Monday, June 04, 2007

Which dollar index?

The Bear Mountain Bull tips us to a rather interesting Minyanville article that outlines the differences between the much-watched US Dollar Index and the Fed's trade-weighted dollar index.

Why does it matter which index you use? Because every picture tells a story (don't it), and these pictures each tell a different tale about the present and future course of the US dollar.

As Minyanville's Lance Lewis tells it, the US Dollar Index is heavily weighted towards the euro (the European currency accounts for 57% of the index weighting), and this construction distorts our view of how the US currency is trading against the currencies of its major trading partners.

While the US Dollar Index continues to defend its long-held support above the 78-80 area, the trade-weighted index shows another picture, one of a potential breakdown through very long-term support. In fact, a breakdown through the 200 month moving average did occur shortly after the article was published.

Why is the movement in the trade-weighted index so important to understand? Read Lewis' article to find out more about the movement of the dollar and its effect on inflation and the gold price.

For more news on the market's view of the various currency indexes, see these recent Bloomberg stories(1,2,3). Just to differentiate, I believe the index that Lewis has charted in his article is the Federal Reserve's "Nominal Broad Dollar Index", while those in the Bloomberg articles may refer to some of the Fed's other trade weighted indexes.