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Managing U.S. dollar risk in uncertain times


March 2023

Dwijen Gandhi
Senior Director, Equity Index Research and Development
Intercontinental Exchange

It’s the leading currency benchmark grabbing headlines as global markets are rocked by volatility: the ICE U.S. Dollar Index (DXY). It’s an index that’s evolved from being purely of institutional interest to a commonplace market indicator, reflecting growing investor participation in broader currency markets. And with recent geopolitical and market events, products benchmarked to the index allow investors and issuers to express a view on the direction of the U.S. dollar’s value against major currencies of selected global trading partners.

The ICE U.S. Dollar Index is a geometrically-averaged calculation of six currencies that are trade-weighted against the U.S. dollar. The components and their weightings are: the euro (57.6%) yen (13.6%), pound (11.9%), Canadian dollar (9.1%), Swedish krona (4.2%) and Swiss franc (3.6%). The index reached an all-time closing high of 164.72 in February 1985 amid a combination of tight monetary policy and expansionary fiscal policy, and an all-time closing low of 71.33 in March 2008 during the global financial crisis.

More recently, the past year has seen a surge of interest in trading derivatives on the DXY, as major currencies hit multi-year lows against the greenback. In the U.K., the prospect of unfunded tax cuts saw the pound hit an all-time low in autumn of 2022 before retracing part of its move. Uncertainty around Europe’s energy prices and supplies amid the war on Ukraine also drove the euro to an almost two-decade low against the dollar. And the Bank of Japan’s continuing dovish stance saw the yen plunge, causing the government to intervene in markets for the first time since the late 1990s. This contrasted with the one of the most aggressive interest rate tightening regimes in U.S. Federal Reserve history.

All these factors fueled a 20-year closing high in the DXY of 114.24 on September 27, 20221. Since then, a change in these dynamics has seen the DXY retrace almost 10%2. A mild European winter has soothed concerns around energy access and boosted the euro. China’s move to end its zero-COVID policy has supported more optimistic macro sentiment globally, leading to further declines in the dollar. And as we move into the new U.S. congressional term, lingering concern over a potential breach of the debt ceiling later in 2023 has depressed the greenback.

Market participants who wish to express a view on the direction of the greenback can gain exposure to the index through the U.S. Dollar Index (USDX) complex at ICE Futures U.S. and ICE Futures Singapore. The complex includes futures and options which allow index exposure to be gained in a single transaction. These derivatives are available for trading at ICE Futures U.S., with a cash-settled mini futures contract from ICE Futures Singapore offering the same exposure in a smaller size and with lower fees, targeted to retail investors.

The contract is also utilized by participants who are hedging physical gold holdings. While global gold demand is influenced by central bank purchases, significant demand in the Asia-Pacific has come from individuals who prefer to hold it as a physical store of wealth. Because gold is denominated and traded in U.S. dollars, the USDX futures contract is used by some of these market participants to hedge their gold holdings against moves in the dollar.

As the world's most recognized traded currency index, ICE’s U.S. Dollar Index is cited by media outlets across the globe. The index itself and third-party indices containing USDX futures are used as a benchmark for various funds and ETFs. While these funds are listed and traded in the U.S., Asia-Pacific investors can express a view on the greenback with ICE’s Mini US Dollar Index® Futures, which offer various cost efficiencies. And as uncertainty continues to stalk global markets, the ability to take a position on the direction of the greenback - and hedge risk exposure - presents opportunity to a growing range of investors.

1. The 114.24 level reached on September 27, 2022 is the highest close since the 115.09 level on May 14, 2022.
2. A -9.24% return between September 27, 2022 and March 13, 2023.