Master the rise and fall of the US Dollar Index and understand the key to global capital flows

Talking about international finance, the “US Dollar Index” is an unavoidable topic. Stock investors and forex traders often hear news such as “US Dollar Index rising” or “US dollar weakening.” But what exactly does this indicator measure? Why does it have such a significant impact on your investment portfolio? This article will guide you to a deeper understanding of the operational logic behind the US Dollar Index.

The Essence of the US Dollar Index: A Measure of Global Currency Relative Value

The US Dollar Index (USDX or DXY) may seem complex, but its principle is quite simple. Just like the S&P 500 tracks the stock performance of 500 large U.S. companies, the US Dollar Index tracks the overall strength or weakness of the dollar relative to other major international currencies.

Specifically, the US Dollar Index measures the exchange rate changes of the dollar against the following six currencies:

• Euro (EUR): 57.6% weight
• Japanese Yen (JPY): 13.6% weight
• British Pound (GBP): 11.9% weight
• Canadian Dollar (CAD): 9.1% weight
• Swedish Krona (SEK): 4.2% weight
• Swiss Franc (CHF): 3.6% weight

In other words, the US Dollar Index answers a core question: Is the dollar stronger or weaker compared to the world’s major trading currencies?

Since the dollar is the primary global settlement currency covering oil, gold, commodities, and international investment valuation, the US Dollar Index essentially acts as a “barometer” reflecting the state of the global economy and capital flows.

US Dollar Appreciation and Depreciation: Chain Reactions in Global Markets

What does a rise in the US Dollar Index mean?

When the US Dollar Index rises, it indicates that the dollar is appreciating relative to other currencies, which means those currencies are depreciating. This phenomenon has multi-layered market effects:

For the U.S. economy, a rising dollar is generally seen as positive. Import costs decrease, allowing American consumers to buy overseas goods with fewer dollars. At the same time, the attractiveness of dollar-denominated assets increases, leading to an inflow of global capital into U.S. markets, pushing up the prices of dollar-denominated assets like U.S. Treasuries and stocks. This also helps the U.S. curb inflation.

However, for export-oriented economies, a stronger dollar is a headwind. Countries like Taiwan that rely heavily on exports find their goods becoming more expensive when priced in dollars, reducing international competitiveness. Export revenues shrink, and stock markets may also feel pressure. Additionally, emerging markets with dollar-denominated debt face increased debt burdens during rate hike cycles, with repayment pressures rising sharply.

The impact of a declining US Dollar Index

When the US Dollar Index weakens, market sentiment reverses. Confidence in dollar assets declines, prompting capital to withdraw from the dollar and seek other investment opportunities, especially shifting toward Asian stocks and emerging markets.

For Taiwanese investors, this shift often signals positive signals: inflow of international capital into Taiwan stocks, expanding upward price potential; appreciation of the New Taiwan Dollar, reducing import costs. But caution is needed regarding exchange losses—if you hold dollar assets or dollar deposits, a depreciating dollar means less NT$ when converting back.

The Six Major Currencies of the US Dollar Index and Their Weighting Logic

The weight distribution among the six currencies is not evenly allocated but calculated using a geometric weighted average based on each country’s economic size, trade volume, and currency influence. This method allows the US Dollar Index to better reflect the actual global economic landscape.

The euro’s dominant 57.6% weight reflects the enormous economic size of the 19 EU member states. The Eurozone, combined, has an economic scale comparable to the U.S. The movement of the euro significantly impacts the US Dollar Index.

The Japanese Yen ranks second with a 13.6% weight. Japan is the third-largest economy globally, with very low interest rates and ample liquidity, often used as a safe-haven by international funds, making its role crucial.

The combined share of the British Pound, Canadian Dollar, Swedish Krona, and Swiss Franc is less than 30%, but each plays a unique role. The Swiss Franc, in particular, is noted for its “safe-haven” status.

Understanding this weight structure is practically valuable: if the US Dollar Index experiences sharp fluctuations, first observe whether there are major news or trend changes in the euro and yen.

The Logic Behind the US Dollar Index Calculation Formula

The geometric weighted average formula used for the US Dollar Index may seem complex, but its core idea can be simplified.

The constant “50.14348112” is a baseline factor to ensure that the 1985 base period value of the dollar index is 100. Each term within the parentheses represents the dollar’s exchange rate against a specific foreign currency, with the exponent corresponding to that currency’s weight (e.g., EUR^-0.576).

Importantly, the US Dollar Index is not an exchange rate or a price; it is a relative index. It measures the long-term change in the dollar relative to other currencies since the base period.

