The US Dollar Index that global investors must master: A comprehensive guide to understanding international capital flows

How the US Dollar Index Moves Your Investment Portfolio

Whenever financial markets experience volatility, the most common terms investors hear are “US Dollar Index strengthening” or “US Dollar Index weakening.” But what does this number actually represent? Why can it influence the performance of your US stocks, gold, and even Taiwan stocks?

In fact, the US Dollar Index (USDX or DXY) is simply an indicator measuring the strength of the US dollar relative to a basket of major international currencies, but its influence far exceeds many investors’ expectations. Since the US dollar is the world’s primary settlement currency—used in pricing crude oil, gold, and various commodity futures—any fluctuation in the dollar index can trigger a chain reaction across global financial markets.

Understanding the Essence of the US Dollar Index: What Is It Really Measuring?

Unlike other indices (such as the S&P 500 or Dow Jones) that track stock performance, the US Dollar Index measures the strength of the dollar against six major international currencies.

These six currencies are:

• Euro (EUR): 57.6%, far exceeding the others
• 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 short, the US Dollar Index is like a global economic thermometer. When it rises, it indicates the dollar’s purchasing power on the international stage is strengthening; when it falls, it signifies dollar depreciation and other currencies appreciating.

The True Meaning Behind the Rise and Fall of the US Dollar Index

Implications of the US Dollar Index Rising

When the dollar index rises, it reflects an actual appreciation of the dollar. From an economic perspective, this usually indicates:

Positive for the US: Investors pour capital into the US because dollar-denominated assets offer higher returns. The cost of imported goods decreases, making overseas purchases cheaper for US consumers. US companies’ dollar revenues become more competitive when converted internationally.

Challenges for Taiwan and other export nations: As the dollar appreciates, Taiwanese-made goods become more expensive on the international market, reducing export competitiveness. Profits denominated in dollars are relatively diluted. For emerging markets with dollar-denominated debt, repayment pressures increase.

Impacts of the US Dollar Index Falling

A declining dollar index means the dollar is weakening relative to other currencies, reducing market risk aversion, and investors start shifting from dollar assets to other opportunities.

Opportunities for Asian emerging markets: Capital flows into Taiwan stocks, Southeast Asian markets, boosting local stock prices. The New Taiwan Dollar (NTD) may appreciate, lowering import costs, but at the same time, export competitiveness diminishes. If you hold US stocks or dollar deposits, watch out for exchange losses—dollar depreciation means fewer New Taiwan Dollars when converting back.

How the US Dollar Index Is Calculated

The dollar index uses a “geometric weighted average” method, which is not a simple arithmetic mean but assigns different weights based on the size of each economy and international trade volume. The high weight of the euro (57.6%) reflects the EU’s large economic size and the euro’s widespread use across 19 countries. The yen follows, as Japan is the third-largest economy with high liquidity and frequent use as a safe-haven currency.

Importantly, the US Dollar Index is a relative index, not an absolute price. Its base period is set at 1985 with a value of 100, and current values indicate the relative rise or fall compared to that baseline. For example, a value of 110 means the dollar has appreciated by 10%; a value of 90 indicates a 10% depreciation.

The Relationship Between the US Dollar Index and Global Assets

US Stocks and the Dollar Index: A Nonlinear Relationship

Many believe that a rising dollar equals rising US stocks, but the reality is more complex. Sometimes, dollar appreciation attracts capital into US equities, boosting prices; other times, a strong dollar hampers US exporters, dragging down the stock market. During the 2020 pandemic, this contradiction appeared—risk aversion pushed the dollar to 103, but Federal Reserve easing policies caused it to quickly fall to 93.78, while US stocks continued to rise. Therefore, relying solely on the dollar index to predict US stock movements is insufficient; one must consider the overall economic environment.

Gold and the US Dollar Index: An Inverse Relationship

Gold and the dollar typically have an inverse relationship. Since gold is priced in dollars, a stronger dollar raises the cost of buying gold, reducing demand and causing gold prices to fall. Conversely, a weaker dollar tends to boost gold prices. However, geopolitical risks, inflation expectations, and oil prices also influence gold independently, so gold prices are not solely determined by the dollar index.

