The U.S. Dollar Index (USDX) is a measure of the U.S. dollar’s value relative to a basket of foreign currencies. The index, also known as DXY, is a weighted geometric mean of the dollar’s value compared to the currencies of some of the U.S.’s most significant trade partners.
Understanding the factors that drive the U.S. dollar and the Dollar Index is important for forex traders or anyone with international business interests. This comprehensive guide will examine everything you need to know about the U.S. Dollar Index.
What is the U.S. Dollar Index (USDX)?
The U.S. Dollar Index (USDX) measures the dollar’s value against a basket of currencies from some of the United States’ largest export partners.
More specifically, the USDX tracks the greenback versus the euro (EUR), Japanese yen (JPY), British pound sterling (GBP), Canadian dollar (CAD), Swedish krona (SEK), and Swiss franc (CHF).
The Dollar Index was created in 1973 by the U.S. Federal Reserve to provide an external bilateral trade weighted average of the dollar. This allows forex traders and international businesses to track the overall strength or weakness of the U.S. dollar.
USDX Weightings
Each currency in the Dollar Index basket is weighted based on its prominence in U.S. international trade markets. The weightings are as follows:
- Euro (EUR) – 57.6%
- Japanese Yen (JPY) – 13.6%
- British Pound Sterling (GBP) – 11.9%
- Canadian Dollar (CAD) – 9.1%
- Swedish Krona (SEK) – 4.2%
- Swiss Franc (CHF) – 3.6%
As you can see, the euro holds the heaviest weighting at over 50% as the U.S.’s most significant trade partner. The remaining currencies represent other top trade partners.
USDX Calculation
The Dollar Index is calculated using a geometric weighted mean formula. This compares the dollar to the value of the basket of currencies at any given time.
The USDX has a baseline value of 100 set based on its value in March 1973. Therefore, a rising index means the U.S. dollar is gaining strength compared to the basket, while a falling index means it is weakening.
For example, if the USDX is at 90, it means the dollar has depreciated 10% against the basket since 1973. If the index rises to 110, it has appreciated 10%.
The Federal Reserve calculates and publishes the USDX daily on its website. However, the DX is not a traded instrument itself.
What Factors Influence the U.S. Dollar Index?
Many complex political and economic factors can affect the value of the U.S. dollar and thus the Dollar Index. Here are some of the most significant influences.
Comparative Interest Rates
Interest rate differentials between the U.S. and other major economies are a primary driver of USDX volatility.
Higher interest rates make the U.S. dollar more attractive relative to other currencies. This leads investors to buy USD to capitalize, increasing demand and pushing up the Dollar Index.
For example, rising U.S. interest rates compared to near-zero rates in Japan and Europe was a major factor in the dollar strengthening significantly against the yen and euro between 2015-2020.
Economic Growth
Robust GDP growth and strong economic data out of the U.S. tend to correlate with a stronger dollar and higher USDX.
Conversely, disappointing growth or data can undermine the dollar versus major currencies, putting downward pressure on the index.
Safe Haven Demand
In times of political uncertainty or market volatility, investors often flock to USD as a safe haven asset. This frequently causes spikes in the Dollar Index.
For instance, during the European debt crisis between 2009-2012, fears over the eurozone boosted safe haven dollar demand. This led the index to surge from around 80 to over 100.
Monetary Policy
Actions by the Federal Reserve also influence the dollar’s value. Rate hikes tend to be USD bullish while unexpected policy shifts can create volatility.
For example, when the Fed halted quantitative easing (QE) in 2014 after years of dollar-weakening stimulus, the USDX shot up.
Trade & Current Account Deficits
Widening U.S. trade and current account deficits can weigh on the dollar. This signals greater imports and weaker export competitiveness.
Conversely, narrowing deficits point to improved trade performance, supporting the greenback against major currencies.
Geopolitics
Geopolitical events like elections, wars, unrest, or diplomatic developments in the U.S. or abroad can impact currency markets. Risk-off reactions tend to benefit the safe haven USD.
In times of global instability, funds flow out of emerging markets and commodities and back into dollars, lifting the Dollar Index.
Historical USDX Levels
Looking at historical levels of the U.S. Dollar Index provides helpful context on the dollar’s long-term trends. Here are some key levels over the past decades:
- March 1973: USDX starts at 100 after launch
- December 1985: Peak of 164.72 during Reagan-era dollar boom
- April 1995: Record low of 80.33 during Clinton administration
- January 2002: Recovers to 120s following dot-com crash
- March 2009: Spikes to 89 during financial crisis as investors flee to safety of USD
- January 2017: Plunges below 100 after Trump takes office
- March 2020: Soars to 103 at height of COVID-19 as dollar surges on demand for liquidity
- August 2022: Hovers around 106 after hitting 20-year high of 114 in July
As you can see, the Dollar Index has witnessed some major long-term swings over the past 50 years. However, it has remained rangebound overall between 80 and 120 for most of that period.
