What Is the DXY Dollar Index?
The DXY is an indicator that many market watchers and commentators reference and quote. So what is the DXY or US Dollar index?
The DXY is a geometrically weighted index of some of the major trading partners of the United States. The composition if the DXY Index is heavily weighted towards the Euro and European countries that have not joined the European shared market. The elements of the DXY Index are (by weighting): Euro (57.6%), Japanese Yen (13.6%), Great Britain- Pounds Sterling (11.9%), Canadian Dollar (9.1%), Swedish Krona (4.2%), and Swiss Franc (3.6%). Because of the composition of the DXY, it is sometimes referred to as the Anti-Euro Index.
The DXY is a functional index to use as a simple method for referencing strength and weakness of the US Dollar (USD). But its ubiquity disguises the fact that it does not mirror the value of the dollar against a general enough basket of currencies. The DXY was produced by JP Morgan in 1973, and it has only been updated once, for the introduction of the Euro money.
The DXY is heavily weighted towards European currencies, it underweight’s the Canadian Dollar, as a proportion of US trade, and it largely ignores important Asian and Pacific trading partners, including Korea, Australia, Taiwan and necessarily China. already if one were interested in including the Chinese Renminbi (Yuan) it would be both difficult and of questionable informational value to include the Renminbi because China keeps their money pegged to a range that is based on the dollar.
A more accurate basket of currencies to track the relative value of the USD would be to value the dollar against the top US trading partners. The top 6 US trading partners, from high to low are: Canada, China, Mexico, Japan, Germany and the UK. It’s hard to say why JP Morgan produced this index and how it came into such prominence. One strange thing about this index is you cannot trade it. There is no market that you can go to and buy the DXY. The closest you can get are futures and options contracts traded on the InterContinental Exchange (ICE).
If it’s so inaccurate, then why is it so widely quoted? While there are more accurate ways to benchmark the USD, absolute accuracyn is not always important for an indicator. Many traders and institutions likely have their own indices that they use to track the USD, but for the sake of comparison, it is very functional to have a shared index. The DXY is also highly correlated to a trade-weighted index most of the time. Relative strength or weakness moves by the USD represents huge flows of money. As I’ve written before, the recent +10% move by the DXY represents more than $1 trillion of moderate wealth destruction. Moves of this extent do not happen in a vacuum and the relative weakness of the DXY is mirrored by corresponding weakness in the trade-weighted index.
While there are shortcomings, the DXY does serve as a reliable indicator of USD strength and weakness and can be used as such, as long as one keeps in mind that it will sometimes be skewed if there are large money moves that occur in the Euro.