This week the USDX touched 107 level while it was around 88 about a year ago, and now we hear analysts talking about the strong dollar’s effect on the world economy. However, as I become older, I like to do my own research thoroughly and break down complex notions to reduce the risk of misunderstanding.
USDX (DXY) is a basket of currencies measured against USD comprised of six currencies namely EUR, JPY, GBP, CAD, SEK (that is right!), and CHF. If you already idealizing the index, don’t. In this basket EUR is the dominant currency with 57.6%, and JPY is the second dominant with 13.6%. To put it simply, DXY measures the safety of investment in European countries (plus the offshore US factory, Japan).
Covid-19 and lockdowns pushed the DXY higher as demand for USD surged and there was a period of concern about dollar reserves shortage among all the nations around the world. This concern was responded to with a massive QE by Fed, buying UST and enabling the US treasury to send stimulus cheques to Americans. All those stimulus cheques were exported out of the US in return for goods and were given to all the nations around the world. However, when the crisis faded away, these dollars were in search of a place to be invested, which caused inflation.
With the start of the Ukraine war, investing in Europe is becoming riskier and returns on investments are evaporating as the whole continent is plunging into stagflation. The capital flew away from Europe in the form of USD to other places and push the EUR lower. To exacerbate this, ECB refuses to raise the rate because they are afraid to enforce recessionary forces while the Fed has started to do so, pushing the DXY to levels that we have never seen since 2002.
Strong USD is of benefit to the US, in particular when it is experiencing an 8.6% CPI, but it will kill the US manufacturing and exports and will create a wave of unemployment. If the Fed signal’s the ECB to raise rates and they refuse, they will have no choice but to start buying EUR, JPY, CHF, and many more CB notes to push USDX lower, and they might call this the World QE.
It is easy to misinterpret USDX if you are not aware of these ratios and market forces. A strong DXY can be misinterpreted as a sign of a lower commodity price while it is not necessarily a good predictor when you decide to omit other factors.