What Is the U.S. Dollar Index?
The U.S. Dollar Index measures the performance of the dollar against a basket of currencies. The index, abbreviated USDX, contains six component currencies: the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc.
A gain in the index indicates that the dollar has appreciated compared to other currencies, while a decline indicates depreciation.
A Brief History of the U.S. Dollar Index
In 1973, the Federal Reserve set up the U.S. Dollar Index to track the performance of the dollar against other currencies after the U.S. government abandoned the gold standard and suspended the Bretton-Woods system two years earlier. The USDX contained 10 currencies prior to the 1999 creation of the euro, which replaced five currencies: the West German mark, French franc, Italian lira, Dutch guilder, and Belgian franc.
The InterContinental Exchange (ICE) has overseen the compilation and weighting of the U.S. Dollar Index since 1985, when futures trading began. Trading on options started in 1986.
The Fed does have its own version of an index matched against currencies of countries that trade heavily with the U.S. The Nominal Broad U.S. Dollar Index typically matches the performance of the USDX.
What Is the Composition of the U.S Dollar Index? How Is It Weighted?
The weighting of the U.S Dollar Index is skewed toward the euro (57.6 percent)—more than any of the other constituent currencies: the British pound (11.9 percent), Canadian dollar (9.1 percent), Swedish krona (4.2 percent), and Swiss franc (3.6 percent).
How Is the U.S. Dollar Index Calculated?
The base value for the U.S. Dollar Index was set at 100, and its range has varied quite a bit since its inception in 1973. The following is the equation for the index, with the dollar as the price currency in foreign exchange rates except for the euro and the pound, for which it is the base.
USDX = 50.14348112 × EURUSD^-0.576 × USDJPY^0.136 × GBPUSD^-0.119 × USDCAD^0.091 × USDSEK^0.042 × USDCHF^0.036
Note: The caret symbol “^” represents an exponent, and the number that follows is in exponential form.
How Influential Is the U.S. Dollar Index?
Investors and analysts track the U.S. Dollar Index as a useful and immediate indicator of the dollar’s strength relative to other currencies.
In addition to the U.S. dollar, many countries’ central banks tend to hold the index’s constituent currencies as part of their international reserves. While the U.S. dollar serves as the currency of choice for most, the euro and yen serve as backup currencies for many. A risk of holding non-U.S. dollar currencies is that any gain or decline in the dollar’s relative value could mean a weakening or a strengthening of those currencies.
How to Invest in the U.S. Dollar Index
Investors can’t trade directly on the index itself, but they can invest via futures, options on those futures, and exchange-traded funds. Futures and options trading tend to take their cue from trading in the spot dollar market. For example, a strengthening of the dollar suggests higher futures prices.
The Bank for International Settlements—a financial institution that is controlled by central banks worldwide and serves as their bank—reported that average daily turnover in US dollar-denominated contracts amounted to $3.3 trillion in April 2019, the latest year for which data is available.
Many investors turn to futures and options trading in the U.S. Dollar Index as a hedge against inflation. When inflation starts to accelerate, the Fed looks at tightening monetary policy. Interest rates begin to rise, and that makes dollar assets more attractive to investors.
Futures and Options
Futures on the index are traded 21 hours each day (including weekends) on the ICE platform in three geographical locations: New York, London, and Singapore. The value of each contract is the index’s value multiplied by $1,000.
For example, if the index was trading at 115, the value of a single contract would be $115,000. Futures trade on quarterly contracts: March, June, September, and December. Unlike futures trading on some commodities, currencies that make up the index can be delivered, in proportion to their weightings, typically on the third Wednesday of the contract month.
Options on those futures are also traded on the ICE platform.
ETFs
ETFs, such as the Invesco DB US Dollar Index Bullish Fund, which is benchmarked against the Deutsche Bank Long USD Currency Portfolio Index-Excess Return, offer a way to invest in the U.S. Dollar Index indirectly. The performance of the Deutsche Bank index is based on the futures of the U.S. Dollar Index.
While not benchmarked against an index, the WisdomTree Bloomberg U.S. Dollar Bullish Fund is another popular fund that bases its performance on the dollar. The WisdomTree index is heavily weighted toward U.S. Treasuries but does invest in some currencies.
Frequently Asked Questions (FAQ)
The following are answers to some of the most common questions investors ask about the U.S. Dollar Index.
Why Are the Swedish Krona and Swiss Franc Still Part of the U.S. Dollar Index?
When the dollar index was created in the early 1970s, Sweden and Switzerland were viewed as stable governments, and consequently, their respective currencies—the krona and the franc—were perceived as stable currencies.
The general perception is that those countries remain stable, and their currencies remain in the index’s weighting. One could argue that other countries also have stable governments and stable currencies, but the conservative approach is akin to the adage: If it ain’t broke, don’t fix it.
Why Aren’t the Yuan and Other Major Currencies Part of the U.S Dollar Index?
China’s yuan doesn’t trade as openly as many other nations’ currencies do in the foreign exchange market, which would make it an unlikely candidate for inclusion in the U.S. Dollar Index. Norway’s krone could be viewed as a possible constituent currency because of stability in the government and its currency. Ultimately, the decision of changing the makeup of the index falls on ICE.
