What is the US Dollar Index?
The US Dollar Index is a measure of the value of the US dollar against six other foreign currencies. Just as a stock index measures the value of a basket of securities relative to each other, the US dollar index expresses the value of the dollar relative to a “basket” of currencies. As the dollar strengthens, the index goes up and vice versa.
The strength of the dollar can be seen as a temperature reading of US economic performance, particularly as it relates to exports. The greater the number of exports, the greater the demand for US dollars to purchase US goods.
How the Dollar Index works and what currencies it contains
The index is a weighted geometric average of six foreign currencies. The economy of each country (or group of countries) being 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%
- Pound sterling (GBP): 11.9%
- Canadian dollar (CAD): 9.1%
- Swedish crown (SEK): 4.2%
- Swiss franc (CHF): 3.6%
The index is calculated according to 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 US dollar is used as the base currency, as in the example above, the value is positive. When the US dollar is the quoted currency, the value will be negative.
This gives you USDX, which can be traded on the Intercontinental Exchange, or ICE. ICE is a global exchange that manages clearing, financial data and operates multiple markets across nine different asset classes. It also owns the trademarks for US Dollar Index, Dollar Index and USDX. The US Dollar Index is the 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, to name a few. The US dollar is the world’s reserve currency and as such it generally maintains strong demand.
History of the US Dollar Index
Before the US dollar index was established by the Federal Reserve in 1973, the US dollar was pegged to physical gold, and world currencies accordingly to the dollar.
This system was facilitated by the Bretton Woods agreement in which essentially most of the major world leaders accepted physical gold as the base of the US dollar and then weighted the other currencies of the world thereafter.
Then-President Richard Nixon effectively ended this agreement in the early 1970s when he announced that the dollar would no longer be based on gold. From there, countries were free to “float” their currencies and let the markets determine their value.
How to Invest in the US Dollar Index
Investors can get involved in trading the US Dollar Index in different ways.
One way is to trade the USDX like any other stock index. Rather than buying or selling multiple “pairs” of US dollars at the same time, you would trade the overall index which would rise and fall based on general sentiment regarding the US dollar. US dollar pairs are the dollar paired with another currency, for example, “USD/GBP” for the US dollar traded against the British pound.
Through the ICE platform, investors can also trade USDX futures. Futures contracts allow traders to hedge their accounts against currency risk and fluctuations in the US dollar. USDX futures trade 21 hours a day via ICE. Index futures can react to domestic and international economic data, as well as other reports related to the strength of the dollar or other currencies.
Perhaps the easiest way to invest in USDX is to use an ETF that offers broad dollar exposure against several different foreign securities, like USDX does. Top picks include 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. Further, investors are cautioned that past performance of investment products does not guarantee future price appreciation.