The significance of the US dollar index decline: The key to understanding global capital flows

If you’ve recently seen news saying “the US dollar index is weakening,” don’t think it has nothing to do with you. Whether you’re trading Taiwan stocks, US stocks, or holding US dollar assets, every fluctuation of the USDX can directly impact your investment returns.

Why should you pay attention to the decline of the US dollar index?

What does a decline in the US dollar index mean? Simply put, “the dollar has weakened,” and market confidence is shifting toward other assets.

When this happens, it triggers a series of chain reactions:

The most direct impact on Taiwanese investors:

• International hot money begins flowing into Asian markets, likely leading to capital inflows into Taiwan stocks
• The New Taiwan Dollar faces upward pressure, making imports cheaper but reducing export competitiveness
• If you hold USD fixed deposits or US stocks, converting back to TWD may result in a loss (this is exchange loss)

Impact on global markets:

• Emerging markets become new favorites for capital, increasing attractiveness of various Asian assets
• Prices of dollar-denominated commodities (including oil, gold, etc.) may rise
• Risk aversion eases, and high-risk assets regain popularity

What exactly does the US dollar index measure?

The USDX is like a global financial thermometer. It tracks the relative strength of the dollar against six major currencies, which are:

Why these six? Because they are the most actively traded currencies worldwide, representing the economies of over 24 developed countries. The euro alone covers 19 EU countries, making its role pivotal.

The USDX is compiled by ICE (Intercontinental Exchange) using a geometric weighted average. A lower index value indicates a relative weakening of the dollar’s purchasing power in international markets.

The interaction between the US dollar index and various assets

The Gold Market’s Pendulum Effect

There is a typical inverse relationship between the dollar and gold. When the USDX declines, the cost of buying gold with dollars decreases, prompting global investors to buy more gold, pushing prices higher. However, war, inflation, and geopolitical events can also influence gold prices, so don’t rely solely on the dollar factor.

Complex Reactions in the Stock Market

The relationship between the dollar and US stocks isn’t simply positive or negative:

• When the dollar falls and boosts global risk appetite, US stocks often benefit
• But if the dollar’s decline is due to worsening US economic data, US stocks may also face pressure
• During the initial outbreak of the pandemic in 2020, the dollar surged to 103 due to safe-haven demand, but later, the Fed’s easing policies caused it to depreciate rapidly to 93.78

The linkage between Taiwan stocks and the TWD is similar—dollar index declines often favor Taiwan stocks, but the real key is the actual global risk sentiment.

Pricing logic of commodities and currencies

Crude oil and bulk commodities are priced in dollars. A decline in the USDX means higher costs for other currencies to buy these commodities, potentially increasing demand. Meanwhile, emerging market currencies may also get relief as the dollar weakens.

What truly drives the fluctuations of the US dollar index?

The Federal Reserve’s policies are the most direct influence

Every rate hike or cut by the Fed immediately impacts the USDX. Rate hikes attract global capital to the US for higher returns; rate cuts encourage capital to seek opportunities elsewhere, weakening the dollar index. That’s why Fed meetings often cause market volatility.

Signals from US economic data

Non-farm payrolls, unemployment rate, CPI inflation, GDP growth—these are key clues for the market to gauge the dollar’s direction. Strong economic data boost the dollar’s attractiveness; weak data undermine confidence.

Changes in geopolitical risk appetite

Wars, political turmoil, regional conflicts—unexpected events that alter investors’ risk preferences. During panic, the dollar often appreciates as a safe-haven asset; when tensions ease and confidence recovers, the USDX may weaken.

Evolution of other major currencies

The USDX is a relative measure. When currencies like the euro or yen depreciate due to domestic economic policies, even if the dollar remains unchanged, the USDX can rise. In other words, the weakening of others’ currencies can make the dollar appear stronger.

Differences between the USDX and the Fed’s preferred index

Investors often watch the “US dollar index,” which tracks six currencies, but the Fed relies more on the “Trade-Weighted US Dollar Index.” The key differences:

US Dollar Index (DXY):

• Traditional indicator compiled by ICE
• Composed of six currencies, with the euro having the largest weight (57.6%)
• More Euro-American perspective

Trade-Weighted US Dollar Index:

• The Fed’s official preferred indicator
• Covers over 20 currencies, including RMB, Korean won, TWD, Thai baht, etc.
• Better reflects the actual trade partners’ exchange rate movements
• Closer to current global market realities

For most investors, the USDX is sufficient for quick market sentiment assessment. But if you’re involved in forex trading or studying Fed policies deeply, the trade-weighted index offers more precise insights.

Practical application: investment decisions when the USDX declines

When the dollar weakens, you should:

Review USD asset allocations—if you hold US stocks or bonds, be aware of exchange risks. Consider reducing exposure or hedging currency risk.

Seize emerging market opportunities—capital inflows into Asia suggest Taiwan stocks and Southeast Asian markets may rise.

Reassess gold holdings—a weaker dollar often boosts gold prices; decide whether to increase your position based on your risk appetite.

Monitor Fed policies—the cause of the dollar’s decline determines its sustainability. If driven by further easing signals, the dollar may remain weak long-term.

Conclusion

A decline in the USDX is more than just a number moving downward; it signifies shifts in global capital flows, diminishing risk aversion, and emerging new investment opportunities. Understanding the logic behind USDX fluctuations helps you better time your moves, optimize allocations, and avoid risks. Regardless of your asset class, grasping the strength or weakness of the world’s reserve currency is a crucial lesson for becoming a smarter investor.