The key to understanding the strength of the US dollar: A comprehensive guide to the US Dollar Index components and investment impacts

If you are interested in investing in the stock market, forex, or gold, you have probably heard terms like “US dollar appreciation” and “US dollar weakening.” But how exactly does the US Dollar Index work? Why are global investors so focused on it? Today, let’s delve into this key indicator that influences the global financial markets.

Components and Construction Principles of the US Dollar Index

US Dollar Index (USDX or DXY) is not a simple exchange rate but a composite index measuring the strength of the dollar relative to a basket of major currencies. It tracks the performance of the dollar against six primary currencies, which are:

• Euro (EUR) — accounting for 57.6%, the highest weight
• 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%

These six currencies represent not just six countries but encompass 19 countries in the Eurozone and other developed economies, totaling over 24 economies. Because of this broad coverage, the US Dollar Index holds significant influence and authority in the global financial markets.

Why is the composition of the US Dollar Index configured this way?

The weightings of the US Dollar Index are not evenly distributed but are based on a “geometric weighted average” method, determined by the size of each economy, international trade volume, and currency influence. The euro has the highest share (over 57%) because the Eurozone has a large economic size, and the euro is the second-largest international currency after the dollar.

The Japanese Yen ranks second because Japan is the third-largest economy globally, and the Yen is often used as an international safe-haven currency due to its low interest rates and high liquidity. This explains why movements in the euro and Yen are most critical when observing the dollar index—they have the greatest impact on its fluctuations.

Why Must Investors Pay Attention to the US Dollar Index?

The rise and fall of the US Dollar Index directly determine the flow of global capital. When you buy US stocks, gold, or even Taiwan stocks, changes in the dollar index will profoundly affect your investment outcomes.

Chain Reaction of US Dollar Appreciation (Index Rise)

When the dollar index rises, it indicates the dollar is strengthening against other major currencies, triggering a series of market changes:

Positive effects for the US:

• Imported goods become cheaper, boosting US consumers’ purchasing power
• Capital flows into US markets, making US Treasuries and US stocks more attractive
• Helps curb inflation and stabilize the economy

Impact on Asian export economies:

• Export-oriented economies like Taiwan and South Korea face pressure as their goods become relatively more expensive when priced in dollars
• Emerging markets with dollar-denominated debt face increased debt repayment pressure
• The Taiwanese dollar (TWD) may depreciate, raising import costs

Investment Opportunities When the US Dollar Weakens (Index Falls)

Conversely, when the dollar index declines, market confidence shifts, and hot money begins seeking new investment opportunities:

• Asian stock markets (including Taiwan) often see capital inflows, with stock prices likely rising
• The Taiwanese dollar appreciates, making exports cheaper and more competitive
• However, if you hold dollar assets (US stocks, USD deposits), you need to watch out for exchange losses, as a weaker dollar means less TWD when converting back

The Relationship Between the US Dollar Index, Gold, US Stocks, and Taiwan Stocks

The Gold and US Dollar Tug-of-War

Gold and the dollar usually exhibit an inverse relationship: when the dollar is strong, gold tends to fall; when the dollar weakens, gold rises. This is because gold is priced in USD, so when the dollar appreciates, the cost to buy gold increases, reducing demand. However, this relationship is not absolute; factors like inflation and geopolitical events also influence gold prices.

The Complex Relationship with US Stocks

The relationship between the US Dollar Index and US stocks is not simply positive or negative:

• In some cases, a rising dollar attracts global capital into the US, boosting US stock prices
• But if the dollar becomes too strong, it can hurt US export companies’ competitiveness, dragging down the overall stock market

For example, during the global stock market crash in March 2020, the dollar surged to an index of 103 due to safe-haven demand. But later, as the pandemic expanded and the Federal Reserve adopted easing policies, the dollar quickly weakened to 93.78. This shows that the relationship between stocks and the dollar depends on the current economic environment and policy context.

Investment Insights for Taiwan Stocks and the TWD

The general pattern is: US dollar appreciation → capital flows back to the US → TWD depreciates → Taiwan stocks face pressure; US dollar depreciation → capital flows into Asia → TWD appreciates → Taiwan stocks benefit. But this is not an iron law; when market sentiment is optimistic, assets may rise together, and during panic, they may fall together.

Core Factors Driving Changes in the US Dollar Index

1. Federal Reserve’s Interest Rate Policies

This is almost the most direct driver of the US Dollar Index. Rate hikes increase the attractiveness of the dollar, attracting global capital into the US, causing the dollar to appreciate; rate cuts have the opposite effect. That’s why every Fed decision can trigger market volatility.

2. US Economic Data

Employment figures, CPI inflation data, GDP growth rates, and other economic indicators directly reflect the health of the US economy. Strong data means a stronger dollar; weak data leads to a weaker dollar.

3. Geopolitical and International Events

Wars, political turmoil, regional conflicts, and similar events trigger risk aversion, with the dollar often serving as the preferred safe-haven asset. This explains why sometimes “the more chaotic, the stronger the dollar.”

4. Performance of Other Major Currencies

Since the dollar index is a relative measure, when currencies like the euro and yen weaken due to their own economic issues or easing policies, the dollar index can rise even if the dollar itself is not appreciating.

US Dollar Index vs. Trade-Weighted US Dollar Index: Which Should Investors Watch?

US Dollar Index (USDX/DXY)

• The most common indicator, most frequently reported by media
• Compiled by ICE (Intercontinental Exchange)
• Includes six major currencies, with Europe having a larger weight
• Suitable for quickly gauging market sentiment

Trade-Weighted US Dollar Index

• The official indicator closely referenced by the Federal Reserve
• Includes over 20 currencies, covering Asian emerging markets (RMB, TWD, KRW, THB, etc.)
• More accurately reflects exchange rate changes with actual US trading partners
• Better aligned with the current global market situation

For most investors, the US Dollar Index is sufficient to judge market direction. But for in-depth macroeconomic or forex trading analysis, the trade-weighted index offers a more comprehensive perspective.

Master the US Dollar Index to Seize Investment Opportunities

The US Dollar Index is like a thermometer for the global financial market; every fluctuation sends signals to investors. Whether it’s gold, crude oil, stocks, or exchange rates, they all feel the impact of dollar index movements.

If investors understand the composition, influencing mechanisms, and market relationships of the US Dollar Index, they can more accurately predict capital flows, assess risks, and even spot investment opportunities in advance. Especially when engaging in forex trading, cross-border asset purchases, or overseas investments, mastering the trend of the dollar index is an essential basic skill.