What is US Dollar Index?

How it Impacts the Indian Market?

What is Dollar Index?

• It is known as the index of the value of the US dollar against a foreign currency basket. The US dollar index is used to measure the value of the US dollar concerning the basket of six major currencies of the United States’ major trading partners.
• The currency basket includes the Euro, British pound (GBP), Canadian Dollar (CAD), Swiss Franc (CHF), Swedish Krona (SEK), and Japanese Yen.
• The value of the index is a clear indication of the value of the dollar in world markets. The higher value of an index means a stronger dollar.

Dollar Index History:

• The Index fell during the year 1990 to 1998 and again risen in the year 2000 due to the tech boom.
• Then it fell sharply after 2002 due to the dot com crisis.
• The Index rises after 2014 but fell recently due to the coronavirus pandemic.

i) 5-Year Trend of Dollar Index:

ii) Correlation of Dollar Index with FII:

The rupee appreciates versus the dollar when the dollar index falls and vice versa. Foreign Institutional Investors (FIIs) and Foreign Portfolio Investors (FPIs) enjoy better returns on their dollar investments when the dollar declines versus the rupee.

Impact of Dollar Index on All Four Markets:

1.Currency Market:

• It has a reverse relationship with the currency markets. As the dollar index rises, other currencies, including the INR, will fall against the USD.

On the other hand, if the dollar index falls, the INR will appreciate against the USD

2. Commodity Market:

• Commodity prices are generally inversely proportional to the dollar index. Hence, if the dollar index rises, the prices of raw materials such as crude oil, metals, etc. falls, and vice versa.
• When the dollar is weak people will try to buy more and create huge demand for it.

3. Bond Market:

• The dollar index has an indirect impact on the bond markets. When the dollar index falls, foreign institutional investors (FIIs) invest more in bonds, which leads to lower bond yields and higher bond prices.
• Whereas, when the dollar index rises, FIIs can sell bonds leading bond yields to rise and bond prices to fall.
• The Bond Market is directly correlated to the dollar index.

4. Equity Market:

• The dollar index also has an impact on the Indian stock markets. However, the effects of the dollar index are more pronounced in the short term only.
• Whereas in the long run, other factors have a greater impact on stock returns.
• If the dollar index falls, FIIs will invest more in Indian stocks because they expect higher dollar yields (with the INR appreciating against the USD), and when it rises, they invest less because they expect dollar yields to decline (with the Depreciation of the INR against the USD).

Example of Effect on Different Sectors:

The Dollar index also has different effects on different sectors in the short term:

• If the dollar index rises, the stock prices of companies in cyclical sectors (sectors with a focus on domestic consumption such as banks, automobiles, oil & gas, capital goods, metals, etc.) fall.
• The rise in the dollar index will be good for export-oriented sectors such as technology, pharmaceuticals, etc. will as exports become more competitive with the devaluation of the INR. The share prices of companies in these sectors are expected to rise as the dollar index rises.
• Whereas, at the corporate level, exporters tend to benefit from the rising dollar and the devaluation of the domestic currency. IT and pharmaceutical companies in India are the major exporters of goods and services and generate most of their sales in US dollars.