A Global Capital Flow Compass: The Composition of the US Dollar Index and Its Deep Impact on Investment Markets

When it comes to the US dollar’s position in the international financial system, the most intuitive reflection is the fluctuation of the US Dollar Index. But many investors actually don’t understand: How exactly is the US Dollar Index composed? Why can an “index” influence global stock markets, forex markets, and commodity markets?

Don’t worry, today we’ll break down this seemingly complex indicator.

Components of the US Dollar Index: How Six Countries’ Currencies Define the Strength of the US Dollar

Before discussing the USDX or DXY, let’s clarify what it tracks. Simply put, the US Dollar Index is a basket of exchange rates of the dollar against benchmark currencies.

This basket contains six currencies, representing major economies worldwide:

Summary in one sentence: In the components of the US Dollar Index, the euro dominates, accounting for over half the weight. This means that once European economic data or ECB policies shift, the dollar index reacts immediately.

Why These Six Currencies? The Logic Behind the Composition of the US Dollar Index

You might ask: Why not include currencies from China, India, or emerging markets?

There are historical and practical considerations:

The US Dollar Index was created by ICE (Intercontinental Exchange) in the 1970s, when global trade and finance were mainly led by developed countries. These six countries (regions) represented the core of the global economy at that time. Although the world has changed and emerging markets have grown significantly, the composition of this index has remained largely unchanged.

Therefore, the US Dollar Index more reflects a “Euro-American perspective” on the dollar’s strength, rather than a truly global view. That’s also why the Federal Reserve monitors another indicator—the Trade-Weighted US Dollar Index—which includes over 20 currencies, covering major trade partners like China, Taiwan, Korea, and Mexico.

But for most investors, the US Dollar Index components, though not comprehensive, are straightforward enough.

Who Is Most Affected When the US Dollar Index Fluctuates?

When major currencies in the index experience sharp changes, global financial markets tend to move accordingly.

The euro’s movement is most critical

Since the euro accounts for 57.6%, the policies of the ECB and economic data from the Eurozone can almost single-handedly drive the US Dollar Index. For example, in 2022, the ECB entered a hawkish rate hike cycle, the euro appreciated, and this directly pushed the dollar index higher.

The Japanese Yen is a “risk sentiment” barometer

The yen is often seen as a safe-haven currency. When global risk assets come under pressure and investors panic, capital flows into the yen, causing it to appreciate, which in turn can lift the US Dollar Index. Conversely, the opposite can happen.

Rising vs Falling US Dollar Index: Different Capital Flows

US Dollar Index Up = US Dollar Appreciates

Chain reactions include:

• Global investors flock to US assets (Treasuries, US stocks), capital flows back to the US
• Commodities priced in USD (oil, gold) become “more expensive” for international buyers, demand drops
• Export-driven economies like Taiwan and Korea get hit: goods become pricier, less competitive
• Emerging markets with dollar-denominated debt face increased repayment pressure

US Dollar Index Down = US Dollar Depreciates

The opposite scenario:

• Capital exits the US, seeking higher risk/higher return assets
• Emerging markets and Asian stock markets attract inflows
• Taiwanese exporters get relief, products become more competitive
• USD assets face exchange loss risks

The Four Major Asset Classes and the US Dollar Index: Who Moves Together?

Gold: Opposite fate

Gold and the US Dollar Index are usually “opposite sides of the same coin.” When the dollar appreciates, the cost of buying gold in USD rises, demand drops, and gold prices tend to fall. Conversely, when the dollar weakens, gold prices often rise.

But note, gold prices are also influenced by geopolitical events, inflation expectations, and real interest rates, so don’t rely solely on the US Dollar Index.

Crude Oil: A strong dollar is a big headwind

Crude oil is priced in USD. When the US Dollar Index rises, purchasing power declines, demand weakens, and oil prices usually fall.

US Stocks: The relationship is complex

A rising dollar doesn’t always benefit US stocks. Sometimes, a strong dollar means lower overseas sales revenue when converted back, dragging down corporate profits. But other times, a rising dollar indicates ample capital and risk appetite, allowing US stocks to rise together.

This explains why during the March 2020 global stock crash, US stocks fell while the dollar index rose to 103—the market was seeking safety.

Taiwan stocks & New Taiwan Dollar: Capital flows determine everything

Simple logic: US Dollar Index down → capital flows into Asia → Taiwan stocks may rise, TWD appreciates. The reverse also holds.

But “simple logic” often doesn’t hold in financial markets. Sometimes, when global sentiment is optimistic, the US Dollar Index, US stocks, and Taiwan stocks all rise together; during black swan events, all assets may plunge simultaneously.

Who Controls the Weights of the US Dollar Index Components?

The weights of the six currencies are not evenly distributed but are calculated using a “geometric weighted average” based on each economy’s size, trade volume, and capital market scale.

Because the Eurozone’s economy is large (19 countries) and its capital markets are developed, the euro has the highest weight. The yen is second, mainly because Japan’s economy is sizable and the yen is highly liquid, often used as an international safe-haven.

These weights are not fixed. In theory, if global trade patterns change dramatically (e.g., emerging markets dominate the global economy), the composition of the index will eventually be adjusted. But for now, the euro will continue to “lead the pack.”

US Dollar Index vs Trade-Weighted US Dollar Index: Which Truly Reflects the Reality?

Besides the US Dollar Index (DXY), there’s a hidden key indicator called the Trade-Weighted US Dollar Index, which the Fed often monitors.

What’s the difference?

The US Dollar Index (DXY): Composed of six currencies, with a strong European bias, and is the most common and widely reported in the media.

The Trade-Weighted US Dollar Index: Includes over 20 currencies, covering major US trade partners like China, Taiwan, Mexico, Korea, Thailand, etc. It better reflects the current global situation and is more relied upon by the Fed for policy decisions.

For investors, the US Dollar Index is usually sufficient. But if you want to understand the Fed’s policy logic, the trade-weighted index offers more insight.

What Drives the US Dollar Index? Four Major Factors

Federal Reserve interest rate decisions

Rate hikes → US dollar attractiveness increases → US Dollar Index rises. Rate cuts have the opposite effect. Every Fed meeting makes markets tense because of this.

US economic data

Employment, CPI, GDP—strong data strengthen the dollar; weak data weigh on it.

Geopolitical conflicts

Wars, political crises—during such times, global capital flows into the “safest harbor,” the US dollar. The more chaotic, the stronger the dollar—sounds contradictory but is real.

Other currencies’ own movements

If the ECB suddenly shifts policy, or Japan’s economic data disappoints, these currencies depreciate. Even if the dollar doesn’t move, the US Dollar Index can rise passively.

Summary: The Global Financial Logic Behind the US Dollar Index Components

The US Dollar Index essentially measures the “strength of the dollar relative to other major economies’ currencies”. Composed of six currencies, with the euro dominating, it carries a clear Euro-American perspective.

For investors, understanding the logic behind the composition of the US Dollar Index helps you:

• Grasp why European news has the biggest impact on the dollar
• Judge capital flows and anticipate the relative performance of emerging markets and US stocks
• Find more precise entry points in forex trading
• Protect USD assets from exchange rate risks

Whether you’re trading the dollar, gold, or tracking Taiwan stocks, the components and fluctuations of the US Dollar Index are crucial indicators you can’t ignore. The key is to understand the underlying logic, not be fooled by surface numbers.