Significance and Role of Dollar Index

By : Sohil Jain

WHAT IS DOLLAR INDEX :IT IS A MEASURE OF THE VALUE OF THE US DOLLAR RELATIVE TO A BASKET OF CURRENCIES OF THE COUNTRY'S MOST SIGNIFICANT TRADING PARTNERS. THE INDEX CONTAINS SIX COMPONENT CURRENCIES -THE EURO, JAPANESE YEN, CANADIAN DOLLAR, SWEDISH KRONA, SWISS FRANC AND THE BRITISH POUND. 

THE EURO HAS THE HIGHEST WEIGHTAGE VERSUS THE DOLLAR IN THE INDEX AT 57.6% FOLLOWED BY THE YEN (13.6%) AND THE POUND (11.9%). THE INDEX WAS ORIGINALLY MEASURED AGAINST A BASKET OF 10 CURRENCIES BUT IN 1999, THE EURO REPLACED OTHER EUROPEAN CURRENCIES THAT WERE INCLUDED PREVIOUSLY , INCLUDING THE FRENCH FRANC, DEUTSCHE MARK, BELGIUM FRANC AND THE ITALIAN LIRA. THE INTERNATIONAL CONTINENTAL EXCHANGE FUTURES COMPILES AND MAINTAINS THE INDEX. 

HOW TO UNDERSTAND THE DOLLOR INDEX MOVEMENTS : • THE INDEX STARTED IN 1973 WITH A BASE OF 100. IT MEASURES THE DOLLAR'S VALUE

RELATIVE TO THE BASE LEVEL. FOR EXAMPLE, IF THE DOLLAR INDEX IS AT 93, IT MEANS THAT THE DOLLAR HAS FALLEN 7% SINCE THE START OF THE INDEX. 

LIKEWISE, IF IT IS AT 110, IT MEANS THAT ITS VALUE HAS RISEN 10% SINCE THE START OF THE INDEX. THE INDEX HAD HIT ITS HIGHEST LEVEL EVER OF 164.7 IN MARCH 1985 AND THE LOWEST LEVEL OF 70.69 IN MARCH 2008,

STRENGTHENING OF DOLLAR INDEX WEAKENING OF DOLLAR INDEX

THE ICE U.S. DOLLAR INDEX IS CALCULATED IN REAL TIME APPROXIMATELY EVERY 15 SECONDS FROM A MULTI-CONTRIBUTOR FEED OF THE SPOT PRICES OF THE INDEX’S COMPONENT CURRENCIES

THE SIZE OF THE U.S. DOLLAR INDEX FUTURES CONTRACT IS $1,000 TIMES THE INDEX VALUE—E.G., WITH THE INDEX AT 97.450, THE VALUE OF THE CONTRACT IS $97,450. EACH FULL INDEX POINT IS WORTH $1000 (1.000=$1000). THE SMALLEST PRICE INCREMENT FOR TRADING IN THE U.S. DOLLAR INDEX FUTURES CONTRACT IS .005, WHICH IS WORTH $5 AND AVAILABLE ON QUATERLY CYCLE .

THE U.S. DOLLAR INDEX FUTURES CONTRACT DERIVES ITS LIQUIDITY DIRECTLY FROM THE SPOT CURRENCY MARKET, ESTIMATED TO HAVE TURNOVER OF OVER $2 TRILLION DAILY .

UNLIKE MANY INDEX FUTURES CONTRACTS, THE U.S. DOLLAR INDEX FUTURES CONTRACT IS A PHYSICALLY DELIVERED CONTRACT. THE CONTRACT SETTLES BY PHYSICAL DELIVERY OF THE INDEX’S SIX COMPONENT CURRENCIES IN THE PERCENTAGES INDICATED IN THE COMPOSITION OF THE INDEX (SEE ABOVE, PERCENTAGES AND WEIGHTS OF COMPONENT CURRENCIES).

IMPACT OF DOLLAR INDEXCURRENCY MARKET :• THE IMPACT OF DOLLAR INDEX ON CURRENCY MARKET IS QUITE OBVIOUS. WHEN THE

DOLLAR INDEX RISES, OTHER CURRENCIES INCLUDING THE INR FALLS RELATIVE TO THE USD. ON THE OTHER HAND, WHEN THE DOLLAR INDEX FALLS THE INR APPRECIATES WITH RESPECT TO THE US

• COMMODITY MARKET :• COMMODITY PRICES ARE USUALLY INVERSELY RELATED TO THE DOLLAR INDEX.

THEREFORE, WHEN THE DOLLAR INDEX RISES, PRICES OF COMMODITIES LIKE CRUDE, METALS ETC FALLS AND VICE VERSA. GOLD HAS A STRONG INVERSE RELATIONSHIP WITH DOLLAR INDEX. IN THE LAST 3 YEARS, DOLLAR INDEX HAS RISEN BY AROUND 20%, WHILE GOLD HAS FALLEN BY AROUND 20%.

BOND MARKET :• DOLLAR INDEX ALSO HAS AN IMPACT ON INDIAN BOND MARKETS, THOUGH

THE IMPACT IS NOT AS STRONG AS THAT ON CURRENCY AND COMMODITY MARKETS. WHEN DOLLAR INDEX FALLS, FOREIGN INSTITUTIONAL INVESTORS (FIIS) INVEST MORE IN BONDS, CAUSING BOND YIELDS TO FALL AND BOND PRICES TO RISE. ON THE OTHER HAND IF THE DOLLAR INDEX RISES, FIIS MAY SELL BONDS CAUSING BOND YIELDS TO RISE AND BOND PRICES TO FALL. DOLLAR INDEX HAS AN INDIRECT IMPACT ON BOND MARKETS. WHEN DOLLAR APPRECIATES VERSUS THE RUPEE, IMPORTS BECOME MORE EXPENSIVE CAUSING CURRENT ACCOUNT DEFICIT TO INCREASE. INCREASE IN THE CURRENT ACCOUNT DEFICIT CAUSES BOND YIELDS TO RISE AND BOND PRICES (ESPECIALLY LONG MATURITY BONDS) TO FALLS. FALL IN DOLLAR INDEX HAS THE OPPOSITE EFFECT ON CURRENT ACCOUNT DEFICIT AND BOND PRICES. THE IMPACT OF DOLLAR INDEX ON DEBT MUTUAL FUND RETURNS IS EXACTLY THE SAME AS THE IMPACT ON BOND MARKET

OUR OBSERVATION :

• EMERGING MARKET ASSETS HAVE TUMBLED RECENTLY, BOTH BECAUSE OF THE RISE IN THE DOLLAR INDEX AND THE US TREASURY YIELDS. A RISE IN THE DOLLAR HURTS THE ABILITY OF EMERGING MARKET COMPANIES TO SERVICE THEIR DOLLAR DENOMINATED DEBT. 

IT HAS LED TO OUTFLOWS FROM EMERGING MARKETS AS HIGHER RATES IN THE US WOULD BOOST THE CURRENCY BY MAKING DOLLAR ASSETS MORE ATTRACTIVE. FROM NOVEMBER 8 CLOSING, THE MSCI EMERGING MARKETS INDEX HAS LOST MORE THAN 5%, WHILE THE SENSEX HAS LOST 6% AND SEEN OUTFLOWS IN EXCESS OF RS 12,000 CRORE. DERIVATIVE ANALYSTS SEE THE DOLLAR INDEX RISING FURTHER IN THE NEAR TERM TO UP TO 105-108 LEVELS, INDICATING THAT SENTIMENT IN EMERGING MARKETS IS LIKELY TO REMAIN ON EDGE. 

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