The Wall Street Journal Dollar Index (WSJ Dollar Index) is a crucial financial benchmark that tracks the value of the U.S. dollar relative to a basket of other major currencies. The index provides a snapshot of the dollar’s strength or weakness, allowing traders, investors, and analysts to gauge currency trends and make informed decisions. This comprehensive guide will explore everything you need to know about the WSJ Dollar Index, from its history and composition to how it’s calculated and used.

Introduction to the WSJ Dollar Index

The Wall Street Journal Dollar Index was created in 1973 by the Wall Street Journal as an alternative to the U.S. Dollar Index. While the USDX tracks the greenback against just six major currencies, the WSJ Dollar Index takes into account 16 currencies. This broader composition provides a more holistic view of the dollar’s value.

The index was developed in response to the Bretton Woods system breaking down in the early 1970s. As exchange rates began fluctuating, a new benchmark was needed to measure the dollar’s overall movement. The WSJ Dollar Index filled this need and quickly became an authoritative reference for policymakers, companies, and traders.

Today, the WSJ Dollar Index is viewed as the premier gauge of the dollar’s value against major global currencies. Billions of dollars in assets are benchmarked to the index, and it provides key insights into foreign exchange markets and the macroeconomy. The WSJ Dollar Index is published daily in the Wall Street Journal and other sources.

Composition of the WSJ Dollar Index

One of the hallmarks of the WSJ Dollar Index is its broad, diverse composition. The index currently tracks the U.S. dollar’s value compared to a basket of 16 other major currencies:

  • Euro (EUR)
  • Japanese yen (JPY)
  • Canadian dollar (CAD)
  • Swedish krona (SEK)
  • British pound sterling (GBP)
  • Swiss franc (CHF)
  • Australian dollar (AUD)
  • New Zealand dollar (NZD)
  • Norwegian krone (NOK)
  • Singapore dollar (SGD)
  • Hong Kong dollar (HKD)
  • South Korean won (KRW)
  • Mexican peso (MXN)
  • South African rand (ZAR)
  • Israeli shekel (ILS)
  • Thai baht (THB)

This diverse mix of European, Asian, Australasian, North American, South American, and African currencies provides a broad snapshot of the dollar’s global strength. Having only six currencies in the USDX—the euro, yen, pound, franc, krona, and Canadian dollar—is seen by many as too narrow. The 16 currencies in the WSJ Dollar Index give a wider, more representative sample.

The composition is heavily weighted toward developed economies that are major U.S. trading partners. The euro currently makes up the largest share at over 30%, reflecting Europe’s importance to the U.S. The Japanese yen, pound sterling, and Canadian dollar each represent around 9% of the index as well. These weightings ensure that the currencies most relevant to the dollar feature prominently in the WSJ Dollar Index.

How the WSJ Dollar Index is Calculated

The Wall Street Journal Dollar Index is calculated using a geometrically weighted geometric mean. This method enables the relative weights and currency conversion rates to shift day to day.

Each currency has a set base percentage weight in the index. These add up to 100%. For example, the euro makes up 31% of the index weight while the Thai baht is just 1%.

The daily index value is calculated by taking these weights and multiplying them by the current dollar exchange rate for each currency. The exchange rates are based on foreign exchange transactions and rates from global markets.

These weighted currency values are then used to derive the geometric mean, which takes the 16th root of their product. The index is scaled to have a benchmark value of 100 on March 1973. Therefore, a value above 100 indicates the dollar is stronger than its 1973 level, while a value below 100 signals weakness.

The geometric weighting and averaging provide a smooth, representative measure of the dollar’s broad moves over time versus the basket. The index tends to be less volatile than bilateral exchange rates.

Key Uses and Analysis of the WSJ Dollar Index

The Wall Street Journal Dollar Index is used extensively in the forex and financial markets for analysis and decision making. Some of the key uses include:

Trading – Traders closely follow moves in the WSJ Dollar Index to inform trades in the currency, bond, commodity, and equity markets. Since currency fluctuations impact these asset classes, the WSJ Dollar Index provides an overall picture of the headwinds or tailwinds the dollar may be creating.

Exchange Rate Forecasting – Analysts use the WSJ Dollar Index to forecast short and long-term exchange rate movements against the U.S. dollar. The index captures broader trends that may impact specific currency pairs.

Performance Benchmarking – Portfolio managers benchmark their returns to the WSJ Dollar Index to isolate currency effects. This enables comparing returns in local currency terms vs U.S. dollars.

