The Dollar Index is an indicator of the value of the American dollar against a basket of foreign currencies.
This basket consists of six different currencies. The weight of each currency within the basket is determined based on its importance in the US's foreign trade. The currencies in the basket and their weights are as follows:
Euro: Holds the most significant share at 57.6%.
Japanese Yen: 13.6%
British Pound: 11.9%
Canadian Dollar: 9.1%
Swedish Krona: 4.2%
Swiss Franc: 3.6%
The Fed created the Dollar Index in 1973 to track the value of the dollar. It was initiated at 100.00 base points. Since 1985, ICE Data Indexes has calculated the index.
The index is monitored as an indicator of the strength of the American dollar in global markets. An index value above 100.00 points signifies that the US dollar is strong against the other currencies in the basket. Conversely, a value below 100.00 indicates that it is weak.
How is the Value of the Dollar Index Determined?
The value of the Dollar Index is determined by the supply and demand for the American dollar and the other currencies in the basket. Some factors that affect the US dollar include:
Interest Rates: As the US dollar's interest rate increases, demand for the dollar rises, and the index goes up. Similarly, decreasing interest rates will exert negative pressure on the index.
Foreign Trade: Developments related to the US's foreign trade can influence the demand for the dollar. For example, the more the US exports, the higher the demand for the dollar, which raises the index.
Risk: When economic, political, or geopolitical risks increase, demand for the dollar may rise due to its status as the world's reserve currency, potentially raising the index. Conversely, when the market's risk appetite is high, demand for the dollar can decrease, leading to a drop in the index.
Similarly, developments related to the other currencies in the basket also affect the index's value. Particularly, developments related to the Euro can significantly impact the index's value due to its weight in the basket.
Is the Dollar Index being updated?
The index was only updated once in 1999 due to the introduction of the Euro. Therefore, it is said that it does not accurately reflect US trade today. The index could be updated to include the currencies of China (CNY) and Mexico (MXN), which are significant US trading partners.
Conclusion
The dollar index measures the performance of the US dollar against a basket of other currencies. Its direction and movements are considered crucial indicators because they provide significant insights into global economic trends and the state of the US economy.