A barometer of global capital flows: How the US Dollar Index influences your investment decisions

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

You might often see headlines like “US Dollar Index Rises and Falls” or “Dollar Continues to Strengthen” in the news, but what does this index actually represent? And why is it so important?

Simply put, the US Dollar Index (commonly referred to as USDX or DXY) is like a thermometer, used to measure the strength or weakness of the US dollar relative to other major international currencies.

When we talk about the performance of a stock, we refer to indices like the S&P 500 or the Dow Jones Industrial Average to gauge the overall trend of a basket of stocks. Similarly, the US Dollar Index tracks a set of benchmarks, but instead of stock prices, it monitors the exchange rates of the US dollar against six major currencies:

• Euro (EUR): the highest weight, approximately 57.6%
• Japanese Yen (JPY): about 13.6%
• British Pound (GBP): about 11.9%
• Canadian Dollar (CAD): about 9.1%
• Swedish Krona (SEK): about 4.2%
• Swiss Franc (CHF): about 3.6%

Why do these six currencies represent the entire global market? Because these currencies cover over 24 developed countries — with the Euro used by 19 EU nations alone. In other words, the US Dollar Index reflects the relative performance of the world’s major economies, which is why it holds such high authority in international financial markets.

The Relationship Between the US Dollar Index and Other Assets

To understand why the US Dollar Index is worth paying attention to, the most straightforward way is to see how it influences other investment assets.

US Dollar Index and Gold: The See-Saw Effect

The relationship between gold and the dollar is the most classic “inverse movement”:

• Dollar appreciates → Cost to buy gold in dollars increases → Gold demand decreases → Gold prices fall
• Dollar depreciates → Cost to buy gold in dollars decreases → Gold becomes more attractive → Gold prices rise

Why does this happen? Because gold prices worldwide are quoted in US dollars. When the dollar strengthens, buyers need to spend more of their local currency to get dollars to buy gold, naturally reducing demand.

However, note that gold prices are also affected by inflation, geopolitical tensions, oil prices, and other factors, so it’s not wise to look at the US Dollar Index alone.

US Stocks and the US Dollar Index: Complex Interactions

The relationship between the strength of the dollar and US stocks is not simply “positive” or “negative”; it depends on the current market context:

Scenario 1: Optimistic Economy
Dollar appreciates → Attracts global capital inflow into the US → US stocks rise in tandem

Scenario 2: Excessive dollar appreciation
Dollar becomes too strong → US export prices rise → Corporate competitiveness declines → US stocks may face pressure

Real-world example: In March 2020, during the initial outbreak of the pandemic, global stock markets plummeted but the dollar surged to 103 (a safe-haven demand); later, as the Fed eased policies, the dollar quickly weakened to 93.78, and US stocks started rebounding.

Taiwan Stock Market and New Taiwan Dollar: Capital Flows Are Key

The impact of the US Dollar Index on Taiwan’s market mainly manifests through “capital flows”:

• Dollar appreciation (US Dollar Index rises) → Capital flows back to the US → Funds withdraw from Taiwan → New Taiwan Dollar (NTD) depreciates, Taiwan stocks come under pressure
• Dollar depreciation (US Dollar Index falls) → Global capital seeks emerging markets → Increased Asian capital inflow → NTD appreciates, Taiwan stocks profit

But there are exceptions. Sometimes, when global risk sentiment is very high, US stocks, emerging markets, and the dollar may all rise together; during black swan events, all assets can decline simultaneously.

The Four Major Drivers of US Dollar Index Movements

Since the US Dollar Index is so important, what causes it to rise or fall? The following factors are the most common influences:

Federal Reserve’s Interest Rate Decisions

This is the most direct and impactful factor. Raising interest rates increases the dollar’s return, prompting global investors to flock into US markets, boosting dollar demand → US Dollar Index rises. Conversely, lowering rates leads to capital outflows and a decline in the index.

Every Fed meeting attracts high market attention because interest rate adjustments have a highly sensitive impact on the dollar’s strength.

US Economic Fundamentals

Indicators like Non-Farm Payrolls, Unemployment Rate, Consumer Price Index (CPI), and Gross Domestic Product (GDP) growth influence investor expectations of the US economy. Strong data → increased confidence in the dollar → index rises; weak data → decreased confidence → index falls.

Geopolitical Risks and Safe-Haven Sentiment

Wars, political turmoil, regional conflicts—these international events trigger global safe-haven demand. During such times, the dollar, as the most stable and liquid store of value, often becomes the first choice for investors, pushing the US Dollar Index higher—that’s why sometimes “the more chaotic, the stronger the dollar.”

