The Dollar Smile Theory

Ever wonder why the U.S. dollar strengthens both in times of tough luck and when the economy is booming like a Beyoncé single?

Currencies tend to fall when their country’s domestic outlook worsens, but the U.S. dollar’s unique global role makes it special so when the U.S. economy isn’t doing great, the currency may still rise.

A helpful to look at why this is the case is to pretend there are two “types” of U.S. dollars.

  1. There is a “domestic” U.S. dollar which behaves like any other currency. It’s linked to the economy’s relative outlook and potential investment returns.
  2. There is also an “international” U.S. dollar that is used as the primary currency used in global trade (for payments) and also needed to buy U.S. government bonds which are coveted for their safety.

This “international” U.S. dollar strengthens for a variety of reasons when markets are volatile and global growth slows.

When there is some sort of “shock” that happens, whether from the U.S. or abroad, and it’s big enough to cause investors and traders to panic and send financial markets lower, then it will likely cause the broad U.S. dollar to appreciate

In fact, this really smart dude who used to work at Morgan Stanley came up with a theory to explain this phenomenon.

Stephen Jen, a former economist at the International Monetary Fund and Morgan Stanley, who now runs a hedge fund and advisory firm Eurizon SLJ Capital in London, came up with a theory and named it the “Dollar Smile Theory.”

The Dollar Smile Theory Explained

His theory depicts three main scenarios directing the behavior of the U.S. dollar. Here’s a simple illustration:

The Dollar Smile Theory

Scenario #1: USD Strengthens Due to Risk Aversion

The Dollar Smile Theory: Panic

The first part of the smile shows the U.S. dollar benefiting from risk aversion, which causes investors to flee to “safe haven” currencies like the U.S. dollar and the Japanese yen.

Since investors think that the global economic situation is shaky, they are hesitant to pursue risky assets and would rather buy up  “safer” assets like U.S. government debt (“U.S. Treasuries”) regardless of the condition of the U.S. economy.

In order to buy U.S. Treasuries though, you need USD, so this increased demand for USD (to buy U.S. Treasuries) causes the U.S. dollar to strengthen.

Scenario #2: USD Weakens to New Low Due to Weak Economy

The Dollar Smile Theory: Dollar bull falling off a cliff

Dollar drops to a new low.

The bottom part of the smile reflects the lackluster performance of the Greenback as the U.S. economy grapples with weak economic fundamentals.

The possibility of interest rate cuts also weighs the U.S. dollar down. (Although if other countries are also expected to cut interest rates, then this might be less of a factor since it’s all about expectations of the future direction of  interest rest differentials.)This leads to the market shying away from the dollar. The motto for USD becomes “Sell! Sell! Sell!”

Another factor is the relative economic performance between the U.S. and other countries. The U.S. economy may not necessarily be horrible, but if its economic growth is weaker than other countries, then investors will prefer to sell their U.S. dollars and buy the currency of the country with the stronger economy.

It’s kind of like if you owned an NBA team and had Reggie Miller as your star player. All of a sudden, a healthy Michael Jordan is available. Obviously, you would trade Miller for Jordan because, on a relative basis, Jordan is the better performing player.

It’s not that Reggie Miller sucks, but there’s just a better alternative at that moment. Now if you make the trade, and all of a sudden, Michael Jordan has a season-ending injury, and Reggie Miller just so happens to be available, then you know what to do.

Dump “Air Jordan” for “Miller Time”. See, it’s all relative.

Scenario #3: USD Strengthens Due to Economic Growth

The Dollar Smile Theory: Dollar bull market

The dollar appreciates due to economic growth.

Lastly, a smile begins to form as the U.S. economy sees the light at the end of the tunnel.

As optimism picks up and signs of economic recovery appear, sentiment towards the dollar begins to pick up.

In other words, the Greenback begins to appreciate as the U.S. economy enjoys stronger GDP growth, and expectations of interest rate hikes increase (relative to other countries).

Let’s take a look at the Dollar Smile Theory in reality…

Dollar Smile 2020

As you can see, due to the global pandemic which has caused a lot of economies all over the world to suffer, the U.S. dollar is acting as a safe haven currency. All countries, including the U.S., aren’t doing so great.

But if the economies from the “rest of the world” (RoW) can improve and start to grow faster than the U.S. economy, then expect the U.S. dollar to weaken.

The key is relative economic growth. If growth from other countries is growing, but the U.S. economy is growing even faster, then the U.S. dollar will swing upward to the right side.