New Taiwan Dollar and Taiwan Stocks: Dual Effects of Capital Flows

When the dollar appreciates, capital tends to flow back to the US, causing the NT dollar to weaken and putting selling pressure on Taiwan stocks. Conversely, when the dollar depreciates, hot money flows into Asia, the NT dollar appreciates, and Taiwan stocks benefit. But there are exceptions—when global economic confidence is high, US stocks, Taiwan stocks, and the dollar may all rise together; during black swan events, all asset classes may decline simultaneously.

Core Factors Driving US Dollar Index Fluctuations

The Decisive Role of Federal Reserve Interest Rate Policies

This is the most direct factor influencing the dollar index. Rate hikes increase the attractiveness of dollar assets, attracting global capital inflows and causing the dollar to appreciate. Rate cuts lead to capital outflows and a weaker dollar. Every Federal Reserve policy meeting often triggers noticeable volatility in the dollar index.

Real Reflection of US Economic Data

Employment figures, CPI inflation, GDP growth rates, and other economic indicators directly reflect the health of the US economy. Strong data boosts market confidence and causes the dollar to appreciate; weak data dampens confidence and leads to dollar depreciation.

Geopolitical Events and Safe-Haven Effect

Wars, political turmoil, regional conflicts, and other sudden events trigger global risk aversion. During such times, the dollar, as a safe-haven asset, often becomes the first choice for investors, leading to dollar appreciation. This explains why “the more chaotic the world, the stronger the dollar” phenomenon occurs.

Independent Fluctuations of Other Major Currencies

Since the dollar index is relative, if the euro or yen depreciates due to economic weakness, loose policies, or political instability in their respective countries—even if the dollar itself does not appreciate—the dollar index can still rise due to their relative weakness. In other words, weakness in other currencies can make the dollar index appear stronger.

US Dollar Index vs. Trade-Weighted US Dollar Index: Which Matters More?

Investors often focus on the “US Dollar Index” compiled by ICE, based on six major currencies, frequently cited by the media. However, the Federal Reserve places more emphasis on the Trade-Weighted US Dollar Index.

Features of the US Dollar Index (DXY):

• Covers six currencies, with the euro accounting for 57.6%, reflecting a Euro-American perspective
• Easily accessible, suitable for quick market sentiment assessment
• Frequently reported in media, with high liquidity

Advantages of the Trade-Weighted US Dollar Index:

• Includes over 20 currencies, such as the Chinese yuan, Korean won, and New Taiwan Dollar
• Based on actual US trade flows, better aligned with real economic structures
• Main reference for Federal Reserve decisions, reflecting the true international competitiveness of the dollar

For most investors, tracking the US Dollar Index suffices for daily judgment. But if engaging in forex trading, macroeconomic research, or seeking a deeper understanding of Fed policy logic, the trade-weighted index offers a more comprehensive perspective.

Practical Application: How to Use the US Dollar Index to Optimize Investment Decisions

By understanding the dollar index’s fluctuations, investors can:

Preempt Capital Flows: When the dollar index rises steadily, beware of capital returning to the US, which may lead to selling pressure on Taiwan stocks and emerging markets; the opposite applies when the dollar weakens.

Adjust Asset Allocation: During dollar appreciation, consider reducing holdings in emerging market assets and increasing dollar-denominated assets; during depreciation, do the reverse.

Assess Forex Risks: Investors holding US stocks or dollar assets should monitor dollar depreciation risks that could lead to exchange losses; those holding NT assets should watch for dollar appreciation risks that could cause currency devaluation.

Capture Trading Opportunities: Forex traders can analyze technical signals and fundamental drivers of the dollar index to identify trading opportunities against major currencies.

In summary, the US Dollar Index is a barometer of global capital flows. Whether investing in stocks, bonds, or currencies, understanding and tracking its movements is essential for making informed investment decisions.