It’s not about U.S. dollar strength, rather Euro dollar weakness

Over this last month the U.S. dollar has been on an absolute tear, moving higher and gaining value. Consider this; on September 1^st, the dollar index hit an intraday low of 91.70, today the dollar index closed up today by +0.45 %, and is fixed at 94.455. That means that the dollar has gained roughly 2.755% in value in less than a single month. But to look deeper into recent moves in the dollar index you need to have a better understanding of the basket of currencies that the dollar index is trading against.

According to Investopedia, “The U.S. dollar index (USDX) is a measure of the value of the U.S. dollar relative to the value of a basket of currencies of the majority of the U.S.'s most significant trading partners. This index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies.”

This basket does not give equal weight to each currency. The basket of currencies comprises of six currencies that compose the counterpart to the dollar index; Euro dollar, Swiss franc (3.6 %), Japanese Yen (13.6 %), Canadian dollar (9.1 %), British pound (11.9%) and the Swedish Krona (4.2%).  By far the largest -weighted currency which trades against the dollar index is the Euro dollar. That single currency comprises 57.6% of the basket.

With this in mind it is quite obvious that moves in the Euro dollar will have a large impact on the dollar index. On September 1^st, the euro traded to a high that was just over $1.20 to each €1.00. Today the euro is trading at $1.1610 for each €1.00. That sharp decline in the euro is one major component to recent gains in the dollar index.

Currently Europe is experiencing a second wave of the COVID-19 pandemic. Similar to what the United States is experiencing, in Europe COVID-19 cases are spiking dramatically.

According to an article published today by TIME magazine, and penned by Melissa Godin, “A resurgence in COVID-19 cases has gripped countries across Europe, leaving politicians grappling with how to curb the spread of the virus. Governments are now strengthening regulations around mask-wearing, limiting the number of people that can gather in public spaces, and honing in on areas with particularly high numbers of cases.”

This week Europe experienced a record high number of new cases reaching 71,365 new cases on September 21, this according to the European Centre for Disease Prevention and Control. In the United Kingdom, Prime Minister Boris Johnson has announced a series of new restrictions yesterday. In that country the coronavirus cases are doubling by the week.

This is a primary component of why the U.S. dollar has gained almost 3% in the last three weeks. Whether or not the U.S. dollar continues to gain value will be largely due to the strength or weakness of the three primary currencies in Europe that are a large part of the dollar index basket. These include the Euro dollar, Swiss franc and the British pound. If these currencies continue to lose value it will be because the economic contractions throughout Europe due to the restrictions being added.

Wishing you as always good trading and good health,