The Dollar Index (DXY), which is a trade-weighted average of major USD exchange rates, has continued from where it was at the end of 2022 and is now down about 1.4% this month. Currently around the 102.00 mark, it has dropped roughly 11% from last September’s highs in the 114s. Analysts point to three reasons for this decline: 1) a quick decrease in US inflation, 2) signs of a sharp slowdown in US growth, and 3) a significant shift towards less aggressive Fed tightening expectations for late 2023 and 2024.

The decrease in Fed tightening expectations happens even though central bank officials keep saying they want to maintain high rates (above 5.0%) for an extended period (through the end of 2023) to prevent inflation from remaining above the bank’s 2.0% annual target. However, the markets are skeptical – the 2-year yield at 4.2% indicates that the Fed’s interest rate is likely to stay about where it is now for the next two years, not 100 basis points higher.

The market’s more dovish view on things has been helping cryptocurrency markets in early 2023. Bitcoin and Ethereum are both up nearly 40% and (many) altcoins have been going crazy. And with the likes of the ECB and BoJ both tilting in a more hawkish direction just as things are looking more dovish for the Fed, the prospect of further US dollar losses (and by extension crypto gains) looks good.

De-dollarisation a Longer-term Dollar Headwind

According to widely followed macro strategist Zoltan Pozsar, the dollar potentially faces a much more important long-term headwind than central bank divergence and the near-term fate of the US economy. That is the threat that the greenback loses its status as the world’s reserve currency.

According to Zoltan, de-dollarisation “started with the launch of quantitative easing in the wake of the financial crisis, as current account surplus countries frowned at the idea of negative real returns on their savings”. “Recently,” he adds, “the pace of de-dollarisation appears to have picked up”, before citing moves by rival superpowers like China and India to pay for commodities in their own currencies, rather than the buck.

Pozsar thinks that the implementation of central bank digital currencies in places like China will help them create a rival to the currently US-dominated global banking system – the power of which was just witnessed in the form of massive, damaging financial and economic sanctions on Russia in wake of their invasion of Ukraine.

“If less trade is invoiced in US dollars and there is a dwindling recycling of dollar surpluses into traditional reserve assets such as Treasuries, the “exorbitant privilege” that the dollar holds as the international reserve currency could be under assault”. US borrowing would cost more should the USD lose its status as the world’s reserve currency.

The implications for crypto aren’t clear. Perhaps a world with greater CBDC adoption would harm crypto, as people might ask “what’s the point?”. But if those CBDCs are used as a tool to control and manipulate society (as the Chinese Community Party plans to use them), this could strengthen the case for a decentralized blockchain-based alternative.

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