Master the US Dollar Index fluctuations to unlock the secrets of investment decisions

In the global financial markets, the “US Dollar Index” is an unavoidable topic. Whenever news reports mention “US dollar strengthening” or “US dollar index falling,” the market reacts with a chain of responses. But do you really understand what this index is telling us? Why does it have such a significant impact on your investment portfolio?

What exactly is the US Dollar Index?

US Dollar Index (abbreviated as USDX or DXY) is essentially a measurement tool used to track the strength or weakness of the US dollar relative to other major international currencies.

If you’re familiar with stock market indices like the S&P 500 or Dow Jones Industrial Average, understanding the US Dollar Index isn’t difficult. The only difference is: stock indices track the performance of a basket of companies’ stock prices, whereas the US Dollar Index tracks the exchange rate movements of the dollar against six foreign currencies.

These six currencies are:

• Euro (EUR): the highest weight, accounting for about 57%
• Japanese Yen (JPY): about 13.6%
• British Pound (GBP): about 11.9%
• Canadian Dollar (CAD): about 9.1%
• Swedish Krona (SEK): about 4.2%
• Swiss Franc (CHF): about 3.6%

Imagine the US Dollar Index as a “health check” for the global financial market. Since the US dollar is the primary currency used in international transactions—ranging from oil and gold to global investments—any movement in this index can ripple across markets worldwide.

What does the value of the US Dollar Index mean?

The US Dollar Index is a relative value, not an absolute price. Its baseline is set at 1985 = 100. Therefore:

• US Dollar Index = 100: indicates the baseline level, with the dollar in a neutral state
• US Dollar Index > 100: signifies the dollar has appreciated compared to the baseline; the higher the value, the stronger the dollar
• US Dollar Index < 100: signifies the dollar has depreciated compared to the baseline; the lower the value, the weaker the dollar

For example, if the index reaches 76, it means the dollar has fallen 24% from the baseline; if it hits 130, it has risen 30%.

What drives the fluctuations of the US Dollar Index?

Investors must understand that behind the fluctuations of the US Dollar Index are often deep-seated changes in the global economy. The following major factors directly influence the strength or weakness of the dollar:

Federal Reserve’s interest rate decisions are the most direct drivers. Rate hikes → US dollar yields increase → global capital flows into the US → dollar appreciation. Rate cuts have the opposite effect. As a result, every Federal Reserve decision can trigger market turbulence.

US economic data are equally critical. Indicators like non-farm payrolls, unemployment rate, CPI inflation, GDP growth rate, etc., when strong, indicate a resilient US economy, which tends to boost the dollar. Weak data have the opposite effect.

Geopolitical risks often act as “accelerators.” When wars, political conflicts, or regional crises occur, investors tend to flock into safe-haven assets, with the dollar often seen as the ultimate safe haven. Interestingly, the phenomenon of “the deeper the chaos, the stronger the dollar” reflects market trust in the dollar’s safety.

Performance of other major currencies also matters. The US Dollar Index measures relative strength; when currencies like the euro or yen weaken due to domestic economic issues or loose policies, the index can rise even if the dollar itself isn’t appreciating.

What are the implications of US dollar appreciation and depreciation?

When the US Dollar Index rises

It means the dollar’s purchasing power in the international market is strengthening. For US companies, this is usually good news—import costs decrease, capital flows back into the US, and investments in US bonds, stocks, and other dollar-denominated assets become more attractive.

However, for export-oriented economies like Taiwan, pressure follows: Taiwanese-made goods priced in dollars become more expensive, reducing competitiveness and squeezing corporate revenues. Emerging markets with large dollar-denominated debt also face increased repayment pressures.

When the US Dollar Index falls

A weaker dollar indicates decreased demand for the dollar, prompting capital to seek new opportunities. For Taiwan, this can be a relatively favorable environment—hot money may flow into Taiwanese stocks, and the New Taiwan Dollar (NTD) may appreciate, lowering import costs.

But if you hold US stocks, dollar deposits, or other dollar-denominated assets, you need to watch out for exchange rate risks: Dollar depreciation = reduced returns when converted back to NTD.

The relationship between the US Dollar Index and global assets

The relationship between the US dollar and gold typically exhibits an inverse correlation. When the dollar is strong → gold priced in USD rises in cost → demand for gold drops → gold prices fall. Conversely, when the dollar weakens, gold prices tend to rise. Of course, gold prices are also influenced by inflation, wars, and other factors, so it’s not solely determined by the US Dollar Index.

The interaction between the US dollar and US stocks is more complex. In the short term, a rising dollar can attract capital into US equities, pushing stocks higher. But if the dollar appreciates too rapidly, it can weaken US export competitiveness, potentially dragging down the stock market. During the March 2020 global stock crash, the dollar surged to 103 due to safe-haven demand; but as the pandemic spread and the Fed launched massive easing measures, the dollar quickly depreciated to 93.78. This illustrates that the relationship between US stocks and the dollar must be analyzed in the context of broader economic conditions.

The correlation between the US dollar and Taiwan stocks/National Taiwan Dollar (NTD) is also variable. Generally, US dollar appreciation → capital flows back to the US → NTD depreciates, and Taiwan stocks face pressure; US dollar depreciation → capital flows into Asia → NTD appreciates, and Taiwan stocks benefit. But this is not a strict rule—during global risk events, stocks, forex, and bonds can all decline simultaneously.

Deep dive: How is the US Dollar Index calculated?

The US Dollar Index uses a “geometric weighted average” method. Simply put, it’s not a simple arithmetic mean of the six currencies but assigns different weights based on the size of each economy and trading activity.

Among these, the euro accounts for over half of the index, because the Eurozone countries are numerous and economically large, making the euro the second-largest international currency after the dollar. Therefore, movements in the euro often have a significant impact on the index.

The Japanese yen ranks second, as Japan is the third-largest economy globally, with low interest rates and high liquidity, often serving as an international safe-haven currency.

The British pound, Canadian dollar, Swedish Krona, and Swiss Franc together account for less than 30%. However, the Swiss Franc’s reputation for stability and safety still makes it a noteworthy component.

Thus, if you see the US Dollar Index fluctuate sharply, it’s wise to observe whether there are major news or developments affecting the euro or yen.

US Dollar Index vs. US Dollar Trade-Weighted Index

Many investors are only familiar with the US Dollar Index but may not know about the US Dollar Trade-Weighted Index. The two differ significantly:

US Dollar Index (DXY)

• The most widely known and frequently cited by media
• Created by ICE (Intercontinental Exchange)
• Includes only six major currencies
• The euro has a weight of over 57%, reflecting a Eurocentric perspective

US Dollar Trade-Weighted Index

• The Federal Reserve’s most commonly referenced indicator
• Calculated based on actual US trade partner currencies
• Includes over 20 currencies, covering emerging Asian markets (RMB, Korean won, NTD, etc.)
• More aligned with actual global market conditions

For the average investor, monitoring the US Dollar Index is sufficient. But for forex traders or macroeconomic research, the trade-weighted index offers deeper insights and aligns more closely with the Fed’s policy considerations.

Practical investment tips

Mastering the fluctuations of the US Dollar Index is crucial for investment decisions. Whether it’s gold, crude oil, stocks, or forex, they are all directly affected by the dollar’s movements. Especially in forex trading, the US Dollar Index is an essential reference tool.

It is recommended that investors regularly monitor the trend of the US Dollar Index and combine it with Fed policies, economic data, geopolitical developments, and other factors to form a comprehensive investment judgment. This approach helps you stay ahead in the ever-changing global markets, seize opportunities, and avoid risks.