The U.S. dollar index (USDX) is a measure of the value of the U.S. dollar relative to the value of a basket of currencies of the majority of the U.S.'s most significant trading partners. This index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies.
The U.S. dollar index allows traders to monitor the value of the USD compared to a basket of select currencies in a single transaction. It also allows them to hedge their bets against any risks with respect to the dollar.
The index is currently calculated by factoring in the exchange rates of six major world currencies, which include the euro, Japanese yen, Canadian dollar, British pound, Swedish krona and Swiss franc. The euro holds the most weight versus the dollar in the index, constituting about 58 percent of the weighting followed by the yen with about 14 percent.
The index started in 1973 with a base of 100, and values since then are relative to this base. It was established shortly after the Bretton Woods Agreement was dissolved. As part of the agreement, participating countries settled their balances in U.S. dollars (which was used as the reserve currency), while the USD was fully convertible to gold at a rate of $35/ounce.
An overvaluation of the USD led to concerns over the exchange rates and their link to the way in which gold was priced. President Richard Nixon decided to temporarily suspend the gold standard, at which point other countries were able to choose any exchange agreement other than the price of gold. In 1973, many foreign government chose to let their currency rates float, putting an end to the agreement.
The U.S. dollar index has risen and fallen sharply throughout its history, reaching its high point in February 1985 with a value of 164.72 and its low point in March 2008 with a value of 70.698. As of June 2018, the index carried a value of 94.04, meaning that the U.S. dollar has depreciated versus the basket of currencies since the index started in 1973. The index is greatly affected by macroeconomic factors, including inflation/deflation in the dollar and foreign currencies included in the comparable basket, as well as recessions and economic growth in those countries.
The contents of the basket of currencies has only been changed once since the index started, when the euro replaced many European currencies previously in the index in 1999 such as Germany's predecessor currency to the euro, the Deutschemark. In the coming years, it is likely currencies will be replaced as the index strives to represent major U.S. trading partners. It is likely in the future that currencies such as the Chinese yuan and Mexican peso will supplant other currencies in the index due to China and Mexico being major trading partners with the United States.
An index value of 120 suggests that the U.S. dollar has appreciated 20 percent versus the basket of currencies over the time period in question. Subtracting the initial value of 100 from the current value of 120 yields 20; dividing the difference by the initial value of 100 gives an appreciation of 20 percent. Simply, if the USDX goes up, that means the U.S. dollar is gaining strength or value when compared to the other currencies.
Similarly, if the index is currently 80, falling 20 from its initial value, then the same calculation would give a depreciation of 20 percent. The appreciation and depreciation results are a factor of the time period in question.
It is possible to incorporate futures or options strategies on the USDX. These financial products currently trade on the New York Board of Trade. Investors can use the index to hedge general currency moves or to speculate.