For example, a value of 100 indicates the base level; 76 indicates a 24% decline from the base, meaning the dollar has depreciated; 176 indicates a 76% appreciation, meaning the dollar has strengthened. The higher the index, the stronger the dollar; the lower, the weaker it is in the international market.

The Interaction Between the US Dollar Index and Global Assets

Why does the US Dollar Index influence investment decisions? Because it directly impacts all dollar-priced assets—stocks, gold, oil, bonds, and even Taiwan stocks.

The inverse relationship between the US Dollar Index and gold

Gold and the dollar have the most direct and clear relationship: they often move in opposite directions like a seesaw.

When the dollar appreciates, the cost of buying gold with dollars increases, reducing demand and putting downward pressure on gold prices. Conversely, when the dollar depreciates, gold priced in dollars becomes cheaper, attracting more buyers and pushing prices higher.

Of course, gold prices are also affected by inflation expectations, geopolitical conflicts, oil prices, and other factors, so the dollar index is just one piece of the puzzle.

The complex relationship between the US Dollar Index and US stocks

The relationship between US stocks and the US Dollar Index is not simply positive or negative; it varies depending on the economic context.

In some periods, a rising dollar coincides with capital inflows into the U.S., boosting stock prices. But if the dollar rises too rapidly, it can hurt U.S. exporters’ competitiveness, dragging down the overall stock market. During the March 2020 global stock market crash, the dollar surged to 103 due to safe-haven demand; later, as the U.S. pandemic worsened and the Federal Reserve adopted easing policies, the dollar quickly weakened to 93.78.

This indicates that the interaction between stocks and the dollar must be judged in conjunction with current economic policies and market background, not just a single trend.

The relationship between the US Dollar Index, Taiwan stocks, and the New Taiwan Dollar

Generally, a rising dollar tends to push capital back to the U.S., putting pressure on Taiwan stocks, and the New Taiwan Dollar may depreciate. Conversely, a falling dollar encourages capital to flow into Asia, benefiting the NT$ and Taiwan stocks.

But this pattern is not absolute. During optimistic global economic periods, US stocks, Taiwan stocks, and the dollar may all rise together; during black swan events, stocks, forex, and bonds may all decline simultaneously.

Core Factors Driving US Dollar Index Fluctuations

Federal Reserve interest rate policy

This is the most direct variable affecting the US Dollar Index. Rate hikes attract global capital into the U.S., pushing up the dollar and the index; rate cuts lead to capital outflows and a weaker dollar. Each Federal Reserve meeting can trigger market volatility.

U.S. economic data

Employment figures, CPI inflation rate, GDP growth, and other economic indicators directly reflect the health of the U.S. economy. Strong data boosts the dollar; weak data undermines market confidence, leading to dollar depreciation.

Geopolitical and international events

Wars, political turmoil, regional conflicts, and other uncertainties trigger global risk aversion. During such times, the dollar, as the preferred safe-haven asset, often benefits, creating a “chaos makes the dollar stronger” phenomenon.

Performance of other major currencies

The US Dollar Index is a relative measure of the dollar against six foreign currencies. When currencies like the euro and yen weaken due to economic downturns or loose policies, even if the dollar itself has no upward momentum, the index can rise due to its relative advantage.

The Difference Between the US Dollar Index and the US Trade-Weighted Dollar Index

Investors usually look at the US Dollar Index, but the Federal Reserve actually more often references another indicator—the US Trade-Weighted Dollar Index. What are the differences?

US Dollar Index (DXY) compiled by ICE tracks the dollar against six major currencies, with the euro’s weight at 57.6%, reflecting a Euro-American perspective, and is the most commonly reported version in media.

US Trade-Weighted Dollar Index is calculated by the Federal Reserve based on actual trade volumes with U.S. trading partners, covering over 20 currencies, including the Chinese yuan, Mexican peso, Korean won, New Taiwan dollar, Thai baht, and others from emerging markets. This index more accurately reflects the dollar’s real influence in global trade.

In short, the US Dollar Index is a traditional quick indicator suitable for understanding overall market sentiment; the trade-weighted index is deeper and more comprehensive, more valuable for macroeconomic analysis or forex trading. Ordinary investors can suffice with watching the US Dollar Index, but for deeper insights into Fed policy logic, the trade-weighted index offers a more complete picture.

Conclusion

The US Dollar Index is a key indicator for understanding global financial flows. It not only reflects the relative strength of the dollar but also influences the prices of gold, oil, stocks, and other assets. Mastering the trend of the US Dollar Index is crucial for developing investment strategies—whether in forex trading, stock allocation, or asset diversification. In the fast-changing financial markets, paying attention to this indicator’s movements is akin to grasping the pulse of capital flows.