One of the most important barometers for global currencies is the Dollar Index (DXY), which measures the value of the US Dollar versus a basket of global currencies. It began at an arbitrary 100.000 in March of 1973.  The basket of currencies essentially consists of nations that have significant trading relationship with the US and are also hard floating currencies. 

The dollar is the most traded currency in the world and an indicator of the relative strength of the US dollar around the world. There are many reasons for the importance of the US dollar. First, most commodities in the world are denominated in US dollars. Second, by comparison, key macro parameters such as market cap, foreign exchange reserves and GDP are compared across countries in US dollars.  Keep reading to learn more on the US Dollar Index, how it is calculated, and what affects it price.

How are these currencies weighted?

In terms of weighting, the Euro (EUR) controls the largest percentage share at approximately 57.6%. This is followed by the Japanese yen (JPY) at 13.7%, the British pound (GBP) at 11.9%, the Canadian dollar (CAD) at 9.1%, the Swedish Krona (SEK) at 4.2% and the Swiss franc (CHF) at 3.6%.

Since the euro is the second-leading reserve currency, it has the highest weighting in the dollar index.

The dollar index is calculated according to the following formula of currency pairs:

USDX = 50.14348112 × EURUSD -0.576 × USDJPY 0.136 × GBPUSD -0.119 × USDCAD 0.091 × USDSEK 0.042 × USDCHF 0.036

The Dollar Index measures the strength of the US$ versus this 6-currency basket. If the dollar strengthens against these currencies the index will rise and if it weakens it will fall.

Reason behind US Dollar Index moment

Another large influence on the US Dollar index’s price is safe haven inflows. The index can rise during periods of uncertainty if traders regard the US dollar as a value store amid global economic crises. The index can fall if risk-on sentiment dominates and investors sell off USD and move into riskier assets.

Why it is important for traders

Investors are keeping an eye on the U.S. Dollar Index as it allows them to monitor the value of the Greenback compared to a basket of major currencies. If a trader is convinced the US Dollar will appreciate across the board, it might be simpler to place a single trade betting on a rising US Dollar Index instead of having to manage multiple forex positions. Some market participants also use the US Dollar Index for hedging purposes. Find out more on how to trade indices to benefit from USDX price movement.

US Index on Pandemic Situation

Coronavirus Impact Most recently, COVID-19 has driven investors to the perceived safety of the U.S. dollar and it has risen markedly since March. In fact, the USD is trading at its highest level since April 2017. In other words, the strengthening U.S. dollar now buys more of the other currencies than it did before. Even though market pundits might suggest that a strong dollar is tied to a strong economy, the reality is that’s not accurate. While it’s complicated, generally speaking a strong USD can be a negative for companies with a significant international business, as a strong USD makes those U.S. goods more expensive abroad. President Trump summarized the challenge that a strong USD can bring when he said a strong dollar is “a beautiful thing in one way, but it makes it harder to compete.” By contrast, a weaker USD would allow U.S. manufacturers to sell more of their products overseas, as their goods become cheaper. But that also means that the American consumer would see prices of goods from overseas companies rise. One more benefit of a strong USD: it makes travelling to foreign countries cheaper for Americans, but more expensive for tourists from other countries visiting the U.S. But since global travel has come to a screeching halt, that’s like having a 100-trillion Zimbabwean dollar note worth about 40 U.S. cents.

Conclusion

The Dollar being the central currency for global trade and commerce becomes an important barometer for global economies. Even for the other currencies, there is an exact relationship between the dollar index (DXY) and the strength of the other pair. However, if a trader plans to use the US Dollar Index to bet on the direction of the Dollar, they must always be mindful of the basket and the weightings. The US Dollar Index can be traded using futures and options or, where permitted, spread betting and CFD trading can also be used to speculate on whether the USDX will go up or down in price.