Wednesday, October 10, 2007

Understanding the US Dollar Index (USDX) !

The USDX recently broke down below its critical long term support of 80.

What is the US. Dollar Index?

According to Investopedia it is 'A measure of the value of the U.S. dollar relative to majority of its most significant trading partners. This index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies.'

''The US Dollar Index (USDX®) is a geometrically-averaged calculation of six currencies weighted against the US dollar. The US Dollar Index has been in existence since 1973.The 1971 Smithsonian Agreement ended the fixed exchange rates that had been set at Bretton Woods in 1944, and the US Federal Reserve Bank began the calculation of the US Dollar Index to provide an external bilateral trade-weighted average of the US dollar as it freely floated against global currencies.''

What then are the implications of a sub 80 level on the USDX ?

Over the long term, a falling USDX is very negative for all investors in USD denominated assets.

In order to attract investors to a falling currency, interest rates would have to rise, causing USD Bonds to fall in value.

Rising interest rates would negatively impact the equity markets as also the mortgage and housing market. Given the current debt levels in the US economy, default rates would rise.

Historically the worlds central banks have always supported the US Dollar at the level of 80, to prevent shapr appreciation of local currencies the USD. Central banks also hold huge USD reserves( U.S government debt), so they would be worried by a falling USD.

The last time the USDX neared 80, in December of 2004; Gold was in the range of $ 450.

Gold is now $ 740.

Does this mark a permanent shift in the USDX index?

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