What Is The Dollar Index?
The Dollar Index is a long-running measure of the value of the U.S. Dollar against a variety of other fiat currencies. Investors can trade ETFs based off the index's movements, along with using it as a gauge of the dollar's fortunes more generally.
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What Is the Dollar Index (USDX)?
The Dollar Index is a tool created in 1973 to track the value of the U.S. Dollar against other major world currencies. It gives investors and analysts the ability to look at a single benchmark to judge how the value of the dollar is performing.
There are also numerous trading products linked to the Dollar Index. This allows investors to hedge their exposure to the value of the dollar in a single transaction. Speculators can also use these products to make bets on future appreciation or depreciation of the dollar using a broadly-accepted and widely-quoted benchmark.
History of the Dollar Index
Prior to the 1970s, there was little need for a dollar index as the value of the dollar was fixed to the price of gold. With the end of the gold standard in 1971, however, the dollar's price began to freely fluctuate against other fiat currencies. Not longer after, an index was created to track its value.
The Dollar Index launched in March 1973 at a starting price of 100 and has operated since then tracking the fluctuations of the currency over the decades.
Note: A rising Dollar Index indicates a stronger dollar, and vice versa. A quotation of 110, for example, would mean that the Dollar Index is 10% stronger today versus its fiat currency peers than it was in March 1973 when the index was launched.
Historically, the Dollar Index has not been all that volatile, or at least not to the extent of stocks or commodities. That said, the index initially dipped following its launch, bottoming out around 85 in 1978 during that inflationary period. The Dollar Index then went on to soar to as high as 150, hitting its all-time high, in 1984.
The Plaza Accord, which included the United States, was soon enacted to weaken the greenback, and it worked with overwhelming success. By 1987, the Dollar Index had fallen back below 100. It would stay there until 1999, when the soaring U.S. economy lifted the index substantially; it would peak in 2001. Amid geopolitical issues overseas and an unsteady economy, however, the Dollar Index weakened dramatically, hitting its all-time low in the mid-70s in 2007. In 2015, the dollar finally recovered, and has been back around the 100 level since then.
Important: The Dollar Index measures the currency's performance against other fiat currencies. The dollar has held its ground against other world currencies since 1973. The Dollar Index does not take inflation into consideration however, and is not a measurement of purchasing power.
What Currencies Are in the Dollar Index?
It is important to realize that the Dollar Index is far from all-encompassing in measuring the dollar's value. In fact, at present, the index is calculated against just six other world currencies. These currencies, and their proportion within the index, are as follows:
- Euro - 58% weight
- Japanese yen - 14% weight
- British pound - 12% weight
- Canadian dollar - 9% weight
- Swedish krona - 4% weight
- Swiss franc - 4% weight
Notably, the index leaves out several prominent currencies that are either major global players or major U.S. trading partners. The Chinese yuan and Mexican peso, for example, are both excluded from the Dollar Index. These are notable omissions, since those countries are the United States' #1 and #3 largest trading partners, respectively.
Other notable exclusions include the Australian dollar, Hong Kong dollar, the Singaporean dollar, and the Indian rupee. There is a decent argument that the Dollar Index should be updated to more closely reflect modern economic and trade flow developments. However, the index has already gained a great deal of popularity and thus has become entrenched as a popular barometer for tracking the dollar's value.
Note: The Dollar Index only covers six of the world's leading currencies in relation to the U.S. dollar. With the exclusion of key trading partners such as China and Mexico, the Dollar Index may not fully reflect the value of the U.S.' currency against its leading peers.
For investors wanting an alternative, the Federal Reserve has created a trade-weighted measurement of the dollar with a different set of underlying currencies. However, it has not gained the same level of mainstream popularity as the older Dollar Index.
The U.S. Dollar Index (USDX) Explained
Despite the Dollar Index's flaws, it does serve a major role. That is in keeping track of the value of the dollar over the decades against its major counterparts. This is of particular value since many of the leading currencies of the 1970s are no longer in existence.
The rise of the euro replaced the former monies of various prominent European nations including Germany, France, Spain, and Italy. It's hard for market historians to calculate the value of the dollar against pre-euro currencies due to this fact. The Dollar Index, however, gives analysts an easy way to deduce the relative value of the dollar at any given point since 1973 even though many of the currencies it traded against are no longer in existence.
Nowadays, the Dollar Index serves several functions. It is widely quoted in financial media as a quick gauge of how the currency is faring. Analysts use it for longer-term studies such as tracking correlations between the value of the dollar and various other assets. And investors can buy financial products which track the value of the Dollar Index.
How To Invest in the U.S. Dollar Index
There are a variety of ways to invest in the dollar and its index more specifically. For many investors, the easiest avenue would be an exchange-traded fund which tracks the index directly. The Invesco DB USD Bullish ETF (UUP), for example, is designed to track the Dollar Index. It has more than $1.5 billion in assets under management and thus is a large and liquid ETF for traders looking to quickly track the value of the dollar. There is also an inverse dollar ETF, Invesco DB USD Bearish Fund (UDN), for traders looking to capitalize on a move in the other direction.
For investors wanting more leverage in a Dollar Index position, the Intercontinental Exchange (ICE) offers a futures contract on the index. This product trades 21 hours a day, five days a week, offering near-continuous liquidity for dollar trading throughout most time zones and market moving events.
While forex trading tends to be more geared toward the buying and selling of individual currencies rather than indexes, some foreign exchange brokers allow actual trading of the Dollar Index as well. Some U.S. brokers now allow their customers to hold cash in other currencies as well, offering another alternative for investors who want to diversify away from the dollar.
This article was written by
Ian worked for Kerrisdale, a New York activist hedge fund, for three years, before moving to Latin America to pursue entrepreneurial opportunities there. His Ian's Insider Corner service provides live chat, model portfolios, full access and updates to his "IMF" portfolio, along with a weekly newsletter which expands on these topics.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.