What is the DXY Dollar Index?

DXY is an indicator cited and quoted by many market observers and commentators. So what is the DXY or US dollar index?

DXY is a geometrically weighted index of some of the major trading partners in the United States. If the DXY index is strictly weighed against the euro and European countries that have not joined the European Common Market, this combination is formed. The composition of the DXY index [calculated by weight]: Euro [57.6%], Japanese Yen [13.6%], UK - British Pound [11.9%], Canadian Dollar [9.1%], Swedish Krona Swiss Franc [3.6%]. Due to the composition of DXY, it is sometimes referred to as the anti-Euro index.

DXY is a convenient indicator that can be used as an easy way to reference the strength of the dollar [USD]. But its ubiquity masks the fact that it does not reflect the value of the dollar to a broad package of treaties. DXY was created by JPMorgan Chase in 1973 and was updated only for the introduction of the Euro currency.

DXY severely weighs European currencies, which weaken the Canadian dollar, which is part of US trade, and strongly ignores important Asia-Pacific trading partners, including South Korea, Australia, Taiwan and China. Even if someone wants to include the renminbi [RMB], the value of information, including the renminbi, is both difficult and questionable because China links its currency to the US dollar.

A more accurate basket of currencies used to track the relative value of the dollar will be the value of the dollar to the top trading partners of the United States. The top six trading partners of the United States are: Canada, China, Mexico, Japan, Germany and the United Kingdom. It's hard to say why JPMorgan Chase created this index and how it became so prominent. A strange thing about this index is that you can't trade it. There is no market to buy DXY. The closest you can get is the futures and options contracts traded on the Intercontinental Exchange [ICE].

If it is so inaccurate, why is it so widely quoted? While there are more accurate ways to measure the dollar, absolute accuracy is not always important to the indicator. Many traders and institutions may have their own prices to track the US dollar, but for comparison, it is very convenient to have a common index. In most cases, DXY is also highly correlated with the trade-weighted index. The relative strength or weakness of the dollar represents a huge flow of funds. As I wrote before, DXY's recent 10% move represents more than $1 trillion in nominal wealth damage. This degree of movement does not occur in a vacuum, and the relative weakness of DXY is reflected in the corresponding weakness of the trade-weighted index.

Despite its shortcomings, DXY can be used as a reliable indicator of the strength of the dollar, and can be used in this way, just remember that if the euro has a large amount of currency movements, it will occasionally be biased.

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