US Dollar Index and its influence on financial markets - US Dollar Index and its influence on financial markets

US Dollar Index and its influence on financial markets

Author: Michael view: 64 Update: 02/10/2023 Downloads: 0

US Dollar Index (DXY) is an index that measures the value of the USD against a basket of other major currencies. This index is widely used in global financial markets as an indicator of the strength of the USD. DXY volatility has a significant impact on financial markets such as foreign exchange markets, bond markets, stock markets and commodity prices.

1. US Dollar Index and its influence on financial markets

The US Dollar Index was created in 1973 by the US Federal Trade Advisory Commission. Originally, the index tracked the value of the USD against a basket of 10 major currencies. In 2006, the currency basket was updated and now includes 6 major currencies:

Euro (EUR) – 57.6% proportion

Japanese Yen (JPY) – 13.6%

British Pound (GBP) – 11.9%

Canadian Dollar (CAD) – 9.1%

Swedish Krona (SEK) – 4.2%

Swiss Franc (CHF) – 3.6%

US Dollar Index and its influence on financial markets - US Dollar Index and its influence on financial markets

When the US Dollar Index increases in value, it means the USD strengthens compared to other currencies. Conversely, when DXY declines, USD weakens against the currencies in the basket.

DXY volatility strongly affects financial markets as follows:

2. Forex market

The USD index is the most important indicator of the greenback’s trend. When DXY increases in price, USD strengthens compared to other currencies, investors will sell weaker currencies to buy USD. That causes the value of the USD to increase compared to other currencies.

For example, if DXY increases, the price of USD/VND, USD/EUR, USD/JPY… will increase accordingly. Investors will sell EUR, VND, JPY and buy USD to benefit from exchange rate differences.

3. Bond market

USD is the main global reserve currency. When DXY increases, USD will be more attractive compared to other currencies. At that time, capital will flow into the US bond market to buy USD.

Increased demand for US bonds will push US bond interest rates up. This makes US bonds more attractive to investors. Conversely, when DXY falls, US bond yields also fall.

4. Stock market

Rising interest rates due to increased DXY will cause businesses’ capital costs to increase. This threatens business profits, pulling stock prices down.

Conversely, when DXY falls, falling interest rates will support rising stock prices. Therefore, US stock indexes such as S&P 500 and Dow Jones have a negative correlation with DXY.

5. Commodity prices

Most goods are priced in USD such as gold, crude oil, copper… When the USD strengthens (DXY increases), the prices of goods will decrease because more must be converted into USD.

On the contrary, when the USD weakens, the price of gold, oil, copper, etc. increases when calculated in USD. This is called the inverse commodity price effect with the USD.

Thus, it can be seen that the US Dollar Index has a strong influence on major financial markets. Investors and businesses need to closely monitor fluctuations in this index to adjust their investment portfolios and business strategies accordingly.

6. Some specific examples of the impact of DXY

  • In March 2020, the Covid-19 pandemic broke out strongly, causing the global economy to fall into crisis. At this time, DXY skyrocketed from 96 to nearly 103 points because USD was considered a safe haven.

Gold price plummeted from 1,700 USD/oz to 1,450 USD/oz due to the opposite direction of gold price with USD. Many gold ETF funds were “withdrawn” because gold prices dropped sharply.

US Dollar Index and its influence on financial markets - US Dollar Index and its influence on financial markets

America’s trading partners, ranked from highest to lowest.

  • The S&P 500 index fell 35% on rising interest rates and a worsening outlook for corporate profits.
  • WTI oil price dropped from 60 USD/barrel to a record low of negative 40 USD/barrel because of a sharp decline in consumption demand.
  • In mid-2022, the US Federal Reserve (Fed) rapidly increased USD interest rates, causing DXY to increase from 102 to a 20-year high of 114 points.
  • Gold price decreased from 2,050 USD to 1,650 USD/oz. Many gold ETFs suffered strong withdrawals.
  • The S&P 500 index fell nearly 25% due to fears of a recession as the Fed tightened monetary policy.
  • WTI oil price decreased from 120 USD to 85 USD/barrel due to weaker consumption demand. US Dollar Index and its influence on financial markets - US Dollar Index and its influence on financial markets

This is historical data of the USD Index, for the period from 2007 – 2019 calculated by the last day of the year.

Thus, it can be seen that the strong fluctuations of DXY have negatively impacted many important financial markets. Investors and businesses need to pay attention and guard against risks from USD fluctuations.

7.Conclude

US Dollar Index (DXY) is an important index reflecting the strength of the USD compared to a basket of other major currencies. DXY volatility has a strong impact on many major financial markets such as foreign exchange, bonds, stocks and commodity markets.

Investors and businesses need to pay attention to monitoring developments in the USD index to adjust their investment portfolios and business strategies accordingly. For countries around the world, DXY affects exports, imports, inflation and market sentiment. Therefore, authorities need to have appropriate policies to respond to fluctuations in the USD.

US Dollar Index FAQ

1. Why does EUR account for the highest proportion in the US Dollar Index calculation basket?

EUR accounts for the highest proportion (57.6%) because it is the second largest currency in the world after USD. In addition, the Euro area (including 19 European countries) is the United States’ largest trading partner. Therefore, USD/EUR is the most liquid forex pair in the world.

2. Why are investors interested in DXY?

DXY shows the trend of USD compared to other currencies. The trend of the USD has a strong impact on many other financial markets. Therefore, DXY helps investors evaluate the general trend of the market to adjust their investment portfolio.

3. Does DXY affect US inflation?

Yes, the correlation between DXY and US inflation is negative. When DXY increases (USD strengthens), US import costs decrease due to favorable exchange rates, helping to curb inflation.

On the contrary, if DXY declines, the weaker USD will cause the price of imported goods to increase, promoting inflation in the US. This is also the reason why the Fed is interested in DXY developments.

 

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