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US DOLLAR INDEX
The US Dollar Index — USDX, DX, DXY, or Dixie for short — measures the US Dollar’s value relative to a basket of six currencies: Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, Swiss Franc.
When the Dollar increases in value against these currencies, the USDX goes up. And when the Dollar decreases in value, it goes down.
Every currency on the USDX is weighted to account for size. Because the Euro covers by far the biggest economic area, it has the largest share of the index — 57.60%. This is followed by the Japanese Yen with 13.60%.
The remaining currencies make up around 30% of the index and are weighted as follows:
- British Pound — 11.9%
- Canadian Dollar — 9.1%
- Swedish Krona — 4.2%
- Swiss Franc — 3.6%
The USDX’s value rises and falls based on two main factors:
- Economic data
The state of the economy in each country on the index affects the currency’s value. If the Swiss economy is going well, for instance, the Swiss Franc’s value goes up. Similarly, economic troubles in the Eurozone will have a negative impact on the Euro’s value.
Central bank policies also affect value, because they influence supply and demand. If a central bank decides to lower interest rates, for example, borrowing will be cheaper. This is likely to increase demand for a currency and, in turn, its value.
- Safe haven inflows
The US Dollar is considered a very stable and safe currency. So, in times of economic uncertainty, there’s often increased demand for it. When this happens, its value goes up.
By contrast, when the global economy is doing well, the market is more comfortable selling Dollars and buying less stable currencies or riskier assets like gold. As a result, demand for the Dollar and, in turn, the Dollar’s value decrease
Traders tend to use the USDX to inform their trading strategies. If the USDX is down, for instance, they’ll likely take steps to hedge against their US Dollar exposure.
You can also trade the USDX as an instrument. This makes it easier to speculate on the US Dollar. Instead of having to buy and sell several US Dollar currency pairs, you can buy one instrument which will rise or fall in line with overall market sentiment about the Dollar.
- The USDX started in March 1973 as a replacement for the Bretton Woods system. Under Bretton Woods, Australia, Canada, Japan, Western Europe, and the US linked their currencies’ values to gold to keep them stable and avoid unfair competition.
- Throughout the 1960s, increases in domestic and military spending made it ever more difficult for the US to stick to the agreement. President Nixon suspended the US’s participation in 1971. This was supposed to be temporary, but the agreement collapsed two years later.
- Before the Euro became legal tender in 1999, the US Dollar Index was made up of 10 currencies. The Euro replaced five of them: the Belgian Franc, the Dutch Guilder, the French Franc, the German Mark, and the Italian Lira.
- Critics of the USDX argue that the basket of currencies isn’t a true reflection of the US’ trading partners. There are no plans in place for the index to be reviewed. But if it were to be reviewed, it’s likely that the Chinese Yuan and the Mexican Peso would be included and that the Swedish Krona and Swiss Franc would be removed.
Want to know more?
- This excerpt from an out of print volume on the Bretton Woods agreement explains in detail how the system collapsed. It makes the interesting observation that Bretton Woods was an anomaly: a rare occasion when the US was willing to give international fiscal policy priority over domestic considerations.
- Wondering how to read the USDX and use it to make better-informed trading decisions? This video explains everything in detail.
Assure Hedge’s perspective
‘The US Dollar Index can give you a reasonably accurate picture of current market sentiment around the Dollar, so monitoring it is very useful — both if you want to speculate and if you’re a business that’s put in a vulnerable position when the Dollar fluctuates.
By understanding whether the Dollar is likely to go up or down, you can make better-informed decisions about which hedging strategies would work best for you.’
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