US Dollar Index Full Explanation | The Key Indicator to Master Global Capital Flows

What Exactly Does the US Dollar Index Measure?

When it comes to the US Dollar Index, many investors may feel unfamiliar. But as long as you’ve been involved in stocks, forex, or commodity trading, you’ve definitely heard terms like “US dollar appreciation” or “Dollar Index strengthening.”

US Dollar Index (abbreviated as USDX or DXY) is essentially a gauge of the dollar’s international competitiveness. It does not track a single asset but follows the relative exchange rate changes of the US dollar against six major international currencies.

Think of the US Dollar Index as a global financial market thermometer. Since the dollar is the world’s primary trading and pricing currency, settling everything from commodities, energy, gold, to cross-border investments in USD, any fluctuation in the index can trigger chain reactions across global capital markets.

The Six Currencies Constituting the US Dollar Index and Their Weightings

The US Dollar Index is not simply an average of six currencies; instead, it uses a “geometric weighted average method” based on each country’s economic size, trading activity, and currency influence for precise calculation.

Distribution of currency weights:

With over half the weight in the euro, this reflects the EU’s massive economic size as a union. Since the Eurozone covers 19 countries, the movement of the USDX largely depends on European economic conditions. The Yen, as Japan is the world’s third-largest economy and with long-term low interest rates and ample liquidity, plays an important role as a safe-haven asset in international markets.

This weighting design means that when observing USDX fluctuations, the first focus should be on the trends of the euro and yen, as their rises and falls often determine the overall direction of the index.

How Is the US Dollar Index Calculated?

The formula used for USDX is:

USDX = 50.14348112 × ((EUR/USD)^(-0.576)) × ((JPY/USD)^(-0.136)) × ((GBP/USD)^(-0.119)) × ((CAD/USD)^(-0.091)) × ((SEK/USD)^(-0.042)) × ((CHF/USD)^(-0.036))

In this formula, 50.14348112 is a fixed base number to ensure that the USDX starting point in 1985 is 100. The parts in parentheses represent real-time exchange rates of USD against each currency, and the superscript numbers are the respective weight coefficients.

It’s important to emphasize that the USDX is not an exchange rate or a specific price; it is a relative index measuring the dollar’s strength compared to the base period (1985).

What does the index value mean?

• Index = 100: The dollar has not appreciated or depreciated compared to the base period
• Index = 76: The dollar has fallen 24% relative to the base period, indicating weakness
• Index = 120: The dollar has risen 20% relative to the base period, indicating strength

In short, a higher USDX indicates a stronger dollar; a lower USDX indicates a weaker dollar in the international market.

The Practical Impact of USDX Fluctuations on Investments

When USDX rises

An increase in USDX means the dollar is appreciating, i.e., strengthening against other major currencies. In this context:

Positive effects on the US economy:

• Lower costs for imported goods, allowing US consumers and businesses to buy overseas products at cheaper prices
• Global investors flock to US markets, increasing attractiveness of US Treasuries, stocks, and other dollar-denominated assets
• Dollar appreciation helps control inflation since imported goods become cheaper

Impacts on other countries and companies:

• Export-driven economies (like Taiwan, South Korea) face challenges as their goods become more expensive when priced in USD, reducing competitiveness
• Emerging markets with dollar-denominated debt face increased repayment pressure
• Non-US investors holding dollar assets may face exchange losses when converting back to their local currencies

When USDX falls

A decline in USDX indicates a weakening dollar, often shifting market confidence toward other asset classes. Typically, this results in:

• Capital flowing out of the US and into Asian stocks or emerging markets
• Export-oriented economies benefiting as USD-priced goods become cheaper
• Local currencies appreciating, which can increase import costs
• Investors holding US stocks and bonds facing exchange rate risk, as a weaker dollar means lower returns when converting back to their home currency

The Relationship Between USDX and Global Assets

USDX and US Stocks

There is no simple positive or negative correlation between USDX and US stocks; it depends on economic cycles and policy contexts:

• During economic recovery, USDX and US stocks often rise together, as a strong US economy attracts global capital inflows
• However, if the dollar appreciates too rapidly, it can pressure US export earnings, potentially causing US stocks to decline
• During the March 2020 global financial crisis, USDX surged to 103, but later, with the Federal Reserve’s large-scale easing policies, the dollar weakened again to 93.78

Thus, the relationship between USDX and US stocks requires considering economic cycles, monetary policy, and other factors.

