Global Capital Indicator: An In-Depth Analysis of How the US Dollar Index Dominates the Market

The Logic Behind the US Dollar Index

Many investors often see news mentioning “the dollar strengthening” or “the dollar depreciating,” but they often do not understand what these fluctuations represent. In fact, the US Dollar Index (USDX or DXY) is not simply an exchange rate concept but a composite indicator that measures the relative strength of the dollar.

Simply put, the US Dollar Index is like a stock market index tracking a basket of stocks, but instead of company performance, it tracks the exchange rate performance of the US dollar against six major international currencies. These six currencies are:

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

In other words, the US Dollar Index reflects the overall position of the dollar in the international financial market—it tells us whether the dollar is appreciating or depreciating relative to major global economies’ currencies.

Four Major Forces Driving the US Dollar Index Fluctuations

Before delving into how the dollar index is calculated, we should understand what factors cause it to fluctuate:

The Federal Reserve’s interest rate decisions are the most direct drivers. Raising interest rates means higher returns on dollar assets, attracting global capital inflows into the US market seeking higher yields, which pushes the dollar index higher; conversely, lowering rates can lead to capital outflows.

US economic data also plays a key role. Strong employment figures, CPI inflation rates, GDP growth—if these indicators are impressive, market confidence in the dollar increases; if not, confidence wanes.

Geopolitical situations and international events are especially important during crises. Wars, political turmoil, regional conflicts—when these occur, investors tend to seek safe-haven assets, and the dollar, as the world’s most commonly traded currency, often becomes the first choice. This explains why sometimes “the more chaotic the world, the stronger the dollar”—a seemingly paradoxical phenomenon.

The trend of other major currencies also influences the dollar index. Since the index is a relative measure, when currencies like the euro or yen weaken due to domestic economic slowdown or loose policies, the dollar index can rise even if the dollar itself hasn’t appreciated.

The Calculation Logic of the US Dollar Index

The US Dollar Index is calculated using a “geometric weighted average” method, which is not a simple average but assigns different weights based on the economic size, trading volume, and global influence of each currency.

It’s important to understand that the Dollar Index is not an exchange rate or an absolute price but a relative index. Its base period is set at 1985 with a value of 100, so:

• An index of 100: equal to the base level, no appreciation or depreciation
• An index of 76: a 24% decline from the base, indicating a relative weakening
• An index of 176: a 76% increase from the base, indicating a relative strengthening

Therefore, the higher the dollar index, the stronger the dollar’s position in the international market; the lower, the weaker.

The Chain Reaction of USD Index Fluctuations on Global Assets

As the world’s most widely used trading and pricing currency, changes in the dollar index directly or indirectly impact various asset classes.

Gold and the Dollar: The See-Saw Effect

Gold and the dollar usually exhibit an “inverse” relationship: when the dollar appreciates, the cost of buying gold in dollars rises, demand drops, and gold prices tend to fall; when the dollar depreciates, the opposite occurs. However, gold prices are also influenced by inflation expectations, geopolitical tensions, crude oil prices, and other factors, so one cannot judge solely based on the dollar index.

The Complex Interaction Between US Stocks and the Dollar

The relationship between US stocks and the dollar index is not simply positive or negative; it depends on the market environment. Sometimes, dollar appreciation attracts capital inflows into the US market, boosting stocks; but if the dollar rises too much, it can hurt US export competitiveness, putting pressure on the overall stock market. For example, in 2020, during the pandemic, global stocks plummeted, but the dollar surged to 103 due to safe-haven demand; later, as the US COVID situation worsened and the Fed adopted aggressive easing, the dollar index quickly fell to 93.78. This shows that the interaction between stocks and the dollar depends on the macroeconomic environment and policy context, not just a single trend line.

Capital Flow Logic Between TAIEX and TWD

When the dollar appreciates (index rises), capital tends to flow back to the US, which can put downward pressure on the New Taiwan Dollar (TWD) and Taiwan stocks due to capital outflows; conversely, dollar depreciation may attract capital into Asian markets, benefiting TWD and Taiwan stocks.

However, there are exceptions. When global risk appetite is high, US stocks, Taiwan stocks, and the dollar may all rise together; during black swan events, all markets may decline simultaneously. The dollar index essentially acts as a market risk indicator, reflecting the overall market sentiment towards risk.

USD Index vs. Trade-Weighted US Dollar Index: Which Is More Important?

The most commonly referenced “Dollar Index” is published by ICE, but in practice, the Federal Reserve more often refers to the “Trade-Weighted US Dollar Index” in its decision-making.

Features of the US Dollar Index (DXY):

• Most common, widely reported by media
• Covers only six major currencies
• Euro has the highest weight (57.6%), reflecting a Eurocentric perspective

Features of the Trade-Weighted US Dollar Index:

• The Fed’s primary reference indicator
• Calculated based on actual US trade partner countries
• Includes over 20 currencies, such as RMB, Korean Won, TWD, Thai Baht, and other Asian currencies
• Provides a more accurate reflection of the dollar’s real influence in global trade

For most investors, the Dollar Index is sufficient to grasp the overall dollar trend; but for in-depth macro analysis or understanding Fed policy logic, the Trade-Weighted Index offers a more comprehensive perspective.

The Significance of the Weights of the Six Currencies in the Dollar Index

It’s worth noting that the six currencies in the dollar index are not equally weighted by simple average but are determined based on the economic size and influence of their respective economies:

Why does the euro have the highest weight? The Eurozone comprises 19 EU countries, representing a large economic bloc, making it the second-largest currency after the dollar. Therefore, any movement in the euro significantly impacts the dollar index—tracking euro trends often helps predict the dollar index’s direction.

The Yen’s key position: Japan is the third-largest economy globally, with low interest rates and abundant liquidity, making the yen a popular arbitrage and safe-haven currency for international capital.

The roles of the other four currencies: GBP, CAD, SEK, and CHF together account for less than 30% of the weight, but the Swiss Franc’s “stability and safety” characteristics make it valuable during market crises.

Overall, these six currencies cover the economic indicators of over 24 developed countries, granting the Dollar Index a high level of authority and broad influence in the global financial market.

The Practical Impact of USD Fluctuations on Investment Portfolios

Many investors ask: “How does the rise or fall of the dollar index relate to me?” The actual impact is profound:

Scenario of USD Appreciation: Your dollar-denominated assets (like US stocks, US bonds) will appreciate when converted to TWD; if you hold USD savings or engage in forex trading, you can profit from exchange rate differences. However, Taiwanese export companies may face more difficulty selling products to the US due to reduced competitiveness; emerging markets with USD-denominated debt may see increased burdens.

Scenario of USD Depreciation: Capital may flow into Asia, benefiting Taiwan stocks and other emerging markets; but your USD assets will lose value, and the amount converted back to TWD will decrease—this is the so-called “exchange loss” risk.

Key Takeaways

The US Dollar Index is a crucial indicator for understanding global financial market dynamics. It not only reflects the dollar’s strength or weakness but also serves as a barometer of global capital allocation, risk appetite, and economic confidence. Whether you’re investing in US stocks, gold, or simply monitoring the TWD exchange rate, understanding the dollar index’s movements is an essential basic skill. Especially in foreign exchange trading, this indicator directly influences trading outcomes. By observing the dollar index and its underlying drivers, investors can better judge asset allocation directions, avoid market risks, and improve investment decision efficiency.