Comparing DXY with the Bloomberg Dollar Spot Index

The U.S. dollar plays a central role in global finance. However, reflecting the dollar's real strength is more complicated than simply looking at an exchange rate. This is where dollar indexes come into play. For decades, the U.S. Dollar Index (DXY) has been the preferred index for traders, economists, and policymakers. In recent years, however, the Bloomberg Dollar Spot Index (BBDXY) has gained popularity as a more modern alternative.

Both measure the dollar's strength, but they do so in different ways. Understanding their differences, however, is crucial for anyone seeking a deeper understanding of currency markets.

What is the U.S. Dollar Index (DXY)?

The U.S. Dollar Index (DXY) was launched in 1973, shortly after the collapse of the Bretton Woods system. The DXY measures the value of the U.S. dollar relative to six major world currencies:

• Euro (EUR)

• Japanese Yen (JPY)

• British Pound (GBP)

• Canadian Dollar (CAD)

• Swedish Krona (SEK)

• Swiss Franc (CHF)

 The euro has the most significant proportion of the index, accounting for nearly 58% of the index's allocation; hence, movements in EUR/USD typically drive the DXY. Although the DXY represents global trade patterns for the 1970s, it does not reflect the diversity of risks in today's global economy.

What is the Bloomberg Dollar Spot Index (BBDXY)?

The Bloomberg Dollar Spot Index was introduced in 2005, aiming to address some of the limitations of the DXY. Instead of measuring against six currencies, it adopts a broader measurement utilizing ten major world currencies from both developed and emerging markets. The composition weights of the BBDXY are revised annually to account for trade flows and liquidity, ensuring the index accurately reflects the dollar's involvement in contemporary global transactions. Some of the BBDXY's components consist of:

• Euro (EUR)

• Japanese Yen (JPY)

• Chinese Yuan (CNY)

• Mexican Peso (MXN)

• South Korean Won (KRW)

• Australian Dollar (AUD)

• Canadian Dollar (CAD)

This means the BBDXY, in contrast to the DXY, captures not only U.S. relationships with Europe and Japan but also relationships with emerging economies.

DXY versus BBDXY Key Differences

1. The number of currencies

• DXY - Six currencies, heavily weighted to Europe

• BBDXY - 10 currencies, including emerging markets

2. Weighting process

• DXY - The absolute trade flow weights, with fixed weights based on trade flows derived from the 1970s

• BBDXY - The weights are dynamic and evaluated regularly, with annual reviews to assess trade flows and liquidity.

3. Global economy representation

• DXY - heavily influenced by connections to Europe and Japan

• BBDXY - It encompasses a broader range of currencies with greater diversity and includes Asia and Latin America.

4. Market trend acceptance

• DXY - Established, widely tracked, and actively traded, particularly in futures contracts.

• BBDXY - Relatively new entry but rapidly being used by analysts with a focus on greater accuracy.

DXY Strengths

• History and familiarity: The DXY has been around for decades. There is a considerable amount of data available, all of which gives a solid view of dollar trends.

• Liquidity: Futures and derivatives related to the DXY are actively traded and widely accepted practices by investors.• Market impact: It is so widely referenced that the index itself can create movement in markets just by being mentioned.

Shortcomings of the DXY

• Old design: The DXY does not include currencies like the Chinese yuan or the Mexican peso, vital trading partners today.

• Heavy euro: With half of the DXY being dependent on euro strength, we see it track EUR/USD instead of gauging the dollar broadly.

Strengths of the BBDXY

• Updated construction: Annually updated to reflect current global trade trends.

• Extended scope: Including Latin American and Asian currencies, it portrayed a more accurate account of dollar fluctuations.

• No fixed weightings: The index itself keeps changing to reflect the current global economy.

Shortcomings of the BBDXY

• Limited history: The BBDXY has limited historical data dating back to 2005, thus shortchanging the usefulness compared to the DXY

• Liquidation: There are not as many financial products directly correlated to the BBDXY, such as options or futures- traders use the DXY more often because they are highly correlated.

• Little recognition: Many traders still revert to the DXY based on habit

Practical Uses for Traders and Investors

Using the DXY

• Monitor macro trends indicating which way the dollar is going against the historically accepted group of currencies.

• Understand how price action is moving in correlation to other major currencies, specifically the yen or the euro.

• Hedges can be done through futures and derivatives linked to the DXY.

Using the BBDXY

• To see what the practical dollar's role in trading overall is.

• Analyze the dollar's performance against the emerging markets.

• To get an accurate account of dollar performance against emerging market currencies.

Case In Point: Divergence between the DXY and the BBDXY

Suppose the dollar weakens relative to the euro but strengthens against Asian currencies, such as the Chinese yuan or the South Korean won. In this situation, if we found both the DXY and the BBDXY derivatives, we would likely see the DXY print lower—because not only is it robustly weighted against the euro, but any weakness in the dollar would also help reinforce the euro's strength.

Meanwhile, the BBDXY might have printed higher, indicating strength against another group of currencies not included in the DXY calculation. For traders, this divergence based on currencies across various indices illustrates how relying on a single index can create a misleading picture of the broader market.

Which is "Better"?

The answer will always differ based on what you are looking to test.

If you want historical depth and major trading products tied to your testing, it's the DXY, with no contest.

If you want a modern and globally representative view of the dollar, it's the BBDXY.

Professionals often track both to combine market knowledge gleaned from both datasets.

Conclusion

The U.S. dollar is too large an asset to be gauged solely from one perspective. The DXY, while it remains the most established and liquid, is not as up-to-date or broadly representative of the U.S. dollar's position globally as Bloomberg's Dashboard Dollar Index (BBDXY).

For traders, analysts, and investors, I suggest taking a balanced approach, not leaning entirely on either one, but instead focusing on understanding what each index represents. The DXY gives continuity and tradition.

The BBDXY offers a different lens for adapting and achieving modern-day relevance. By using both indices, you will often develop a more precise and refined view of where the dollar is going—and how that might impact the markets.