Is the US Dollar Index the right barometer to measure USD strength.

Contrary to most expectations the US Dollar Index has started to appreciate from the beginning of the current year and after moving down in the initial part of the current month has appreciated sharply.

In general most people tend to track this index and form views on the direction of currencies other than those comprising the index. For this it is important to see the composition of the index and then form a view whether emerging market currencies can be formed using this index. I frankly do not think so and I believe that going forward the USD Index might continue to move up (though not sharply), however its movement against faster growing emerging economies currencies will be one of depreciation. The composition of the USD Index is as follows

Euro 57.6%

Japanese Yen 13.6%

Pound 11.9%

Swiss Franc 3.6%

Swedish Kroner 4.2%

Canadian Dollar 9.1%

Out of the above mentioned countries/groupings most of the countries have issues going for them. The Japanese Economy continues to be in doldrums, UK is in a bad state, Sweden is going nowhere, and Switzerland has its own issues related to its banks and increased scrutiny of assets held in those banks. The Euro zone despite having a number of strong economies unfortunately has to bear the repercussions of having countries like Spain, Greece, Ireland etc in the grouping and creating issues for that currency. The Euro is likely to take the hit for having countries with totally different economies within a group, which worked well in good times but is likely to be a problem in bad times.

Moreover given the fact that the Chinese Yuan is effectively pegged to the US Dollar and not allowed to appreciate the way it should the USD has also become a proxy for China. Unless China lets go of its currency the probability of USD depreciation remains low. Under the circumstances tracking the US Dollar Index to measure US Dollar strength might not be the right thing to do as this index in all probability keep on appreciating (at least in the near term), however the USD might not appreciate against the currencies of fast growing emerging economies like India, Brazil etc.

However, as I wrote in a previous article the expectations that risky assets will take a beating as the US Dollar Index moves up might not actually come through due to improving economic outlook and the fact that historically there has been no such correlation.

Technically it looks like the US Dollar index should be moving to the 80 levels over the next few days.