The US dollar has been the most important currency of the international financial system for many years. It is the currency of the largest economy in the world with the most liquid financial market of the world. The US dollar index is the easiest indicator to use in tracking the movements and assessing the behavior of the US dollar compared to the most important foreign currencies. In this article we are going to focus on important aspects about the index such as the definition, history and calculation.
Definition of the dollar index
The US Dollar Index (USDX) represents the value of the US dollar compared to a basket of six major currencies. The index was introduced for the first time to the international financial system in 1973 at a value of 100. The US Dollar Index represents the weighted average of dollar in comparison with 6 major currencies, where the euro has heaviest weight of the index with 57.6 percent, as depicted in the following pie chart.
History of Dollar Index
The index was established after the Bretton woods agreement, as the participating countries agreed to settle their balances in us dollar, noting that the dollar was fully convertible to gold at a at that time at a rate of $35/ounce.
Thereafter, concerns over the process of overvaluation of the dollar and its exchange rate, in addition to the way of linking the dollar price to gold prompted US President Richard Nixon to temporarily suspend the gold standard, which enabled other countries to choose any exchange agreement other than the price of gold. In 1973, many foreign governments chose to let their currency rates float, putting an end to Bretton woods agreement.
The fluctuation of the dollar index through years
The dollar index experienced many ups and downs throughout its history. The highest point was recorded in February 1985 with a value of 164.72 while the lowest point was hit in March 2008 with a value of 70.698. As of June 2018, the index registered a value of 94.04, this means that the dollar index has depreciated lower than its base value of 100 that was introduced in 1973. The index is greatly reflects macroeconomic factors weighing on the United States and the countries of the included currencies.
US dollar index calculation
If the value of the six-currency index reached 115 this means that the dollar has appreciated by 15 percent versus the currencies included in the basket. The calculation is similar to the percentage change as we subtract the current value from the base value then divide the difference by the initial value of 100. This will give an appreciation of 15 percent, which means the dollar has strengthened against other currencies.
By the same manner, if the index is currently 85, which means dropping 15 from its initial value, then the same calculation would result in a depreciation of 15 percent. But given the high of weight of the euro, the appreciation or depreciation of the index could largely depend on the euro movements.
How to trade dollar Index?
The index is maintained and published by Intercontinental Exchange Inc (ICE) futures and is calculated every 15 seconds. Traders can start trading through an online forex, CFD and spread betting broker during the official trading hours, with the open at 23:00 GMT on Sunday and close for the week at 22:00 GMT on Friday.
Trading the dollar index would depend on the trading strategy used by the trader and could depend on several factors, including technical and fundamental analysis.
What are the causes of the dollar’s rise between 2011 and 2016?
There are 5 factors that affected the dollar’s strength during this period:
1. After Greece financial crisis, and the struggle of the euro area to deal with the debt crisis, investors started to worry about holding the euro and therefore piled to the US dollar instead.
2. After china’s growth slowed down in 2015, this prompted investors to go back to U.S dollar.
3. Investors mainly deal with the dollar as refuge currency during any global crisis. So, the dollar has been able to take advantage of any tensions over the previously mentioned period.
4. China and Japan regularly purchase dollars in order to control the value of their currencies, as they aim to boosting their exports by making them cheaper.
5. Because of the Federal
Reserve’s hike to the fed funds rate, which began in 2015, forex traders
resorted to the dollar to benefit from the higher rates.