USDX and Gold

Gold and USDX typically exhibit an inverse relationship:

• When the dollar appreciates, gold priced in USD becomes more expensive, reducing demand and causing gold prices to weaken
• When the dollar weakens, gold becomes cheaper in USD terms, increasing demand and pushing prices higher

This inverse relationship is straightforward: a strong dollar raises the cost of buying gold in USD, decreasing its attractiveness. However, gold prices are also influenced by inflation, geopolitical tensions, wars, and other factors, so relying solely on USDX for gold price predictions is insufficient.

USDX and Asian Stocks & New Taiwan Dollar

For Asian economies like Taiwan:

• When USDX rises, capital flows from Asia to the US, putting downward pressure on the New Taiwan Dollar (NTD) and Taiwan stocks due to foreign investor withdrawal
• When USDX falls, international capital re-enters Asian markets seeking higher returns, leading to NTD appreciation and support for Taiwan stocks

However, this relationship is not absolute. In optimistic global economic scenarios, US stocks, Asian stocks, and the dollar may rise together; during black swan events, assets can decline simultaneously.

Key Factors Driving USDX Fluctuations

1. Federal Reserve Interest Rate Policies

This is the most direct factor influencing USDX. Fed decisions during meetings significantly impact global markets:

• Rate hikes: Increase US dollar borrowing costs, attracting global capital into the US to chase higher yields, pushing USDX higher
• Rate cuts: Reduce dollar attractiveness, leading to capital outflows and a decline in USDX

USDX often experiences significant volatility before and after Fed meetings.

2. US Economic Data

Indicators like Non-Farm Payrolls, unemployment rate, CPI inflation, and GDP growth directly reflect US economic strength:

• Strong data → optimistic outlook for US economy → dollar appreciation → USDX rises
• Weak data → declining market confidence → dollar depreciation → USDX falls

3. Geopolitical and Unexpected Events

Wars, political turmoil, regional conflicts, and other events trigger global risk aversion:

• When uncertainty rises, investors tend to flock to safe-haven assets like the dollar
• This often results in “more chaos, stronger dollar” phenomena

4. Movements of Other Major Currencies

Since USDX is a relative index, changes in other currencies’ policies, economic weakness, or political instability can influence it:

• Even if the dollar itself remains unchanged, depreciation of other currencies can make USDX appear to rise

USDX vs. US Dollar Trade-Weighted Index

Investors most commonly refer to the US Dollar Index (DXY), but the Federal Reserve mainly considers the Trade-Weighted U.S. Dollar Index. The differences are:

US Dollar Index (DXY):

• The most well-known, most frequently reported
• Created by ICE (Intercontinental Exchange)
• Based on USD against six major currencies
• Highest weight in euro (57.6%), with a clear Euro-American bias

Trade-Weighted U.S. Dollar Index:

• The core reference for Fed policy decisions
• Based on actual US trade flows with countries, weighted accordingly
• Includes over 20 currencies, covering Asian emerging markets
• Incorporates RMB, Korean won, TWD, Thai baht, etc., better reflecting global trade realities

In summary, the USDX is a quick gauge of market sentiment, while the trade-weighted index provides a deeper insight into the dollar’s true purchasing power and the Fed’s policy considerations.

Conclusion

The US Dollar Index acts like a wind vane for global capital flows. Understanding its fluctuation patterns can help investors anticipate trends in gold, oil, stocks, and other assets. Especially in forex trading, USDX is an essential decision-making tool.

Whether you’re positioning in US stocks, gold, or forecasting the TWD’s movement, changes in USDX are worth continuous attention and analysis. Building a systematic understanding of USDX will greatly enhance your investment decision quality.