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Bitcoin's (BTC) traditional inverse correlation with the U.S. dollar index (DXY) has been upended in recent weeks, as the flagship cryptocurrency grapples with an uphill battle to gain traction amidst the relentless sell-off of the greenback. Nevertheless, there is optimism among some observers that this state of affairs will be short-lived.

Last week, the dollar index experienced a significant decline of 2.26%, marking its poorest performance since November. It fell below the 100.00 threshold, reaching its lowest level since April of the previous year.

However, despite the surge in equities, including meme stocks, Bitcoin continued to predominantly fluctuate within the $30,000 to $32,000 range, prolonging its multi-week consolidation period.

"The negative relationship between DXY and BTC is likely to return, as gyrations in the dollar index influence global liquidity conditions, which in turn affect valuations in risk assets, including cryptocurrencies," according to Noelle Acheson, author of Crypto is Macro Now newsletter and former head of research at CoinDesk and Genesis.

The dollar holds a prominent position as a global reserve currency, exerting a significant influence on worldwide trade, international debt, and non-bank lending. Whenever the value of the dollar surges, individuals or entities with dollar-denominated debts encounter increased expenses for servicing their debts and tend to reduce their exposure to risky assets. Conversely, when the dollar weakens, the opposite effect takes place.

"The BTC-DXY relationship will be hard to shake for long, though. It's not just that the U.S. dollar is the denominator in the most-quoted pair for the crypto asset (and when the denominator goes down in value, the ratio goes up, all else being equal) – it's also that a weaker dollar boosts global liquidity by giving U.S. dollar debt holders around the world more room to breathe," Acheson said in Monday's edition of the newsletter.

Share of foreign currency debt issuance (Federal Reserve/Refinitiv)

From early 2000 to 2022, the chart illustrates the issuance of debt by companies in a foreign currency compared to their domestic currency. Undoubtedly, the U.S. dollar emerges as the most favored option, maintaining a consistent share of approximately 70% since 2010.

Finally, although the widespread belief credits the remarkable bull run of gold in the 2000s to the introduction of spot-based exchange-traded funds (ETFs), the favorable macroeconomic conditions, which encompassed prolonged periods of DXY weakness, also significantly contributed to its success.

Therefore, it is crucial for cryptocurrency market participants to pay close attention to trends in the DXY as they hold significant importance. If the value of the US dollar continues to decline, there is a possibility that Bitcoin will experience an increase in demand.

DXY sell-off has legs

Goldman Sachs (GS) predicts that the dollar's recent decline will persist.

"The Dollar sold off sharply in response to cooler inflation and anticipation of a more patient Fed stance beyond July. We think this can extend in the near term because the same factors that weighed on this report look likely to be softer still in coming months, and the policy implications bring welcome relief to a number of corners of the market," Goldman's Economics Research team said in a note to clients on Friday.

Acheson echoed the same viewpoint, asserting that the underlying factors indicate an ongoing deterioration in the value of the dollar.

"The USD decline feels solid. It was a long time coming, and fundamentals point to its continued slide. Despite signs that the consumer in the U.S. is still strong (more on this below), inflation is heading lower, fast. Headline inflation in the U.S. on a year-on-year basis is now lower than that of Japan. Let that sink in. True, this only applies to headline inflation and not core, but still," Acheson noted.

Traders are anticipating a pause in the Federal Reserve's tightening cycle as indicated by the Fed fund futures. Following an expected 25 basis point interest rate hike later this month, the central bank will likely halt its series of rate increases. Since March 2022, the Federal Reserve has gradually raised rates by a total of 500 basis points, reaching the range of 5% to 5.25%. It's worth noting that this tightening of monetary policy played a significant role in the crypto market crash witnessed last year.

Source Coindesk