The U.S. Dollar Index hasn't been
updated in years, and other vehicles give a broader perspective of how the
greenback is doing.
When we talk about the dollar, we talk
about the U.S. Dollar Index.
There's almost no escaping it. The U.S. Dollar Index is the standard
measure for the greenback, much as the Dow or the S&P is the standard
measure for the stock market.
But what happens when an index gets
As The Wall Street Journal
points out, the U.S. Dollar Index "hasn't been adjusted in 12
years." And the weightings in the index are strange. The numbers may
fluctuate a little, but the following breakdown is roughly on point:
Japanese yen 12.6%
Pound sterling 11.9%
Canadian dollar 9.1%
Swiss franc 3.6%
Immediate questions spring to mind
with that mix. Where is the Australian dollar? Or the Chinese yuan? And the Swedish krona
still has a stronger weighting than the Swiss franc? Really?
The biggest concern of all is that the
U.S. Dollar Index has become a giant
With such an overwhelming weighting
towards euros (nearly 59%), the fortunes of Europe
have a hugely outsized impact on the dollar. What's more, if you chose to
lump in the British pound and Swedish krona, nearly
75% of the index could be considered Europe-based.
"The U.S. Dollar Index was
created by the Federal Reserve in 1973," the WSJ
reports, "and was meant to be a trade-weighted average of the dollar's
value as it freely floated against other currencies."
While the index originally had a
basket of 10 currencies, that number was dropped down to six with the
introduction of the euro -- and hasn't changed since.
The U.S. Dollar Index is certainly
still tradable. It's the underlying basis for dollar-index futures, and thus
also for the PowerShares dollar bullish and bearish
ETFs (UUP:NYSE and UDN:NYSE
But it's helpful to remember that, in
terms of the question "What's happening to the dollar?" the index
does not necessarily give a full or accurate picture.
Sort of like the Dow Jones Industrial
Average without Apple (AAPL:NASDAQ)
or Google (GOOG:NASDAQ).
Can we really say that such a limited slice represents the true market?
Also like the Dow and S&P, the
U.S. Dollar Index is liquid, popular and deeply entrenched in terms of
various trading vehicles tied to it. There is a "network effect" at
work -- the more traders and investors who pay attention to the index and use
it as a proxy, the stronger its influence becomes.
The real acid test of the U.S. Dollar
Index may come alongside seismic currency shifts in Asia. If the Japanese yen
succumbs to debt crisis, for example, or the Chinese yuan
moves to a new level of convertibility, the outdated composition of the index
may have to be addressed.
In the meantime, it's easy enough to
get a rundown of "what's happening with the dollar" through a
handful of readily available instruments.
Here is a quick reference list:
euro currency (FXE:NYSE)
Japanese yen (FXY:NYSE)
Canadian dollar (FXC:NYSE)
Australian dollar (FXA:NYSE)
British pound (FXB:NYSE)
Swiss franc (FXF:NYSE)
Mexican peso (FXM:NYSE)
All of the above are exchange-traded
funds, or ETFs -- some of them much more liquid than others. Each provides a
snapshot of a single currency as traded against the dollar.
When one wants to "see how the
dollar is doing," it may make sense to quickly scroll through long-term
charts of the above -- if not the currency futures or spot forex pairs -- as opposed to quickly glancing at the U.S.
Dollar Index. If the euro and $USD are in gridlock but other important
movements are afoot -- like major moves in the franc, yen or Aussie dollar,
for example -- a scan of individual forex pairs
will show it.
You may notice that the final entry,
GLD, does not fit in with all the rest. Adding gold is somewhat tongue in
cheek, but also a fair addition to the list, given the yellow metal's
longstanding role as a "neutral currency."
keep following the U.S. Dollar Index and considering the merits of the
attached trading vehicles... but with recognition that it's a bigger and more
diverse world now.
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originally published here