Relative Performance of Other Major Currencies

Remember, the US Dollar Index is a relative measure: “Dollar vs. six foreign currencies.” Even if the dollar itself isn’t strengthening, if the euro, yen, or other currencies weaken due to economic weakness or loose monetary policy, the index will still rise. In short, the weaker other currencies are, the stronger the dollar appears.

How the US Dollar Index Is Calculated

The US Dollar Index uses a “geometric weighted average” formula, involving a fixed constant (50.14348112, which ensures the 1985 base period equals 100) and the exchange rates of the currencies.

Key point: The US Dollar Index is not an exchange rate or a price; it’s a relative index. It shows the overall strength or weakness of the dollar compared to those six currencies since the base period.

Simple interpretation:

• Index = 100: at the base period, no change
• Index = 76: down 24% from the base, dollar is relatively weaker
• Index = 176: up 76% from the base, dollar is relatively stronger

The Practical Impact of US Dollar Index Movements

When the US Dollar Index rises

Dollar strengthens, meaning the dollar appreciates against other currencies. In this case:

Positive effects on the US:

• Imported goods become cheaper (buying foreign goods with dollars costs less)
• US dollar-denominated assets like US Treasuries become more attractive, attracting global capital inflow
• Helps the US curb import inflation and control inflation

Challenges for other economies:

• Export-driven economies (like Taiwan) face difficulties: their goods priced in dollars become more expensive, reducing foreign demand and impacting corporate revenues
• Emerging markets with dollar-denominated debt face increased debt repayment pressure

When the US Dollar Index falls

Dollar weakens, indicating market confidence in the dollar declines, and capital shifts toward other assets and regions. In this scenario:

Global capital flows change:

• Hot money may flow into Asian stocks and emerging markets seeking higher returns
• Beneficial for Taiwan and other Asian economies: more capital inflow → increased stock market potential

Exchange rates and asset values:

• NTD may appreciate
• Investors holding US stocks, dollar deposits, or dollar assets should watch for exchange losses—because a weaker dollar means fewer NT dollars when converting back

Who Uses It: US Dollar Index vs. Trade-Weighted US Dollar Index

Investors often wonder: why are there two measures of dollar strength? What’s the difference?

US Dollar Index (DXY) — the most commonly reported one by media

• Created by: ICE (Intercontinental Exchange)
• Composition: six major currencies
• Euro has the highest weight (57.6%), with a clear Euro-American focus
• Easily accessible and most frequently reported in news

Trade-Weighted US Dollar Index — the one actually used by the Fed

• Created by: Federal Reserve
• Composition: over 20 currencies, including more Asian emerging market currencies (RMB, Korean won, TWD, Baht, etc.)
• Based on actual US trade relationships and weights
• Better reflects the real exchange rate dynamics between the US and its trading partners

Quick rule: if you’re a general investor wanting a quick sense of dollar movement, look at the US Dollar Index; if you’re doing macro analysis, forex trading, or want a deeper understanding of Fed policy logic, the trade-weighted index provides a more accurate global market perspective.

Practical Application: How to Use the US Dollar Index for Investment Guidance

Mastering the US Dollar Index’s movements can help you make smarter decisions at three key moments:

Assessing Global Capital Flows

Observe whether the index is rising or falling; essentially, it indicates whether global investors are flocking to the US or dispersing elsewhere. When rising, beware of capital outflows from emerging markets; when falling, watch for opportunities in Asian assets.

Evaluating Currency Risk of Foreign Assets

If you hold US stocks, dollar deposits, or US bonds, a falling dollar index signals potential currency losses. Conversely, if the index rises, your dollar assets will be worth more when converted back to NT dollars.

Predicting Commodity and Asset Price Fluctuations

Gold, oil, and other dollar-priced commodities often move inversely to the US Dollar Index. Understanding this relationship can help you position ahead of price movements.

Conclusion

The US Dollar Index is a mirror of the global financial market. It reflects not only the dollar’s strength but also the flow of global capital, central bank policies, and international economic conditions.

Whether you invest in gold, oil, US stocks, or Taiwan stocks, or engage in forex trading or cross-border investments, understanding the logic behind the US Dollar Index will make your decisions more grounded. Next time you see news about “Dollar Strengthening” or “Dollar Weakening,” you’ll know what it really means and what chain reactions it might trigger.

Mastering this fundamental skill is like holding the key to understanding the entire global financial market.