So will the Dollar Smile Theory hold true?

Only time will tell.

In any case, this is an important theory to keep in mind. Remember, all economies are cyclical. They strengthen, then they weaken, they strengthen, then they weaken, and repeat.

The key part is determining which part of the cycle the U.S. economy and then compare how it’s doing against the rest of the world (RoW).

Bloomberg Dollar Spot Index

The Bloomberg Dollar Spot Index (BBDXY) tracks the performance of a basket of 10 global currencies against the U.S. dollar.

Its composition is updated annually and represents a diverse set of currencies that are important from a global trade and liquidity perspective.

Bloomberg Dollar Index Chart

Since other dollar indices (ahem…DXY) do not update their composition and are comprised of only a handful of currencies with concentrated weights, Bloomberg claims their index provides a better measure of the U.S. dollar.


The BBDXY Index data starts from Dec 31, 2004, with a base level of 1000.

Each currency in the basket and its weight is determined annually based on their share of international trade and FX liquidity.

Currencies That Are Trading Partners and Liquidity

A Better Measure of the U.S. Dollar?

Let’s see how the Bloomberg Dollar Spot Index (BBDXY) differs from the widely used ICE Dollar Index (DXY).

BBDXY is more representative.

The Bloomberg Dollar Spot Index tracks a more representative basket of currencies by considering global currency market liquidity and trading partners of the U.S.

Bloomberg Dollar Spot Index Basket

BBDXY is more diversified.

Unlike DXY, the Bloomberg Dollar Spot Index is NOT dominated by the euro.

ICE US Dollar Index

It also includes major emerging market currencies such as the Indian rupee, Korean won, Mexican peso and Chinese renminbi which are all major trading partners of the U.S.

Bloomberg Dollar Spot Index

BBDXY is more dynamic.

Unlike the DXY’s static composition, BBDXY is dynamic, with an annual rebalancing process that captures the changing state of currency markets.

This results in the index that includes important currencies (like the Australian dollar) that rank higher in liquidity and trading versus the Swedish krona.

Why does USDX include Sweden? Because the index still livin’ in the past! The ICE U.S. Dollar Index measures the value of the U.S. Dollar against a basket of currencies of the top six trading partners of the United States, as measured in 1973! This included the Euro zone, Japan, the United Kingdom, Canada, Sweden, and Switzerland.

Here’s a snapshot of how the Bloomberg Dollar Index has rebalanced over the years.

Bloomberg Dollar Spot Index Rebalancing

Notice how currencies like the Singaporean dollar (SGD) and Brazilian real (BRL) used to be part of the cool club but eventually got the boot and were replaced.

BBDXY don’t play around. It likes to keep it fresh!

This is in contrast to the U.S. Dollar Index (USDX, DXY, DX) where the currencies never change. Maybe they should call themselves the “Boring Dollar Index”. 😂

Which Currencies Are Part of the Bloomberg Dollar Spot Index?

Here is the most recent composition of the Bloomberg Dollar Spot Index compared to the previous year.

2020 Bloomberg Dollar Spot Index Composition

How the Bloomberg Dollar Spot Index Determines Which Currencies to Include

The index rebalances once a year to incorporate new data from:

  • The annual survey of major trading partners versus the U.S. dollar as reported by the Federal Reserve.
  • The triennial survey of most liquid currencies as reported by the Bank of International Settlements (BIS).

Currencies pegged to the U.S. dollar are excluded and currencies heavily managed (like Chinese renminbi) have their exposure capped.

To ensure tradability, currencies with weights of less than 2% are removed.At each annual rebalance, the following steps are taken to select which currencies to include and their weights:

  1. Identify the top 20 currencies in terms of trading activity versus the underlying currency. For the U.S. dollar, this is as defined by the Federal Reserve in its Broad Index of the Foreign Exchange Value of the Dollar.
  2. Identify the top 20 currencies from the Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity. Specific information about foreign exchange turnover can be found here.
  3. Select the top 10 currencies of both lists, but exclude any pegged currencies. For example, currencies pegged to the U.S. dollar (such as the Hong Kong dollar or Saudi riyal) are removed for the Bloomberg Dollar Spot Index.
  4. Assign a preliminary weight for each currency based on its trade weight and liquidity weight. 
  5. Cap the exposure of Chinese renminbi and remove smaller currency positions, defined as any position that has a weight of less than 2%.
  6. Voila! BBDXY calculation complete!

