A Rising Dollar Index: Why Treasury Yields and the Renminbi Can Move the Other Way

The Dollar Index measures the dollar against a basket of just six currencies: the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. The euro has a weight of 57.6%, the yen 13.6% and the pound 11.9%. Under ICE's formula, a 1% move in the euro against the dollar corresponds to an approximately 0.58% move in the index in the opposite direction. The euro and yen therefore have a strong influence on the index, but its performance cannot be equated with the dollar's strength across the world.

Which currencies have been falling in recent weeks?

The euro has fallen to around $1.12. On October 5, it touched an intraday low of $1.1160, its lowest level in nearly a year. With the euro accounting for more than half the basket, a weaker euro can push DXY higher without any change in US fundamentals.

The sequence of moves in the yen is worth a closer look. The yen was at its strongest against the dollar on September 9, when the exchange rate was ¥153.50 per dollar, before the Bank of Japan raised rates. On September 18, the day of the rate increase, the rate was ¥156.87; by September 24, it had reached ¥158.92. The rate increase did not preserve the yen's earlier strength.

One major currency has not followed

Over the same period, the dollar has fallen back to between 6.69 and 6.70 yuan per dollar, putting the Chinese currency at its strongest since July 2022, with an appreciation of about 4.1% this year. A rising Dollar Index and a stronger renminbi may appear contradictory. The reason they can coexist is that the renminbi is not in the basket: its movements are not included in the index.

How should we read the Dollar Index?

A rising Dollar Index can have two types of driver. First, the dollar itself may strengthen as US fundamentals make American assets more attractive and draw in capital. Treasury yields rise alongside it, and the move tends to be more durable. Second, currencies in the basket may weaken because of changes in their own fundamentals or policies. In that case, the dollar's rise reflects relative exchange-rate movements more than an increase in the appeal of US assets.

One yardstick is to ask whether the US 10-year Treasury yield is rising alongside the Dollar Index. When yields rise, the move is more often driven by strength originating in the dollar itself. When yields fall, weakness in other currencies is pushing the index higher.

The Dollar Index is an observation, not a final conclusion. When the dollar appears to be strengthening, it is worth asking one more question: is the dollar itself appreciating, or are the currencies in its basket falling?