What is the US Dollar Index (DXY)?

The Dollar Index (DXY) measures the value of the United States dollar relative to a basket of foreign currencies. This benchmark provides traders, investors, policymakers and economists worldwide with insights into the dollar’s strength globally. Financial professionals rely on the DXY as a reference point in currency and commodity markets.

The origins of the Dollar Index date back to 1973, when it was introduced by the U.S. Federal Reserve. This coincided with the end of the Bretton Woods monetary system, which had pegged global currencies to the U.S. dollar. With exchange rates now floating, the Dollar Index aimed to provide a comprehensive assessment of the dollar against other major currencies. It was initially set at 100.

The DXY weighs the U.S. dollar against six major currencies: the euro, Japanese yen, British pound sterling, Canadian dollar, Swedish krona, and Swiss franc. These currencies were chosen due to their prominence in international finance and trade at the time. The Eurozone and Japan, for instance, represented significant portions of global GDP. The inclusion of European and Asian currencies provided a broad geographical representation.

Fluctuations in the Dollar Index over time show the relative strength or weakness of the U.S. dollar compared to the basket. For example, a rising DXY indicates the dollar is strengthening against those currencies, while a falling DXY shows the dollar is weakening.

The index is calculated using a weighted geometric mean of the dollar’s value against each currency.

  • EURUSD is weighted at -57.6%,
  • USDJPY is weighted at 13.6%,
  • GBPUSD is weighted at -11.9%,
  • USDCAD is weighted at 9.1%,
  • USDSEK is weighted at 4.2%,
  • USDCHF is weighted at 3.6%.

The euro is weighted most heavily at over 50%, reflecting the prominence of Eurozone trade. The yen and pound have the next highest weights, followed by the remaining currencies.

The Dollar Index holds great significance in the financial world. Investors closely monitor the DXY to gauge dollar strength and anticipate potential movements in currency and commodity markets. For example, a rising Dollar Index often leads to a sell-off in gold prices, as investors shift assets back into a stronger dollar.

Central banks also keep a close eye on the DXY when formulating monetary policies aimed at stabilising their economies. Sustained spikes in the index are seen as indications of an overvalued or strengthening dollar, which could negatively impact exports. As such, central banks may respond by adjusting interest rates or currency pegs.

However, critics argue the Dollar Index has limitations in today’s global economy. The basket represents just a handful of currencies, lacking emerging market currencies like the Chinese renminbi. With the rise of digital and cryptocurrencies, along with shifting world economic dynamics, some experts have questioned the ongoing relevance of the DXY.

That said, the Dollar Index remains deeply entrenched in financial markets. Traders analyse the DXY daily to identify trends and key technical levels that may signal entry or exit points for trades. For example, a dropping Dollar Index can foreshadow a good opportunity to buy gold or euros for example. The DXY also informs decisions on hedging currency risk in portfolios.

While no single metric can perfectly capture currency movements, the Dollar Index has provided an accessible, easily understood focal point for tracking the greenback’s value for nearly 50 years. Despite its flaws, the widespread use and impact of the DXY solidifies its place as a key barometer in global financial markets today and for the foreseeable future.