The History of The Dollar Index and Understanding What Really Drives It
You might've heard about the dollar index in trading terms and many people might have told you that it's an inconsequential piece of data.
Well, THEY ARE WRONG!!
It's something that needs to be analysed before doing trades on the global markets, especially in the case of Commodities.
Understanding the Dollar Index:
The Dollar Index is a widely accepted measure that's used to evaluate the strength and performance of the United States Dollar (USD) against a selection of major currencies.
It serves as a medium to assess the overall value of the USD compared to currencies like the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.
The Dollar index is denoted by using the symbol DXY. Investors, traders and economists can gain insights into the currency's strengths or weaknesses and obtain a comprehensive understanding of its global position. The fluctuation ae thereby an indicator of the dynamic that the international currency market plays and these fluctuations could potentially have significant implications for various sectors, including trade, investment and decisions about the monetary policy.
So before diving deeper into understanding the dollar index, we've got to understand the history behind this unique entity.
History of the US Dollar Index (DXY):
The history of the US Dollar Index is quite interesting. The Dollar index dates back to the early 1970s when the Bretton Woods system which fixed the exchange rates to the US dollar had collapsed.
As a direct result of this, and in response to the changing international monetary system, the DXY was introduced in 1973 by the Intercontinental Exchange(ICE).
Throughout time the US Dollar Index has fallen as sharply as it has risen. It reached an all-time high in 1984 at nearly 165. However, its all-time low was nearly 70 in 2007. Over the last few years, the US dollar index has been going at a range-bound pace between 90 and 110.
The basket of currencies have only gone through a shift once since the index started and that was when the Euro had replayed several European currencies previously in the index in 1999, such as Germany's predecessor currency, the Deutschemark. French France, Italian Lira and more.
The Dollar Index - What currencies does it consist of?
The dollar index encompasses a unique basket of foreign currencies. Only 2 times have the matrix of the currencies been adjusted, once in 1973 and the next in 2002 when the euro replaced many European currencies.
The calculation is as follows:
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However, in the coming year, new currencies will likely be replacing the current ones as the US's trading partners have undergone a drastic change. Currencies such as the Chinese yuan (CNY) or the Mexican peso(MXN) would supplant several other currencies in the index due to countries being trading partners. However, things are changing concerning that as well.
Dollar Index - What Drives The Index?
Coming to the creamy part of the article, knowing how to trade in the dollar index is an essential component whilst endeavouring in the commodities market or even forex trading.
Geopolitics:
One thing that everyone has to understand is that the DXY or the DOllar index is moved by macroeconomic events and data such as GDP, the economic health of each country that has their currencies in the index and also the monetary policies of each central bank. Hence, these movements are closely watched by several sources to give traders the information to make informed decisions.
Safe Haven Inflows:
Another significant influence on the US dollar index price is safe haven inflows. The index usually rises during certain periods of uncertainty if traders regard the US dollar as a value store amidst the global economic crises. Inversely, the index could fall if risk on sentiment dominates and investors sell off USD and move into riskier assets.
The Federal Reserve's Influence:
As I've discussed in one of my previous newsletters the influence that the Federal Reserve has on the global markets is not to be taken lightly. When the Federal Reserve implements measures resulting in increased interest rates or strict monetary conditions as can be seen now, it boosts the dollar's attractiveness for investors searching for great returns in commodities.
During periods of market volatility or global economic uncertainty, investors often turn to the dollar as a safe haven increasing its demand relative to other currencies and strengthening its position.
Final Note:
The US Dollar Index is a unique phenomenon that all traders and investors have to know about. Mastery of this unique index will aid in understanding geopolitics, hedging and also in commodity trading.
There are several interesting facets concerning this phenomenon, and we're not done just yet.
I'll be back with more insight into the dollar index.
So until then, Ankit Kapoor signing off!!
Happy Trading!!
Claims Adjuster at Crawford & Company
11moValuable information for traders.