What it means
The index is calculated and published by ICE, the exchange operator, and it began in March 1973 with a starting value of 100. The six currencies in the basket are the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.
Each has a fixed weight, with the euro making up well over half of the total. Because the weights are fixed, the index does not track every country that trades with the United States.
Currencies such as the Chinese yuan and the Mexican peso are not part of it, even though those economies are major trading partners. The index is therefore best read as a measure of the dollar against a group of developed market currencies, not as a complete trade-weighted picture.
The calculation uses a geometric average, in which each exchange rate is raised to the power of its weight and the results are multiplied together with a constant. The constant is about 50.14, chosen so the index started at exactly 100.
A move of 5% in the dollar against every currency in the basket moves the index by about 5%. For businesses, a stronger dollar makes US exports more expensive abroad and imports cheaper at home.
Companies that earn revenue in foreign currencies see their dollar results fall when the index rises, because the same foreign sales convert into fewer dollars. Commodities priced in dollars often become more expensive for foreign buyers when the dollar is strong.
Treasury and finance teams use the index to spot trends and to explain results, but they do not hedge against it directly. Hedging is carried out in the specific currency pairs the company actually trades.
The index is a signal, not a trading instrument for the company's own exposures. The index is also traded through futures contracts, which lets investors and companies take a position on the dollar's overall direction.
Most corporate treasurers, however, hedge using forward contracts in the exact currencies they deal with. That is because an index move can hide big differences between individual currencies.
In practice
Real-world examples.
Example
A US furniture exporter sees the index rise from 100 to 108 over a year. Its European customers now pay about 8% more in local currency for the same product, so sales volumes soften.
Example
A multinational with large sales in Europe and Japan reports lower dollar revenue despite stable local sales. The finance team points to the stronger dollar and explains the translation effect to the board.
Example
A commodity analyst notes that the index has fallen sharply. She expects dollar priced commodities to become cheaper for foreign buyers, which could support demand.
Formula
Calculation
USDX = 50.14 x product of each currency pair rate raised to its fixed weight (the six weights add up to 1)
Because the weights add up to 1, a change that affects all six pairs in the same proportion moves the index by that same proportion. Suppose the index stands at 100 and the dollar then gains 5% against every currency in the basket. The new index is 100 x 1.05 = 105. If the dollar then falls 4% across the basket, the index is 105 x 0.96 = 100.8. In practice the six currencies move by different amounts, so the index reflects a weighted blend.Case study
Seen in the real world.
Northgate Cycles is an illustrative, fictional bicycle maker that sells 40% of its output in Europe, priced in euros. Over a year, the dollar index rises by 10%, and the euro weakens significantly.
The finance director finds that each euro of sales converts into fewer dollars, so reported revenue from Europe falls by about 8% even though unit sales are flat. She explains to the board that the decline is a currency translation effect, not a drop in demand.
In this illustrative story the company starts hedging part of its expected euro sales using forward contracts. The index did not guide the hedge, but the clear move in the dollar prompted management to review its currency exposure.
Watch out
Common mistakes.
- Treating the index as a measure of the dollar against all currencies, when it covers only six, with the euro carrying the largest weight.
- Assuming a high reading always means the economy is strong, when a strong dollar can hurt exporters.
- Trying to hedge a company's exposure with the index, when hedging should be done in the actual currencies the business deals in.
Questions
People also ask.
Who publishes the dollar index?
ICE publishes it, and it is also tracked by a futures contract traded on that exchange.
Why is the euro weighted so heavily?
The weights were set when the index was created and reflect the importance of European currencies to US trade at that time.
Is there a broader measure of the dollar?
Yes, the Federal Reserve publishes trade-weighted dollar indexes that cover more currencies.
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