Hedging Currency Exposure – Companies hedge currency risk using instruments tied to the WSJ Dollar Index rather than individual exchange rates. This provides a diversified hedge across multiple currencies simultaneously.

Central Bank Policy – Central banks closely watch the WSJ Dollar Index to inform monetary policy decisions. Since exchange rates impact trade flows, inflation, and capital flows, the index provides key signals on external competitiveness.

Economic Analysis – Economists incorporate the WSJ Dollar Index in models, reports, and analysis of the U.S. and global economy. Trends in the index influence macro factors like trade flows, corporate earnings, and commodity prices.

Financial Market Insights – Broader financial market trends often correlate to moves in the WSJ Dollar Index. Monitoring the index provides insights into emerging risks, shifts in market sentiment, changing correlations, and more.

Historical Overview and Milestones

As one of the longest-running financial indices, the Wall Street Journal Dollar Index has seen the dollar fluctuate dramatically over the decades. Key milestones include:

  • 1973 – The WSJ Dollar Index debuts with a value of 100. The index is created in response to the collapse of Bretton Woods and transition to floating exchange rates.
  • 1985 – The WSJ Dollar Index peaks at 164.72 as the Plaza Accord drives an unprecedented dollar rally against major currencies, especially the yen and deutsche mark.
  • 1995 – The index falls to an all-time low of 67.12 following a decade of dollar weakness after the Plaza Accord overshot its goals.
  • 2001 – China joins the World Trade Organization, initiating a multi-year slide in the index as record trade deficits weaken the dollar.
  • 2008 – The global financial crisis sparks a sharp rally in the safety of the U.S. dollar, driving the WSJ Dollar Index up to 88.46.
  • 2017 – The index falls to new 14-year lows below 70 as synchronized global growth boosts other major currencies vs the greenback.
  • 2020 – Pandemic-driven safe haven flows boost the index to a 3-year high near 90. The dollar has remained relatively elevated since.
  • 2022 – Soaring inflation leads to Fed tightening and support for the dollar. The WSJ Dollar Index reaches its highest level in 20 years.

These milestones demonstrate how the WSJ Dollar Index fluctuates across decades based on trade flows, risk appetite, central bank policies, economic trends, and black swan events. Periods of dollar strength are often followed by multi-year weakness and vice versa as policy and market dynamics evolve.

Current Environment and Outlook

In 2022 and into 2023, the WSJ Dollar Index has surged to its highest level since 2002. This reflects the combined impact of several catalysts:

  • Aggressive Fed Tightening – To curb inflation, the Fed has hiked rates significantly, boosting the yield advantage and demand for dollar-denominated assets.
  • Safe Haven Flows – Geopolitical tensions related to Russia’s invasion of Ukraine have supported safe haven dollar demand.
  • Economic Divergence – U.S. growth has outperformed other major economies as Europe and China slow. This divergent path benefits the dollar.
  • Commodity Prices – Elevated energy and commodity costs have weighed on import-dependent economies and currencies. The self-sufficient U.S. dollar has been buoyed.
  • Technical Momentum – Trend-following dynamics and options hedging have created self-reinforcing dollar upside technical momentum.

With the Fed focused on bringing down inflation, policy divergence with other central banks may persist for some time. This suggests the factors supporting dollar strength could remain in place in the near term.

However, history shows extended dollar rallies eventually peak and reverse as policy and growth dynamics shift. At some point currency trends will normalize. When that inflection arrives is unclear, but the WSJ Dollar Index will capture the move once underway.

Conclusion and Recap

Created in 1973, the Wall Street Journal Dollar Index has become the premier benchmark tracking the U.S. dollar’s value against a basket of 16 major global currencies. The inclusion of developed and emerging market currencies provides a holistic view of the greenback’s strength or weakness.

The index is calculated using a weighted geometric mean formula. Component currencies have set weightings adding to 100%, ensuring the most relevant currencies like the euro and yen feature prominently. The weights capture shifting exchange rates on a daily basis.

Key uses include trading, forecasting exchange rates, hedging, benchmarking performance, and analyzing the macroeconomy. The index has fluctuated dramatically over the decades, rising with dollar strength and falling during periods of weakness.

In 2022 the WSJ Dollar Index has tested multi-decade highs, reflecting the combined impact of Fed tightening, safe haven demand, economic divergence, commodity prices, and technical momentum. While extended dollar rallies eventually reverse, additional near-term strength is likely amid current dynamics.