The rebalanced target weights are applied after the close of the last U.S trading day in December every year.

Here’s a chart that visualizes the above process:

How to Computer BBDXY

How to View the Bloomberg Dollar Spot Index

For Bloomberg subscribers, you can run BDXY on the Bloomberg Terminal® to view the Bloomberg Dollar Spot Index.

But if you can’t afford to pay the  $20,000 annual fee for a Bloomberg Terminal subscription, you can access the live BBDXY quote for free on Bloomberg’s website.

On Bloomberg’s BBDXY page, you’ll see a live quote that looks like this:

Bloomberg Dollar Index Quote

You can even view a full chart by clicking near the top right corner.


You can also access the DXY quote on Bloomberg’s website as well.

Trade Weighted Dollar Index

There is also another kind of U.S. dollar index.

It was created by the Federal Reserve and is now used widely by lots of sexy people, like economists and currency analysts.

It is called the “Trade Weighted U.S. Dollar Index“.

You can find it on the Federal Reserve Economic Data (FRED) website here.

Their website is probably one of the most beautiful websites ever made…

Trade Weighted US Dollar Index

Just kidding. It’s a government website.

Beautiful? Like lipstick on a pig.

Useful? Hell yeah. 👍

The trade-weighted US dollar index, also known as the broad index, is a measure of the value of the U.S. dollar relative to other foreign currencies.

It is a trade-weighted index that tries to improve on the older AND privately-owned ICE U.S. Dollar Index (USDX) by using more currencies and updating the weights yearly.

The Fed wanted to create an index that could more accurately reflect the dollar’s value against foreign currencies based on how competitive U.S. goods are compared to goods from other countries.It was formed in 1998 in order to keep up-to-date with U.S. trade.

Trade Weighted US Dollar Index

The Trade-Weighted U.S. Dollar Index

The Federal Reserve Bank of St. Louis, provides “weighted averages of the foreign exchange value of the U.S. dollar against the currencies of a broad group of major U.S. trading partners.”

From strongest to weakest, here is the current weighting (in percentage) of the index:

United Kingdom5.306
Hong Kong1.41
Saudi Arabia0.499

*Weights as of December 16, 2019

The main difference between the USDX and the trade-weighted U.S. dollar index is the basket of currencies used and their relative weights.The trade-weighted index includes countries from all over the world, including some developing countries.

Given how global trade is developing, this index is probably a better reflection of the U.S. dollar’s value across the globe.

How to Use the USDX for Forex Trading

I bet you’re wondering, “How do I use this USDX in my trading arsenal?”

Well, hold your trigger finger and you’ll soon find out! We all know that most of the widely traded currency pairs include the U.S. dollar.

If you don’t know, some that include the U.S. dollar are EUR/USDGBP/USDUSD/CHF, USD/JPY, and USD/CAD.What does this mean? If you trade any of these pairs, the USDX can be the next best thing to sliced bread (or hamburger on a bun… or chocolate ice cream).

If you don’t, the USDX will still give you an idea of the relative strength of the U.S. dollar around the world.

In fact, when the market outlook for the U.S. dollar is unclear, more often times than not, the USDX provides a better picture.

In the wide world of forex, the USDX can be used as an indicator of the U.S. dollar’s strength.Because the USDX is comprised of more than 50% by the euro zone, EUR/USD is quite inversely related. Check it:

USDX Daily Chart

Next, take a look at a chart of EUR/USD.

EUR/USD Daily Chart

It’s like a mirror image! If one goes up, the other most likely goes down.

Will you look at that? It seems like the trend lines almost inversely match up perfectly. This could be a big help to those big on trading EUR/USD.

Some of our forex trading friends in the forums monitor the USDX as an indicator for EUR/USD. Hang out with them if you wanna learn more about using this index.

If the USDX makes significant movements, you can almost surely expect currency traders to react to the movement accordingly.

Both the USDX and forex traders react to each other. Breakouts in spot USD pairs will almost certainly move the USDX in a similar breakout fashion.

To sum it all up, forex traders use the USDX as a key indicator for the direction of the USD.Always keep in mind the position of the USD in the pair you are trading.

For example, if the USDX is strengthening and rising, and you are trading EUR/USD, a strong USD will show a downtrend on the EUR/USD chart.

If you are trading a pair in which the USD is the based currency, such as the USD/CHF, a rise in the USDX will most likely show a rise in USD/CHF charts like the one shown below.

