down, like when they have to do another round of QE bigger than before and we actually get flight from the dollar—I realize this is long term but it’s going to be interesting to imagine the ways and probabilities that will happen. For now it’s like we’re in the titanic header for an iceberg with no way to avoid it. Happy Sunday!

  2. Fantastic education on the impact of USD on cryptocurrencies.

  3. So if we expect short-mid term market rebound, but proper bear market later 2022 shouldn’t we be more or less at the about same valuations as today given price hike and then drop?

  4. Tascha,

    Great analysis. Only thing to add is the effect of the Ukraine war. In bad times people seek the haven of the perceived strongest currency . This is DXY bullish. Big time. How long that effect lasts cannot be accurately determined and depends on innumerable political / geopolitical factors. My take is that it persists for at least 6 months.

    Thereafter we get effect of flight from USD as peace sets in but also as billionnaire class / nation states think twice about leaving their assets in seizable dollar accounts. Starts happening over next 1 – 3 years.

    So 6 months very dollar bullish (crypto bearish), long term very dollar bearish (crypto bullish).

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