The US dollar is the world's reserve currency, and its movements ripple through every corner of global financial markets. Whether you trade stocks, commodities, or bonds, understanding how the dollar impacts your markets is essential. In this guide, we will explore the dollar's influence and how to incorporate it into your trading analysis.
Understanding the Dollar Index (DXY)
The Dollar Index (DXY) measures the US dollar's value against a basket of six major currencies: the Euro (57.6%), Japanese Yen (13.6%), British Pound (11.9%), Canadian Dollar (9.1%), Swedish Krona (4.2%), and Swiss Franc (3.6%).
Key insight: Because the Euro makes up nearly 58% of the index, DXY is heavily influenced by EUR/USD movements. A rising DXY means the dollar is strengthening against these currencies; a falling DXY means it is weakening.
How the Dollar Affects Different Markets
1. Commodities
Most commodities are priced in US dollars globally. When the dollar strengthens, commodities become more expensive for buyers using other currencies, which tends to reduce demand and push prices lower.
Example: Dollar-Gold Relationship
The dollar and gold typically have a strong inverse correlation:
- Dollar rises 2% over a week
- Gold often falls 1-3% in the same period
- Dollar weakness typically supports gold prices
This inverse relationship makes the dollar a key indicator for commodity traders.
Key dollar-commodity relationships:
- Gold: Strong inverse correlation with the dollar
- Oil: Generally inverse, but supply factors can override
- Copper: Inverse correlation, sensitive to global growth
- Agricultural commodities: Inverse correlation, affects export demand
2. US Stocks
The dollar's impact on stocks is more nuanced and depends on the type of company:
- Multinationals: Strong dollar hurts. Foreign revenue is worth less when converted back to dollars, and US exports become less competitive
- Domestic companies: Less affected or may benefit from cheaper imports
- Importers: Benefit from a strong dollar as their costs decrease
Example: Multinational Earnings Impact
A US tech company earns 50% of revenue in Europe:
- EUR/USD falls from 1.10 to 1.00 (dollar strengthens 10%)
- European revenue of 1 billion euros now converts to $1B instead of $1.1B
- Company reports $100 million currency headwind on earnings call
3. Emerging Markets
A strong dollar creates significant pressure on emerging markets:
- Many EM countries have dollar-denominated debt, which becomes harder to service
- Capital flows out of EM seeking higher US yields
- EM currencies weaken, potentially causing inflation
- EM stocks often underperform during dollar strength
Trading insight: When the dollar is strengthening, consider reducing emerging market exposure. When the dollar weakens, EM often outperforms developed markets.
4. US Bonds
The dollar and US Treasury yields are connected through interest rate differentials. Higher US rates relative to other countries attract foreign capital, which must be converted to dollars first, strengthening the currency.
What Drives Dollar Strength?
Interest Rate Differentials
The primary driver of currency values over time is interest rate differentials. If US rates are higher than other countries, capital flows to the US seeking yield, boosting the dollar.
Safe Haven Flows
During global crises, investors often flee to the dollar as a safe haven, regardless of interest rates. This flight to safety can cause the dollar to spike during market turmoil.
Economic Growth Expectations
Stronger US economic growth relative to other countries tends to support the dollar, as it suggests future rate increases and attracts investment.
Trade Balances
Large trade deficits (like the US runs) create selling pressure on a currency, but other factors often dominate in the short to medium term.
Practical Trading Applications
1. Dollar as a Risk Indicator
A rapidly strengthening dollar often signals risk-off conditions in global markets. If DXY is spiking higher, be cautious with risk assets like stocks and high-yield bonds.
2. Sector Selection
Adjust your sector exposure based on dollar trends:
- Strong dollar: Favor domestic-focused retailers, healthcare, utilities
- Weak dollar: Favor multinationals, exporters, materials, industrials
3. Commodity Trade Confirmation
Before entering commodity trades, check the dollar's trend. Trading against a strong dollar trend in gold or oil is fighting the tide.
Example: Dollar Confirmation
You see a bullish setup in oil. Before entering:
- Check DXY - is it trending down or at least stable?
- If DXY is breaking out higher, the oil trade has a headwind
- If DXY is weakening, the setup has tailwinds
4. Earnings Season Awareness
During earnings season, pay attention to currency impacts. Many large-cap companies will cite dollar strength or weakness as a factor in their results. This can create tradeable moves in affected sectors.
Monitoring the Dollar
Key symbols and ETFs to watch:
- DXY: Dollar Index futures
- UUP: Bullish Dollar ETF
- UDN: Bearish Dollar ETF
- EUR/USD: Primary component of DXY
- USD/JPY: Important for risk sentiment
Track Dollar Impact on Your Trades
Pro Trader Dashboard helps you monitor how currency movements affect your portfolio and identify opportunities across different market conditions.
Summary
The US dollar's influence extends far beyond the currency market. Its movements affect commodities, stocks, bonds, and emerging markets in predictable ways. A strong dollar typically pressures commodities and multinational earnings while supporting imports and domestic-focused companies. By incorporating dollar analysis into your trading, you gain additional context for your trade ideas and can better anticipate market moves. Make DXY a regular part of your market analysis routine.
Continue learning about market relationships in our guides on commodity and stock correlations and intermarket analysis.