USD Index strength in times of market uncertainty

on May 24, 2012 in Currency, Home | 2,190 comments

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The US Dollar Index (USDX) is a measure of the value of the USD relative to a basket of foreign currencies.

Currently, this index is calculated by factoring in the exchange rates of the following currencies: EUR, JPY, CAD, GBP, SEK, and CHF. The current index value of 82 relative to the base of 100 set in the 70s, would suggest that the USD experienced an 18% decreased in value over the time period against the basket.

The USD is indeed facing sign of dissatisfaction as a reserve currency, amid concerns over the US government’s inability to rein in spending and the Federal Reserve’s huge expansion of its balance sheet.

Especially in periods of market confidence, this process is reinforced and investors want to pursue more aggressive investment strategies. Investors will often short USD and move into riskier currencies, such as the AUD, in the hope of steady appreciation. Thus, in risk on periods, the USD usually declines in value relative to commodities related currencies such as the AUD or CAD.

However, in risk off periods, the USD status as a safe haven currency gains momentum, as investors avoid exposure to risky currencies and assets.

Even though there is great concern around the trajectory of the USD, the USD index has risen to a 4-month high as US data stabilizes and Euro zone concerns broaden. Besides, other safe haven currencies such as JPY and CHF, which also attract investors’ attention in risk off environment, are currently out of favor. Due to the Bank of Japan and Swiss National Bank resisting own currency appreciation, the USD may maintain a safe haven status…forever? I will therefore be long USD and short AUD, CAD and especially EUR at least for the coming 6 months.