What Is the U.S. Dollar Index (USDX) and How to Trade It

What Is the U.S. Dollar Index (USDX)?

The U.S. dollar index is a measure of the value of the U.S. dollar relative to a basket of foreign currencies. The USDX was established by the U.S. Federal Reserve in 1973 after the dissolution of the Bretton Woods Agreement. It is now maintained by ICE Data Indices, a subsidiary of the Intercontinental Exchange (ICE).

The six currencies included in the USDX are often referred to as America's most significant trading partners.

The index has only been updated once, in 1999, when the newly-created euro replaced the German mark, French franc, Italian lira, Dutch guilder, and Belgian franc. Consequently, the index does not fully reflect present-day U.S. trade.

Understanding the USDX

Purpose

The USDX can provide investors and consumers with insight into the relative strength of the dollar and how it might affect prices for goods and services as well as demand for imports and exports. It can also shed light on reasons for the state of the economy.

Composition

The U.S. dollar index is currently calculated by factoring in the exchange rates of six foreign currencies, which include the euro (EUR), Japanese yen (JPY), Canadian dollar (CAD), British pound (GBP), Swedish krona (SEK), and Swiss franc (CHF).

The euro is, by far, the largest component of the index, making up 57.6% of the basket. The weights of the rest of the currencies in the index are JPY (13.6%), GBP (11.9%), CAD (9.1%), SEK (4.2%), and CHF (3.6%).

The index has risen and fallen sharply over time. It reached an all-time high in 1984 at nearly 165, and an all-time low of around 70 in 2007. In the years since then, the U.S. dollar index has been relatively range bound, fluctuating between 90 and 110. As of October 2024, USDX is trading around 102.

The index is affected by macroeconomic factors, including inflation/deflation in the dollar and foreign currencies in the basket, as well as recessions and economic growth in those countries.

History of the USDX

The index began in 1973 with a base of 100, and all subsequent values 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 established 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 exchange rates and their link to the way in which gold was priced. President Richard Nixon decided to temporarily suspend the gold standard.

At that point, other countries were able to choose any exchange agreement other than the price of gold. In 1973, many foreign governments chose to let their currency rates float, putting an end to the agreement.

The Basket of Currencies

The contents of the basket of currencies have only changed once. That happened in 1999 when the newly-created euro replaced several European currencies previously in the index, such as Germany's predecessor currency, the deutschmark.

It is likely that the currencies in the index will change again, as the index adapts to better represent those countries that the U.S. buys from and sells to most.

For example, currencies such as the Chinese yuan (CNY) and Mexican peso (MXN) may replace others in the index, given the significance of China and Mexico as key U.S. trading partners.

Interpreting the USDX

An index value of 120 suggests that the U.S. dollar has appreciated 20% versus the basket of currencies over a particular time period. Simply put, if the USDX goes up, that means the U.S. dollar is getting stronger in value compared to the other currencies.

Similarly, an index value of 80, indicating a fall of 20 from its initial value, implies a 20% depreciation in strength relative to the other currencies. The appreciation and depreciation results are a factor of the time period in question.

How to Trade the USDX

Traders use the U.S. dollar index to track the value of the USD against a basket of select currencies in a single transaction. They can also protect against currency risks using tradable derivatives of the index, such as USDX futures and options.

These financial products currently trade on the ICE Futures exchange, formerly known as the New York Board of Trade. Traders and investors can use them to hedge general currency moves or to speculate.

The index is also available to investors indirectly as part of exchange-traded funds (ETFs) and mutual funds.

For instance:

• The Invesco DB U.S. Dollar Index Bullish Fund (UUP) is an ETF that tracks the changes in value of the U.S. dollar via USDX future contracts.
• The WisdomTree Bloomberg U.S. Dollar Bullish Fund (USDU) is an actively-managed ETF that goes long the U.S. dollar against a basket of developed and emerging market currencies.
• Invesco DB also offers its U.S. Dollar Index Bearish Fund (UDN), which shorts the dollar, and gains in value when the dollar weakens.

The Bottom Line

The U.S. Dollar Index (USDX) is a relative measure of the U.S. dollar's strength against a basket of six influential currencies, including the euro, the British pound, the Japanese yen, the Canadian dollar, the Swedish krona, and the Swiss franc.

The index was created in 1973 and remains useful to this day. The USDX can be a proxy for the health of the U.S. economy and traders can use it to speculate on the dollar's change in value or as a hedge against currency exposure.