The U.S dollar index – USDX / DXA

The U.S. dollar index (USDX) is a measure of the value of the U.S. dollar against a basket of six world currencies – Euro, Swiss Franc, Japanese Yen, Canadian dollar, British pound, and Swedish Krona – otherwise known as the U.S’s most significant trading partners.

The value of the index is a key indicator of the dollar’s value across global markets. Similar to other trade-weighted indexes, USDX also uses the exchange rates from the same major currencies.

History

In 1973, the USDX was established by the Federal Reserve, shortly after the Bretton Woods Agreement dissolved, and has been managed by ICE Futures US since 1985. Starting with a base of 100, with values since then relative to this base. Participating countries settled their balances in U.S. dollars (which was used as the reserve currency), while the USD was fully convertible to gold at a rate of $35/ounce.

As a result of an overvaluation of the USD, concerns over the exchange rates and their link to how gold was priced started to surface. At the time, President Richard Nixon decided to temporarily suspend the gold standard, at which point other countries were able to choose any exchange agreement other than the price of gold. An end to the agreement was finally put in place in 1937 after several foreign governments chose to let their currency rates float.

How is the index calculated?

By factoring in the exchange rates of the six major world currencies stated above. The largest component of the index is the EUR making up almost 58 percent of the basket (57.6%).

The weights of the remaining currencies in the index are as follows: JPY (13.6%), GBP (11.9%), CAD (9.1%), SEK (4.2%), and CHF (3.6%).

In the 1970s, the index fluctuated between 80 and 110 as the US economy struggled through rising inflation and a tough recession. Interest rates were increased by the Fed in an attempt to reduce inflation in the late 1970s, with money flowing into the US Dollar – causing the USD Index to jump.

What factors influence the price of the USDX?

The USD Index is mainly affected by the supply and demand of the US dollar and the other currencies that form the basket. The supply and demand for these currencies are largely influenced by the monetary policies and their interest rates, which are set by the central banks in each respective country.

Due to a high volume of income/export activities in today’s world, the DXA and most major indices react to factors that occur globally, such as economic news, inflation, economic performance, credit ratings, market sentiment, political upheaval and even natural disasters.

Each of these factors will impact demand and supply related to import and export activities in the various sectors represented under the index, which in turn influences the price of the index as a whole.

To make informed trades, it’s important to stay on top of economic data coming out of the US and each of the respective countries in the basket.

Look out as well for figures on job creation, unemployment, GDP and of course interest rates out of the US and the other countries in the basket.

Why is the USDX important for traders?

The US Dollar Index is important for traders both as a market in its own right as well as being used as a key indicator of the strength of the US Dollar around the world.

It is not only used in technical analysis to confirm trends related to the following markets:

• Currency pairs that include the US Dollar
• Commodities priced in USD
• Stocks and indexes

Many traders use this index as a way to try to hedge risk – for example, offsetting some of the risk associated with a long USD/GBP trade by going short on the.