Explainer: The rising dollar index and what it means for other asset classes

The dollar index continues to rise as it outperforms other currencies. The index is already trading at multi-month highs after breaking through previous resistance levels. It has surged to over 96, its highest level since June 2020, crossing the previous technical barrier of 94.50. While bulls expect the two-week rally to continue towards 98, the next barrier of 96.50 threatens to erode all gains made.

The reinstatement of Jeremy Powell as the Chairman of the Federal Reserve and rising inflation are some of the reasons behind the new surge. Further, the steady stance on interest rates of many major central banks has driven down other major currencies.

But as market analysts and traders keep an eye on the index, what exactly is the dollar index and what does it mean for everyday investors?

Established in 1973, the US dollar index is used to measure the value of the US currency against the euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona.

The euro is almost 57.6 percent of the basket followed by the yen at 13.6 percent. The pound has 11.9 percent weightage, Canadian dollar 9.1 percent, Swedish krona 4.2 percent and Swiss franc has 3.6 percent weightage.

As the recovery of the global economy still remains in flux over concerns of unchecked inflation, the US dollar has emerged as a safe and reliable bet for investors to park their money. The greenback has also surged on the back of expectations of a more hawkish stance of the Federal Reserve, that may soon raise interest rates. Rising interest rates increase the value of dollar-related assets like treasury bonds, and yield bonds.

Banks like HSBC, Citibank and JPMorgan Chase have already forecast further gains for the US dollar.

When the value of the dollar rises, the value of all underlying assets related to the dollar also rises. These include the stocks of American companies, treasury bonds, US government bonds, currency bonds and others.

Additionally, for non-US economies, the companies that export goods to the US also see a rise in their valuation. This is because as these companies earn in dollars, they are able to exchange it for larger amounts of their local currencies. For instance, IT and pharma companies from India benefit from a stronger dollar

For corporations that either import goods or raw materials from the US, the reverse is true. Since they have to spend more to get the same amount of material, their valuations fall.

Since the price of crude oil is also fixed against the dollar, a stronger dollar also means an increase in the cost of oil. For oil importers and Indian refineries, this means a higher bill when the dollar is stronger.

A stronger dollar also means that there is less interest from foreign institutional investors (FIIs) to invest in emerging markets as their returns become diluted due to the dollar’s dominance.