Extreme highs and lows are often short-lived as economic forces and currency markets tend to restore equilibrium over time.
Trading the U.S. Dollar Index
While the Dollar Index itself is not tradable, traders can take positions on the U.S. dollar in several ways:
Forex Pairs
The most direct way to trade the U.S. dollar is through major currency pairs like EUR/USD and USD/JPY.
If you think the USDX will rise, you would go long USD against other major currencies. If it may fall, you would look to short the dollar versus currencies like the euro or yen.
Futures & Options
DX futures and options contracts allow traders to speculate on Dollar Index moves. You can go long or short futures or buy call/put options.
ETFs
A variety of ETFs track baskets of currencies that mirror the USDX components. Popular options are the Invesco DB US Dollar Index Bullish Fund (UUP) and the WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU).
Currencies vs. USD
Even currencies not in the USDX basket, such as emerging market or commodity-linked currencies, often move relative to dollar trends.
When the USDX rises, currencies like the Mexican peso or Australian dollar tend to fall against the greenback.
USD-denominated Assets
A stronger dollar tends to create headwinds for assets priced in USD like stocks, bonds, gold, and oil. Thus, the USDX can serve as a gauge for broader markets.
By analyzing the factors that drive the Dollar Index and understanding technical price levels, traders can better time entries and exits in the greenback and other U.S. dollar-correlated assets.
USDX Charts & Technical Analysis
Analyzing USDX charts and key technical indicators can provide insights into price action and trends. Here are some key technical tools to utilize:
Moving Averages
Plot 50-day, 100-day and 200-day simple moving averages over USDX charts. Crossovers of shorter and longer-term averages create trading signals.
For example, a golden cross with the 50 SMA crossing above the 100 SMA indicates upside momentum. A death cross signals bearish momentum.
Support & Resistance
Identify horizontal support and resistance levels on USDX charts to watch for potential breakouts or breakdowns. Key rounded levels like 100, 110 and 120 often act as technical barriers.
MACD & RSI
Track momentum with the MACD oscillator. When the MACD line crosses above or below the signal line, it flags a change in trend.
Overbought or oversold RSI levels above 70 or below 30 suggest a reversal could be ahead.
Bollinger Bands
Bollinger Bands with 20 periods and 2 standard deviations depict overbought or oversold conditions relative to the 20-day SMA.
When price touches the upper or lower band, it often snaps back toward the mean.
Volume
Watch for surges in trading volumes on breakouts or breakdowns for confirmation. High volume adds credibility to upside or downside moves.
By combining chart patterns, indicators, and volume analysis, traders can better forecast USDX direction. However, technicals only reflect past price action. Fundamentals drive longer-term trends.
The Future of the U.S. Dollar Index
Forecasting where the U.S. Dollar Index could head in the future requires analyzing the macroeconomic and geopolitical landscape. Here are some potential USDX scenarios:
Continued Fed Rate Hikes
If the Federal Reserve sustains its current pace of interest rate hikes through 2023, it could support further dollar upside. Markets are pricing in rates surpassing 4% potentially.
Recession Risks
Conversely, if rapid tightening pushes the U.S. economy into recession, it could halt Fed rate hikes. This may lead the dollar to peak if global growth appears more resilient.
China’s Economy
China reopening its economy post-COVID could provide a growth engine for the world. If China’s yuan appreciates as a result, it could contribute to USDX declines.
Europe’s Energy Crisis
Europe faces major uncertainty and recession risks from the Russia-Ukraine war and energy supply disruptions. If the eurozone underperforms, euro weakness could lift the index.
Emerging Market Resilience
Despite dollar strength in 2022, many emerging economies have shown resilience. Further adaptation and policy adjustments could drive EM currency gains versus the dollar.
While the road ahead is cloudy, the USDX’s trading range established over decades offers clues. Significant breakouts above 120 or below 95 seem unlikely in the near-term without major shakeups.
Key Takeaways on the U.S. Dollar Index
- The U.S. Dollar Index tracks the dollar versus a basket of major currencies weighted by trade prominence. The euro holds the heaviest weighting.
- Factors like interest rates, economic growth, safe haven demand, and trade deficits influence USDX swings.
- Extreme highs and lows are often short-lived as currency markets restore equilibrium.
- Traders can play Dollar Index moves via forex pairs, futures, ETFs, and USD-correlated assets.
- Analyzing technical indicators, chart patterns, and volumes identifies USDX trading signals.
- Forward fundamentals like Fed policy, growth differentials, and geopolitics will shape future trends.
Understanding the U.S. Dollar Index provides invaluable insight for forex and international macro traders. By combining technical and fundamental analysis, traders can better time entries and exits in the greenback and related markets.
The U.S. dollar remains the world’s reserve currency and most traded currency pair. As a benchmark of dollar strength, the USDX merits attention from all global market participants with exposure to currency risks.
