The U.S. Dollar Index

What is the Dollar Index?

If you've traded stocks, you're probably familiar with all the indices available such as the Dow Jones Industrial Average (DJIA), NASDAQ Composite Index, Russell 2000, S&P 500, Wilshire 5000, and the Nimbus 2001. Oh wait, that last one is actually Harry Potter's broomstick.

Well if U.S. stocks have an index, the U.S. dollar can't be outdone. For currency traders, we have the U.S. Dollar Index (USDX).

The U.S. Dollar Index consists of a geometric weighted average of a basket of foreign currencies against the dollar.

Say whutttt!?! Okay before you fall asleep after that super geeky definition, let's break it down.

It's very similar to how the stock indices work in that it provides a general indication of the value of a basket of securities. Of course, the "securities" we're talking about here are other major world currencies.

The Basket

The U.S. Dollar Index consists of six foreign currencies. They are the:

Euro (EUR)
Yen (JPY)
Pound (GBP)
Canadian dollar (CAD)
Krona (SEK)
Franc (CHF)
Here's a trick question. If the index is made up of 6 currencies, how many countries are included?

If you answered "6", you're wrong.

If you answered "21", you're a genius!

There are 21 countries total, because there are 16 members of the European Union that have adopted the euro as their sole currency, plus the other five countries (Japan, Great Britain, Canada, Sweden, and Switzerland) and their accompanying currencies.

It's obvious that 21 countries make up a small portion of the world but many other currencies follow the U.S. Dollar index very closely. This makes the USDX a pretty good tool for measuring the U.S. dollar's global strength.




USDX Components

Now that we know what the basket of currencies is composed of, let's get back to that "geometric weighted average" part. Because not every country is the same size, it's only fair that each is given appropriate weights when calculating the U.S. dollar index. Check out the current weights:



With its 16 countries, euros make up a big chunk of the U.S. Dollar Index. The next highest is the Japanese yen, which would make sense since Japan has one of the biggest economy in the world. The other four make up less than 30 percent of the USDX.

Here's something interesting: When the euro falls, which way does the U.S Dollar Index move?

The euro makes up such a huge portion of the U.S. Dollar Index, we might as well call this index the "Anti-Euro Index". Because the USDX is so heavily influenced by the euro, people have looked for a more "balanced" dollar index. More on that later though. First, let's go to the charts!

U.S. Stocks Tumble on Economic Worries

U.S. stock markets are tumbling today amid fears of a weakening U.S. economy. The Dow Jones Industrial Average fell 333 points by noon, a drop of 3 percent.

Fears of a double dip recession are clearly taking hold among traders and economists.

"The market is sending a strong and clear message that the U.S. economy is in a soft patch, the question is whether the soft patch is temporary, or something more serious," said Hugh Johnson, chief investment officer of Hugh Johnson Advisors LLC.

Markets are reacting in particular to weekly jobless claim data from the Labor Department that shows the job market remains weak. In the week ending July 30, there were 400,000 new unemployment claims. This was a decrease in initial claims from the week earlier, but clearly not enough of a decrease to give investors confidence in the strength of the U.S. economy as whole. Jobless numbers for July are due out Friday morning before the markets open.

Fear about a spreading debt crisis in Europe are also contributing to the sharp market decline today. Last week's dismal GDP data and weak manufacturing data earlier this week are also among the factors inciting investors' worries.

The Dow managed to snap an eight-day losing streak by ending the day slightly positive on Wednesday. If today's major declines take hold the Dow will have ended the day lower in nine out of 10 days. It's set to be the worst losing streak for stocks since 2008.

On Tuesday, the Senate passed an agreement to raise thedebt ceiling and avoid a default on U.S. debt, following passage in the House on Monday evening.

"The initial increase of the debt limit by $900 billion and the commitment to raise it by a further $1.2-1.5 trillion by yearend have virtually eliminated the risk of such a default, prompting the confirmation of the rating at Aaa," Moody's stated in a report.

Moody's assigned a negative outlook to its rating, saying it could downgrade the U.S. if fiscal discipline weakens in the coming year, further "fiscal consolidation" does not take place in 2013, the economic outlook "deteriorates significantly," or there is an appreciable rise in the government's spending "over and above what is currently expected."

Fitch Ratings confirmed its AAA rating for United States debt over the short-term, but warned of more tough choices coming soon.

"While the agreement is clearly a step in the right direction, the United States, as in much of Europe, must also confront tough choices on tax and spending against a weak economic back drop if the budget deficit and government debt is to be cut to safer levels over the medium term," Fitch said in a statement.

On Tuesday, U.S. financial markets were first buoyed by the news of a possible debt limit deal in Washington, but slid after a report on manufacturing showed weak progress for the economy.

"Consumer and businesses rally need to regain some confidence and start to spend more if we're going to have a resurrection in the third quarter," Bruce McCain, chief investment strategist with Key Private Bank, said.

GLOBAL MARKETS-Stocks sink as economic outlook dims, bonds jump

he European Central Bank kept interest rates unchanged on Thursday, but traders said the central bank has been buying bonds of peripheral euro-zone countries in an effort to keep rates lower.

German Bunds gained, while Italian and Spanish government bond yields rose in volatile trade on Thursday, after a euro- zone monetary source said the European Central Bank was only planning to buy Portuguese and Irish bonds. For more see [ID:nR1E7IF024].

Markets were unconvinced the ECB bond buying will be effective in stopping contagion and some were disappointed that Italian and Spanish bonds, whose yields climbed above 6 percent recently, were not the target of the purchases.

"It wasn't a unanimous decision to (buy bonds). (ECB President Jean-Claude) Trichet looked really uncomfortable saying it," one trader said.

"The market obviously dismissed it pretty rapidly," another trader said.

Brent fell more than 2 percent and U.S. crude lost 3.2 percent to $89 a barrel. Copper pricesdropped 1.5 percent. (Additional reporting by Julie Haviv, Marius Zaharia and Emelia Sithole-Matarise; Editing by James Dalgleish and Jan Paschal)