Forex Trading USDX
USD/CHF Daily Chart vs. USDX

Here are two little tips you should always remember:

  1. If USD is the base currency (USD/XXX), then the USDX and the currency pair should move the same direction.
  2. If USD is the quote currency (XXX/USD), then the USDX and the currency pair should move in opposite directions.

How to Read the US Dollar Index

Just like any currency pair, the US Dollar Index (USDX) even has its own chart.

Holler at the U.S. Dollar Index:

US Dollar Index (USDX) Chart

First, notice that the index is calculated 24 hours a day, five days a week.

Also, the US Dollar Index (USDX) measures the dollar’s general value relative to a base of 100.000. Huh?!?

Okay. For example, the current reading says 86.212.

This means that the dollar has fallen 13.79% since the start of the index. (86.212 – 100.000).

If the reading was 120.650, it means the dollar’s value has risen 20.65% since the start of the index. (120.650 – 100.00)

The start of the US Dollar Index is March 1973. This is when the world’s biggest nations met in Washington D.C. and all agreed to allow their currencies to float freely against each.

The start of the index is also known as the “base period“.

The U.S. Dollar Index Formula

This is strictly for the grown and geeky. Here is the formula for calculating USDX:

USDX = 50.14348112 × EUR/USD^(-0.576) × USD/JPY^(0.136) × GBP/USD^(-0.119) × USD/CAD^(0.091) × USD/SEK^(0.042) × USD/CHF^(0.036)

Got that? Good! Now you can get a wedgie from the school bully.

We’re kidding!

What is the US Dollar Index (USDX)?

If you’ve traded stocks, you’re probably familiar with all the indices available such as the Dow Jones Industrial Average (DJIA), NASDAQ Composite Index, Russell 2000, S&P 500, Wilshire 5000, and the Nimbus 2001.

Oh wait, that last one is actually Harry Potter’s broomstick.Well if U.S. stocks have an index, the U.S. dollar can’t be outdone.

For currency traders, we have the U.S. Dollar Index (USDX).

And to be technically correct, the ICE U.S. Dollar Index. 

The U.S. Dollar Index consists of a geometric weighted average of a basket of foreign currencies against the dollar.

Say whutttt!?!

Okay before you fall asleep after that super geeky definition, let’s break it down.

It’s very similar to how the stock indices work in that it provides a general indication of the value of a basket of securities.Of course, the “securities” we’re talking about here are other major world currencies.

The US Dollar Index Currency Basket

The U.S. Dollar Index consists of SIX foreign currencies. They are the:

  1. Euro (EUR)
  2. Japanese Yen (JPY)
  3. British Pound (GBP)
  4. Canadian dollar (CAD)
  5. Swedish Krona (SEK)
  6. Swiss Franc (CHF)

Here’s a trick question. If the index is made up of 6 currencies, how many countries are included?

If you answered “6”, you’re wrong.

If you answered “24”, you’re a genius!

The euro is the official currency of 19 of the 27 member states of the European Union.

Add the other five countries (Japan, Great Britain, Canada, Sweden, and Switzerland) and their accompanying currencies.

And you get 24!

It’s obvious that 24 countries make up a small portion of the world but many other currencies follow the U.S. Dollar index very closely.

This makes the USDX a pretty good tool for measuring the U.S. dollar’s global strength.

USDX can be traded as a futures contract (DX) on the Intercontinental Exchange (ICE).

It is also available in exchange-traded funds (ETFs), contracts for difference (CFDs) and options.

ICE U.S. Dollar Index®

From a legal perspective, the designations “U.S. Dollar Index,” “Dollar Index” and “USDX” are trademarks and service marks of ICE Futures U.S., Inc.

The U.S. Dollar Index is the exclusive property of ICE, also known as Intercontinental Exchange Group.

ICE U.S. Dollar Index

Intercontinental Exchange Group (ICE) is a global exchange, clearing, financial data, and technology company, operating multiple markets and services across nine different asset classes.

ICE operates 13 regulated exchanges, including ICE futures and OTC exchanges in the US, Canada, Europe, and Singapore. It also is the parent company of the well-known New York Stock Exchange.

Today, the company is among the largest exchange groups in the world.

So if you see “ICE U.S. Dollar Index®“, now you know why. It’s privately owned and trademarked.

Since the inception of futures trading on the U.S. Dollar Index in 1985, ICE compiles, maintains, determines and weights the components of the U.S. Dollar Index.

