The trade-weighted dollar index was the first index created to track the value of the U.S. dollar against other major currencies across the globe. It is a weighted average of the value of the dollar against the currencies of a broad group of major U.S. trading partners.
The index was created by the U.S. Federal Reserve in 1973 and updated in 1998, when the euro currency came into existence and replaced five national currencies that had been part of the original index. The Fed also wanted to broaden the index so that it more closely aligned with U.S. trade patterns.
There are 26 members in the index:
- United Kingdom
- Hong Kong
- Saudi Arabia
According to the Fed, the currency weights are updated annually except "in unusual circumstances," when they may be revised accordingly. The index weights are derived from the shares of U.S. exports and U.S. and foreign imports.
The Fed actually publishes three indexes: the main, or "broad" index, as it is commonly known, and two subindexes, which cover smaller subsets of the countries in the broad index.
The Broad Index
The 26 members in the broad index were chosen "pragmatically" in 1998 because their "bilateral shares of U.S. imports or exports" exceeded 0.5%.
The Major Currencies Index
Seven of the 26 currencies in the broad index—the euro and the currencies of Canada, Japan, the U.K., Switzerland, Australia and Sweden—make up the major currencies subindex. These currencies trade widely in international markets, and the weights are derived from those in the broad index. This index replaced the Fed's prior main dollar index, which was called the G-10 index.
"Because the major currencies generally trade in liquid financial markets, the major currencies index can be used to gauge financial market pressures on the dollar," the Fed says.
Other Important Trading Partners Subindex
The remaining 19 currencies come from "other important trading partners'' (OITP) of the U.S. Their currencies generally do not trade widely outside their home country.
The weights of the currencies in the two subindexes are calculated by rescaling the currencies' respective weights in the broad index so that they add up to one in each subindex.
The main objective of the indexes is to measure the effects of changes in the value of the dollar on the relative competitiveness of American versus foreign goods. The Fed also uses the indexes to track financial market pressures on the dollar.
While the Fed's trade-weighted dollar index has been around the longest and comes from an objective government source, other indexes have been created largely for commercial and hedging purposes. Most of these indexes don't track the dollar against as many currencies and countries as the Fed's indexes do, just against the most widely traded ones.
For example, the Dow Jones FXCM Dollar Index Basket (USDOLLAR) tracks the dollar against four major currencies: the euro, British pound, Japanese yen and Australian dollar. The index represents an equivalent US$10,000 position in each of the four currencies.
The ICE U.S. Dollar Index (USDX) is a futures contract that tracks the value of the greenback against six major currencies: the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. It bills itself as "the world's most widely-recognized traded currency index."
"In a single transaction the USDX enables market participants to monitor moves" in the dollar "as well as hedge their portfolios against the risk of a move in the dollar," ICE says.
In 2012, the Wall Street Journal and DJ FX Trader launched the Wall Street Journal Dollar Index (BUXX). The index tracks the dollar against the same currencies as the ICE index plus the Australian dollar, or the same ones the Fed tracks in its major currencies index.
The WSJ says the index "attempts to improve on existing indexes by basing its value on actual, up-to-date turnover by all participants in the foreign-exchange market."
The respective weights of each currency are based on foreign-exchange trading volume from the Bank for International Settlements, which collects forex market activity data from central banks every three years.
The trade-weighted dollar index was created in 1973 by the U.S. Federal Reserve to track the value of the U.S. dollar against the currencies of a broad group of major American trading partners.
The index was updated in 1998 when the euro was created. Twenty-six members are included in the main index. Since the Fed created its index, several private companies have created their own, largely for hedging purposes.