The USD dollar index provides a general indication of the international value of the US dollar. It is a measure of the value of the dollar relatives to its most significant trading partners. Of course, the USD index plays a dominant role in financial markets. It affects on many asset classses like commodities, gold, bonds and stock markets. In this topic, we will study the USD dollar index as well as its applications.
The USD index is calculated by taking the geometric weighted average of the dollar's value against a basket of six major world currencies including EUR, JPY, GBP, CAD, CHF and SEK. Their weightings are Euro 57.6%, Yen 13.6%, GBP 11.9%, CAD 9.1% and Swedish knona 4.2%, CHF 3.6%. They are showed in a pie chart below
From the end of WWII until 1970, the USD was tied to other major currencies by the Bretton Woods fixed exchange rate agreement. After that, it became free floating regime. Hence, the USD dollar went up significantly. It rose to an all time high of 160 in 1985. In 2008, it sank to an all time low of 70 due to global financial crisis. There are some fundamental factors affecting the USD index: the fed funds rate, the US trade deficit, CPI inflation, GDP, NFP and 6 major currencies EUR, JPY, GBP, CAD, CHF and SEK.
One of the most important correlation is the USD dollar trends in the opposite direction of commodities. Hence, a falling dollar is bullish for commodities and a rising dollar is bearish for commodities. The chart shows this inverse relationship.