The U.S. Dollar Index can be traded as a futures contract for 21 hours a day on the ICE platform. The U.S. Dollar Index futures contract derives its liquidity directly from the spot currency market, estimated to have a turnover of over $2 trillion daily.

Futures contracts based on the U.S. Dollar Index were listed on November 20, 1985. Options on the futures contracts began trading on September 3, 1986. U.S. Dollar Index futures and options on futures are available exclusively on the ICE electronic trading platform.

The ICE U.S. Dollar Index futures contract is the only publicly-available, regulated market for U.S. Dollar Index trading allowing virtually round-the-clock access to futures traders around the world.

This is why the ICE U.S. Dollar Index (USDX) futures contract is considered the leading benchmark for the international value of the U.S. dollar and the world’s most widely-recognized traded currency index.

USDX vs. DX vs. DXY

If you’ve Googled “U.S. Dollar Index”, you might’ve seen three acronyms associated with the phrase: USDXDX, and DXY and wondered, “What the heck is the difference between them?!”

What is USDX?

USDX is the umbrella term for the U.S. Dollar Index. You can’t go wrong using this term if you’re talking about the original dollar index.

What is DX?

The ICE Exchange symbol for the futures contract is DX, followed by the month and year code.

The ICE Exchange symbol for the value of the underlying Dollar Index (sometimes called the cash or spot index) is also DX (without a month or year code), although different data providers may use different symbols.

What is DXY?

DXY is a popular ticker or symbol used by Bloomberg Terminal users so that index is sometimes referred to as the “Dixie.”

DXY is more commonly used when referring to the dollar cash or spot rate, while DX is geared more for futures traders. Although as mentioned, DX can also refer to the spot rate as well. Confusing right? 🤯

US Dollar Index (USDX) Components

Now that we know what the basket of currencies is composed of, let’s get back to that “geometric weighted average” part.

Because not every country is the same size, it’s only fair that each is given appropriate weights when calculating the U.S. dollar index.

Check out the current weights:


With its 19 countries, euros make up a big chunk of the U.S. Dollar Index.

The next highest is the Japanese yen, which would make sense since Japan has one of the biggest economies in the world.

The other four make up less than 30 percent of the USDX.Here’s a question…

When the euro falls, which way does the U.S. Dollar Index move?

The euro makes up such a huge portion of the U.S. Dollar Index, we might as well call this index the “Anti-Euro Index“.

FUN FACT: Before the creation of the euro, the original USDX contained ten currencies: the ones that are currently included (except the euro), plus the West German mark, the French franc, the Italian lira, the Dutch guilder, and the Belgium franc. The euro replaced the last five of these currencies.

Because the USDX is so heavily influenced by the euro, traders have looked for a more “balanced” dollar index.

We will cover two other U.S. dollar indexes later:

  1. Trade Weighted Dollar Index
  2. Bloomberg Dollar Spot Index

As a currency trader, you should be familiar with ALL three of them.

Is the ICE U.S. Dollar Index adjusted or rebalanced?

There are no regularly scheduled adjustments or rebalancings of the ICE U.S. Dollar Index.

The Index was adjusted once when the euro was introduced as the common currency for the European Union (EU) bloc of countries.

ICE, specifically, ICE Futures U.S., monitors the index methodology to ensure that it properly reflects the covered currencies and the FX market in general and makes adjustments as and when necessary (which is like…never).

How is the U.S. Dollar Index calculated?

The ICE U.S. Dollar Index is calculated in real-time approximately every 15 seconds. This real-time calculation is redistributed to all data vendors.

The prices of the DX futures contracts are set by the market, and reflect interest rate differentials between the respective currencies and the U.S. dollar.

Where can I get real-time prices for the ICE U.S. Dollar Index?

The real-time prices for the underlying cash U.S. Dollar Index and for futures contracts based on the U.S. Dollar Index are available from market data vendors and on WebICE (an Internet-based subscription service that provides real-time access to trading activity on the ICE trading platform).

Basically, since ICE controls the price data, and they charge a fee for the data feed, access to a real-time fee does not come FREE!

Delayed prices for the cash U.S. Dollar Index can be found on websites such as Bloomberg, MarketWatch, CNBC, WSJ, and Yahoo! Finance.

Delayed prices for ICE U.S. Dollar Index futures are available on the ICE website.

US Dollar Index Futures Data