What is the U.S. Dollar Index?
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The U.S. Dollar Index is a measure of the value of the U.S. dollar against six other foreign currencies. Just as a stock index measures the value of a basket of securities relative to one another, the U.S. Dollar Index expresses the value of the dollar in relation to a “basket” of currencies. As the dollar gains strength, the index goes up and vice versa.
The strength of the dollar can be considered a temperature read of U.S. economic performance, especially regarding exports. The greater the number of exports, the higher the demand for U.S. dollars to purchase American goods.
How the Dollar Index works and what currencies are in it
The index is a geometric weighted average of six foreign currencies. Since the economy of each country (or group of countries) is of different size, each weighting is different. The countries included and their weights are as follows:
- Euro (EUR): 57.6 percent
- Japanese Yen (JPY): 13.6 percent
- British Pound (GBP): 11.9 percent
- Canadian Dollar (CAD): 9.1 percent
- Swedish Krona (SEK): 4.2 percent
- Swiss Franc (CHF): 3.6 percent
The index is calculated using the following formula:
USDX = 50.14348112 × EURUSD^-0.576 × USDJPY^0.136 × GBPUSD^-0.119 × USDCAD^0.091 × USDSEK^0.042 × USDCHF^0.036
When the U.S. dollar is used as the base currency, as in the example above, the value is positive. When the U.S. dollar is the quoted currency, the value will be negative.
This gives you the USDX, which can be traded on the Intercontinental Exchange, or ICE. ICE is a global exchange that handles clearing, financial data, and operates multiple markets across nine different asset classes. It also owns the trademarks for U.S. Dollar Index, Dollar Index, and USDX. The U.S. Dollar Index is property of the Intercontinental Exchange.
Many factors will affect how the USDX moves. Inflation or deflation of any currency, monetary policy, geopolitical conflicts, and export/import ratios, just to name a few. The U.S. dollar is the world’s reserve currency, and as such usually maintains high demand.
History of the U.S. Dollar Index
Before the U.S. Dollar Index was established by the Federal Reserve in 1973, the U.S. dollar was pegged against physical gold, and the world’s currencies accordingly against the dollar.
This system was facilitated by the Bretton Woods Agreement in which essentially most of the major world leaders agreed to physical gold as the basis for U.S. dollars, and then weighted the world’s other currencies thereafter.
Then-President Richard Nixon effectively ended this agreement in the early 1970s when he announced the dollar would no longer be based on gold. From there, countries were free to “float” their currencies and allow markets to determine their value.
How to invest in the U.S. Dollar Index
There are a couple of different ways investors can get involved in trading the U.S. Dollar Index.
One way is to trade the USDX like any other equity index. Rather than buying or selling several U.S. dollar “pairs” at the same time, you would trade the overall index that would rise and fall in line with the overall sentiment regarding the U.S. dollar. U.S. dollar pairs are the dollar paired with one other currency, for example, “USD/GBP” for the U.S. dollar traded against the British pound.
Through the ICE platform, investors can also trade USDX futures. Futures allow traders to hedge their accounts against currency risk and fluctuation in the U.S. Dollar. USDX futures trade for 21 hours a day through ICE. Index futures can react to both national and international economic data, as well as other reports that relate to the strength of the dollar or other currencies.
Perhaps the simplest way to invest in the USDX is through an ETF that provides broad exposure to the dollar against several different foreign securities, like the USDX does. A few top choices are the WisdomTree Bloomberg US Dollar Bullish ETF (USDU) and the Invesco DB US Dollar Index Bullish Fund (UUP).
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.