A comprehensive explanation of the US Dollar Index (DXY): Why should you pay attention to the global capital flow indicator?

Is the US Dollar Index Really That Important?

If you’ve been paying attention to the news, you’ve probably heard phrases like: “The US Dollar Index hits a new high” or “The dollar continues to strengthen.” But what does this actually mean? Why can an invisible “index” influence the stock market, forex market, and even your USD assets?

The truth is quite simple — the US Dollar Index is like a “thermometer” for the global financial markets. Since the dollar is the world’s most commonly used trading currency, most international commodities, energy, gold, and even global investments are priced in USD. When the US Dollar Index changes, it triggers a chain reaction.

What exactly is the US Dollar Index (DXY)?

Rather than calling it a “price,” it’s better described as a “relative strength indicator.”

Imagine:

• The S&P 500 tracks the performance of 500 major US companies’ stocks
• The US Dollar Index tracks the overall performance of the dollar against six major currencies

These six currencies are:

• Euro (EUR): 57.6%, the largest 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%

In simple terms, the US Dollar Index measures whether the dollar is appreciating or depreciating relative to other major currencies. A higher value indicates a stronger dollar; a lower value indicates a weaker dollar.

How do rises and falls in the US Dollar Index affect your investments?

When the US Dollar Index rises

The dollar appreciates, summarized in one sentence: “The dollar gets stronger, capital flows back to the US.”

What effects does this have?

• Commodities priced in USD, like gold and crude oil, seem cheaper (because the dollar is worth more)
• Global investors withdraw funds from emerging markets and shift to US markets and US Treasuries
• US stocks may benefit (capital inflow), but US export companies could suffer (products become more expensive, competitiveness declines)

For export-driven economies like Taiwan:

• Taiwanese goods become relatively more expensive, risking lost orders
• The New Taiwan Dollar (NTD) faces depreciation pressure
• Emerging markets also face increased USD debt burdens

When the US Dollar Index falls

The dollar weakens, and other currencies appreciate. How does market sentiment respond?

• Investors seek higher yields, pulling money out of US Treasuries
• Hot money flows into Asian stock markets and emerging markets
• Taiwan stocks may see a net capital inflow opportunity
• The NTD appreciates, making imported goods cheaper

But note: If you hold USD assets (US stocks, US bonds, USD deposits), a weaker dollar means you get fewer NT dollars when converting back, which is the “exchange loss” risk.

What factors drive changes in the US Dollar Index?

1. Federal Reserve interest rate policy

The most direct driver is the Fed’s interest rate decisions.

• Rate hikes → higher US interest rates → attracts global capital → US Dollar Index rises
• Rate cuts → capital flows out of the US → US Dollar Index falls

This is why every Fed meeting can trigger significant market volatility.

2. US economic data

Non-farm payrolls, unemployment rate, CPI inflation, GDP growth — these are confidence indicators.

Strong economic data → market optimism about the dollar → USD Index rises Weak economic data → market confidence drops → USD Index falls

3. Geopolitical events and risk aversion

Wars, political instability, regional conflicts… such events trigger global risk aversion. The dollar, as the safest haven asset, often rises during crises. This explains why sometimes “the more chaotic, the stronger the dollar.”

4. Performance of other currencies

Remember, the USD Index is a “relative value” of the dollar versus six foreign currencies.

Even if the dollar itself doesn’t change, if the euro or yen depreciate due to economic weakness or loose policies, the USD Index will rise accordingly.

How does the US Dollar Index interact with other assets?

US Dollar Index and Gold

This is the classic “see-saw” relationship:

• Dollar appreciates → gold becomes more expensive in USD → gold prices fall
• Dollar depreciates → gold becomes cheaper in USD → gold prices rise

But gold prices are also influenced by inflation, wars, and oil prices, so don’t rely solely on the dollar.

US Dollar Index and US Stocks

The relationship is more complex, depending on underlying economic logic:

• Sometimes USD appreciation → capital inflow into the US → stock prices rise
• But if the dollar gets too strong → hurts US exports → drags down stocks

For example, in 2020, during the March global stock market crash, the USD Index soared to 103 (risk aversion). But as the pandemic spread and the Fed printed money aggressively, the dollar quickly dropped to 93.78. Context is key to understanding these movements.

US Dollar Index and Taiwan stocks / New Taiwan Dollar

The general pattern is:

• Dollar appreciation → capital flows back to the US → depreciation pressure on the NTD → Taiwan stocks under pressure
• Dollar depreciation → capital flows into Asia → NTD appreciates → Taiwan stocks may benefit

But this isn’t a strict rule. Sometimes, the entire global market is optimistic, and US stocks, Taiwan stocks, and the dollar all rise together; during black swan events, everyone panics, and stocks, forex, and bonds may all decline simultaneously.

USD Index vs. Trade-Weighted US Dollar Index: Which is more accurate?

These two concepts are often confused, but they are fundamentally different.

US Dollar Index (DXY)

• The most common, widely reported
• Compiled by ICE (Intercontinental Exchange)
• Includes only six major currencies
• Euro has the largest weight (57.6%), so the index leans toward a Euro-American perspective

Trade-Weighted US Dollar Index

• The main reference for the Fed
• Includes over 20 currencies
• Covers Asian emerging market currencies (CNY, KRW, TWD, THB, etc.)
• Reflects the actual trade partners’ exchange rate changes more accurately, closer to the real global market conditions

In simple terms: The DXY is a traditional indicator, quick to gauge market sentiment. But if you’re doing macroeconomic research or forex trading and want to understand Fed policy logic, the trade-weighted index is a deeper reference.

How is the US Dollar Index calculated?

The USD Index uses a “geometric weighted average” method. The logic is:

• Use the exchange rates of each currency against the dollar
• Weight each by its respective importance (e.g., EUR 57.6% becomes a -0.576 power)
• Adjust with a fixed constant 50.14348112 so that the base period (1985) equals 100

The result is a relative index:

• 100 = baseline, no change
• 76 = 24% decline from base, dollar weaker
• 176 = 76% increase from base, dollar stronger

Therefore, a higher USD Index indicates a stronger dollar; a lower index indicates a weaker dollar on the international stage.

How should investors apply this knowledge?

Understanding the USD Index helps you to:

1. Assess asset value: When the dollar appreciates, US stocks and bonds in USD increase in USD terms, but may shrink when converted to NT dollars due to exchange rates
2. Predict exchange rate trends: Rising USD Index → NT dollar usually depreciates; falling index → NT dollar usually appreciates
3. Identify investment opportunities: When the dollar is weak, it’s a good time to buy into emerging markets; when strong, it might be a good entry point for gold
4. Manage exchange rate risk: Holding USD assets means monitoring the USD Index to avoid losses from exchange rate movements

Whether you’re trading forex, investing in US stocks, or just want to understand NT dollar trends, mastering the USD Index is essential. It acts like a wind vane for global capital flows; observing its fluctuations helps you better understand market dynamics.