What is the U.S. Dollar Index?
The U.S. Dollar Index – abbreviated USDX – is the value of the U.S. dollar measured against a group of six foreign currencies. Just as a stock index measures the value of a basket of securities, 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 U.S. Dollar Index is owned by Intercontinental Exchange (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 Dollar Index and USDX.
The strength of the dollar can be considered a temperature reading of U.S. economic performance, especially regarding exports. The greater the level 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 U.S. Dollar Index index is a weighted geometric average of six foreign currencies, and this index is maintained by ICE. 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 in the example above, the exponent’s value is positive, such as with the Japanese Yen, Canadian Dollar, Swedish Krona and Swiss France. When the U.S. dollar is the quoted currency, the exponent’s value will be negative such as with the Euro and British Pound. The result gives you the value of the USDX index.
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 to the price of physical gold, and the world’s currencies accordingly against the dollar. This system was facilitated by the 1944 Bretton Woods Agreement in which major world leaders agreed to physical gold as the basis for U.S. dollars, and then weighted the world’s other currencies.
Then-U.S. President Richard Nixon effectively ended this agreement in the early 1970s when he announced the value of 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.
To track the value of the dollar in this new world, the Federal Reserve set up the U.S. Dollar Index.
How to invest in the U.S. Dollar Index
Investors can trade the U.S. Dollar Index in a few ways.
One way is to trade the USDX through ETFs or mutual funds. Rather than buying or selling several U.S. Dollar “pairs” at the same time, you would trade the index, which would rise and fall in line with the overall sentiment regarding the U.S. Dollar. Two ETFs here are the WisdomTree Bloomberg US Dollar Bullish ETF (USDU) and the Invesco DB US Dollar Index Bullish Fund (UUP).
Investors can also trade USDX futures. Futures allow traders to hedge their accounts against currency risk and fluctuation in the U.S. Dollar or to simply wager that the index will move in one direction or the other. 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.
Investors can also buy and sell options on ETFs that track the index, giving them a leveraged way to profit on price changes in the ETF.
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.
