What is DXY? How does this index impact the financial markets?

In today's market economy, you have probably heard at least once the phrase "the strength of the USD". In addition to affirming America's economic strength compared to the rest of the world, the phrase From there it also shows the position of the USD compared to 6 other currencies representing 5 countries and 1 common economic region. So what is the correlation of the USD with the rest of the world and what is the DXY index? What role does it play in the world economy? Join Coin68 to learn about the DXY index and its impacts on the financial market through the article below.

What is DXY? How does this index impact the financial markets?

What is DXY index? History of creation and composition of the DXY index

History

In 1971, the 37th President of the United States, Richard Nixon, signed a decree ending the Bretton Woods System, floating the value of the USD instead of pegging it to the gold standard. However, fearing an economic crisis will occur, lawmakers have proposed another method to ensure the strength of the USD. This proposal will include components other than the market, gold and the USD.

Definition and composition

To make it easier to understand, the DXY index is a tool that measures the strength and value of the USD against 6 currencies representing countries and territories. Those countries are America's allies in both trade and politics. The DXY index will be positively correlated with the value of the USD. If the USD increases in price compared to a basket of currencies, the DXY index will tend to increase and vice versa.

As mentioned above, the DXY index is a measurement of the value of the USD compared to a basket of 6 currencies including: the European common currency Euro (EUR), Japanese Yen (JPY), Pound British Pound (GBP), Canadian Dollar (CAD), Swedish Krona (SEK), Swiss Franc (CHF). In particular, the market share of the European common currency accounts for more than half, which is quite understandable because the above countries are not only allies of the United States, but also large countries that share interests with the United States. And yet, each of the two sides' monetary policies strongly affects the other.

Coin

Ratio (%)

Nation

EUR

57.6%

European's common currency

JPY

13.6%

Yen

GBP

11.9%

GBP

CAD

9.1%

Canadian Dollar

SEK

4.2%

Swedish Krona

CHF

3.6%

Swiss Franc

However, we need to clearly understand that not only does the exchange rate affect the results of the USD Index, but in addition, supply and demand is also an issue that affects this index. The interrelationship between the supply and demand of the USD and the supply and demand of the above 6 currencies significantly affects the results of the index. Besides, factors such as inflation, deflation, monetary policy and economic policy also leave a significant mark on the results of the DXY index.

How to view and read the DXY index

To read the DXY index and the meaning it brings to investors, we need to clearly identify a specific milestone to make accurate predictions. At the time of writing, February 6, 2024, the DXY index has a value of 104.43, meaning that the USD exchange rate is 4.43% higher than the basket of currencies. And vice versa, if the DXY index has a value of 95.57, it means the USD exchange rate is 4.43% lower than the basket of currencies.

DXY index February 6, 2024 (source: Investing.com)

The influence of the DXY index on the financial market

With its nature built on the value of the USD, the DXY index will have a direct impact on the financial market. 

Forex market

As we all know, the nature of Forex is commodities and once we mention commodities, we need prices. When it comes to prices, we need to have a common currency to trade. And no other currency has the strength and stable price anchor like the USD. At this time, the DXY index will directly affect the increase or decrease in exchange rates between currencies.

For example: 

• For the USD/EUR exchange rate pair , when the USD is the base currency, the EUR will tend to move in the same direction as the USD (USD increases, EUR increases; USD decreases, EUR decreases).
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• For the EUR/USD exchange rate pair , EUR is in the base currency position, the trends of the two currencies will go in opposite directions (USD increases, EUR decreases; USD decreases, EUR increases).

Gold market

Although it is a strong currency and has a stable value, due to being affected by many factors related to the economy, there will be rare cases where the USD drops in value. Therefore, it is understandable that many people choose gold for shelter. When the USD price increases, people will sell gold to get USD; conversely, when the USD price decreases, people will buy gold to preserve capital. 

Cryptocurrency market

As mentioned at the beginning of the article, the US is still the largest market in the world and therefore, the USD is currently considered a tool to measure the value of goods, currencies and stocks, etc. It is not too difficult to understand that the fluctuations of DXY directly affect the rise and fall of the financial market in general.

To clarify the influence of the DXY index on the cryptocurrency market, we must go through a bit of concepts. As we all know, Bitcoin, the cryptocurrency with the largest market capitalization in the eyes of law enforcement, is always considered a valuable commodity instead of a currency. Therefore, the correlation between the DXY index and cryptocurrency is negative.

To make it easier to understand, let's take a look at the scenario below:

In a perfect market, the DXY index is not affected by economic or monetary factors but increases and decreases randomly according to market factors. Mainly this increase or decrease will depend largely on the decisions ofUS Federal Reserve (Fed). Among them, the decision to increase interest rates will directly affect the DXY index. The FED's purpose of raising interest rates is to reduce the supply of the USD, thereby causing the USD to increase in value compared to the other 6 currencies. 

Then, because the DXY index increases, it will directly decrease the price of goods including Bitcoin because USD is used in currency reserves. In addition, for speculators, the appreciation of the USD will cause them to withdraw money from risky assets and focus on the USD for profit or shelter.

summary

Above is information about the DXY index and its impacts on the financial market. Hopefully through the article, readers will be able to read and understand this important index. Besides, there are applications of DXY in the investment process so that traders do not go against the market waves.