What is the DXY Index?
The DXY Index, more commonly known as US Dollar Index (USDX), is a measure of the value of the US dollar relative to the value of a basket of currencies of major US trading partners (Japanese Yen, Canadian Dollar, British pound, Euro and Swedish Krona), providing a good way of quantifying USD strength. It is subject to changes, and Mexican Peso and Chinese Yuan are likely to join the index replacing other currencies in the following years.
DXY Index is affected by recessions and economic growth, inflation and deflation, interest rate differentials, trade movements, among others.
It was created by the Federal Reserve of the United States in 1973, following the termination of the Bretton Woods Agreement, to offer an external bilateral trade-weighted average value of the dollar while it floated freely against foreign currencies. DXY Index was established with a basis of 100, and all values since then have been relative to this base.
On March 5, 1985, it hit an all-time high of 163.83. On April 22, 2008, it hit an all-time low of 71.58, down 28.4 percent from its creation. It is the most frequently used criterion for evaluating the world’s global reserve currency’s performance.
How to calculate the DXY Index
The formula to calculate the DXY Index relies on the weight assigned to every currency inside the basket.
They are distributed as:
- Euro (EUR), 57.6% weight
- Japanese yen (JPY) 13.6% weight
- Pound sterling (GBP), 11.9% weight
- Canadian dollar (CAD), 9.1% weight
- Swedish krona (SEK), 4.2% weight
- Swiss franc (CHF) 3.6% weight
And its equation is:
USDX=50.14348112 x EURUSD-0.576 x USDJPY0.136 x GBPUSD-0.119 x USDCAD0.091 x USDSEK0.042 x USDCHF0.036
Where the value in the formula is positive when the US dollar is the base currency; and negative when it’s the quote currency. The first factor, 50.14348112, is the index’s historical value of 100 on the start date of the reference.
What is the current DXY Index?
The current DXY Index is 96.6 on January 2022. Last month the index was at 95.97, and a year ago was at 89.94.
What is a good DXY Index for investing?
A value of 110 indicates that the US dollar has appreciated 10% against the basket of currencies over the specified period. Therefore, if the USDX rises, it implies that the US dollar is strengthening or gaining value against other currencies.
Likewise, if the index is 90, it has depreciated by 10% from its starting value. The appreciation and depreciation results are a factor of the time in question.
How to use the DXY Index?
Investors can use the US Dollar Index to monitor the value of the USD against a basket of major currencies in one transaction. It also allows them to protect their investments against any dollar-related risks.
It may be used in technical analysis to confirm patterns in, among other things, the following market
Commodity Markets
The dollar index has an inverse relationship with commodity prices. As a result, when the dollar index rises, commodity prices fall, and vice versa. Given gold’s historical prominence in the monetary system, it has a strong inverse relationship with the dollar index because investors seek other investment options to hold value when the currency loses strength, and gold is one of the favorites.
Equity Markets
Data has shown that usually, a higher dollar has been accompanied by US shares outperforming their developed and developing market counterparts. In a rising dollar situation, emerging market stocks face considerable pressure and underperform developed market equities. As US dollars are required to acquire shares, an increase in dollar’ value will almost certainly enhance the value of American stock indexes.
Bond Markets
Historically, the dollar strength is due to FED increasing rates, which lead to lower bond prices and higher yields. The dollar index also has an indirect influence on emerging bond markets, particularly those with current account deficits, because higher bond yields make servicing their dollar-denominated debt more difficult.
What are the limitations of the DXY Index?
There are several issues with using the DXY Index as a standalone measurement:
- It is less diverse (European countries account for 77% of the basket) and has fewer participants (no emerging markets).
- It is an insufficient measure of the dollars’ worth since it excludes significant US trading partners such as China, Mexico, and Saudi Arabia.
- Since it has no regularly scheduled revisions or rebalancing (just once in 1999) and distributes fixed weights to nations, the DXY Index is not designed to represent changes in global trade.
Is the DXY Index a reliable indicator?
The short answer is that yes, the DXY Index has been one of the most trustable indexes for a long time and while it has a fair number of drawbacks, US Dollar Index is an essential tool in the arsenal of a strategic investor because it adds weight to trade setups.
If the DXY is oversold, currency pairings with the US dollar as the base currency, for example, USD/CHF, may be a good purchase. Likewise, if the DXY is overbought, selling these markets makes sense.
If the USD is the quote currency, such as EUR/USD or GBP/USD, buying these currency pairs may be appealing if the DXY is overbought. Likewise, if the DXY shows an oversold level, traders may consider selling these markets.
It is worth mentioning that DXY Index should be complemented with other indicators to maximize it and get a better-investing strategy.
We suggest using this indicator along with our complete list of 12- essential market indicators to make educated financial decisions. These metrics include:
