If you have worked in the financial industry for even a short amount of time, it is highly likely that you are familiar with the DXY index. In this article, we will go over exactly what the DXY index is and how it works.
In addition, we will talk about the background of the index, the reasons why it is so important to the economy, and the different ways it can be applied. Please continue reading to find out more.
What Is the U.S. Dollar Index (DXY)?
Simply explained, the DXY measures the value of the US dollar in relation to a bundle of six foreign currencies. ICE (Intercontinental Exchange, Inc.) has been maintaining the index since 1985. In the index, the basket of currencies comprises six currencies that are measured against the US dollar.
The EUR is the most heavily weighted currency in this basket, followed by the JPY, GBP, CAD, SEK, and CHF. Here is a list of the currencies:
- EUR – 57.6%
- JPY – 13.6%
- GBP – 11.9%
- CAD – 9.1%
- SEK – 4.2%
- CHF – 3.6%
The DXY is pretty outdated and needs improvements as of now. This is due to the fact that there are some nations that are not included in the DXY yet are larger trading partners than some of the nations that are included.
When compared to China, Brazil, Mexico, and South Korea, the Swedish Krona (SEK) and the Swiss Franc (CHF) are very minor trading partners. Changes to the index could take place in the not-too-distant future.
The History of the DXY Index
The index was first formed after the breakdown of the Bretton Woods system in 1973. In 1985, when trading in DXY first began, the exchange was taken over by the Intercontinental Exchange (ICE). Throughout the course of its history, the index has reached two moments of significance, which are referred to as its all-time high and all-time low, respectively.
- All time low of 70.57 in March of 2008
- All time high of 164.72 in February of 1985
The financial crisis of 2008 was another factor that had a significant role in the decline of the DXY index to its all-time low value. The year that the index first began futures trading was also the year that it reached its all-time high. The DYX index has stayed reasonably fairly stable between the levels of 90 and 100 during the course of the last 6 years.
It’s also possible to conceive of the DXY index as the inverse of the Euro index. Because the euro accounts for roughly 60% of total weight, the EUR/USD pair will have a correlation with the DXY. This indicates that a rise in the DXY will result in a lowering of the USD and vice versa.
How the DXY Moves
Every trader should try to analyze how the DXY index moves. We’ve already discussed how the USD/EUR pair is tied to one another. However, you should understand that if the dollar index rises, US base pairs will rise as well. This occurs in currency pairs where the USD is the initial pair, such as USD/CAD or USD/CHF.
If, on the other hand, the DXY rises, USD quote pairings will fall. This occurs in pairs where the USD is the second currency, such as EUR/USD, GBP/USD, or XAU/USD, among others.
(Graph showing the correlation between DXY and the EUR. Source: RockFortMarkets)
The graph below depicts the nearly identical inverse connection between the DXY and the EUR/USD. The graph indicates that when the DXY increases, so does the EUR/USD, and vice versa.
(Graph showing the correlation between DXY and the CAD. Source: RockFortMarkets)
When analyzing DXY against USDCAD, you see that the highs and lows closely correspond. If you look at the change in the DYX vs the CAD as shown above, you will see that the change is not completely the same.
This is when the currency’s weightage comes into play. As we have shown above, the CAD does not have a huge weight value when compared to the EUR.
Takeaways
- If you have worked in the financial industry for even a short amount of time, it is highly likely that you are familiar with the DXY index.
- Simply explained, the DXY measures the value of the US dollar in relation to a bundle of six foreign currencies.
- The EUR is the most heavily weighted currency in this basket, followed by the JPY, GBP, CAD, SEK, and CHF.
- The index was first formed after the breakdown of the Bretton Woods system in 1973.
- The year that the index first began futures trading was also the year that it reached its all-time high.
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Macroeconomic movements in the USD and other currencies in the basket impact the index andit is also influenced by economic development or financial crises in the countries included.
