What Is The DXY Index?

Why is DXY Index important?

The US dollar is the most widely used and recognized currency worldwide. Central banks and governments hold US dollars as the primary exchange asset of their foreign exchange reserves. The dollar is the world’s reserve currency.

Reserve currencies are liquid, making them the foreign exchange instruments of choice for central banks and financial institutions for settling international transactions. Settling cross-border obligations with a reserve currency eliminates the need to exchange a country’s currency for each transaction.

The US dollar is the leading reserve currency because of the long history of political and economic stability in the US, the world’s leading economy. The dollar index (DXY) trades in the futures market on the Intercontinental Exchange (ICE) and the over-the-counter market between foreign exchange dealers.

The DXY reflects dollar strength or weakness and is a pricing mechanism for many commodities

Commodities are the raw materials that feed, clothe, power, and shelter the world. Production is a local affair in areas where the earth’s crust is rich in ores, minerals, metals, and energy. Agricultural products require suitable climates and available water supplies. Consumption is ubiquitous as people worldwide require essential commodities.

The pricing benchmark for most commodities is the US dollar because of its liquidity, stability, and role as the leading reserve currency. Local production costs and consumer prices may in various currencies, but wholesale supplies use the US dollar as the means of exchange. Over time, a rising dollar is typically bearish for commodity prices, while weakness in the reserve currency is a bullish factor. A strong dollar makes local production expenses fall, allowing foreign producers to sell output at lower prices and vice versa.

How is the DXY Index Calculated

The dollar index measures the US currency against other reserve currencies. Since the euro is the second-leading reserve currency, it has the highest weighting in the dollar index.

The dollar index is calculated according to the following formula of currency pairs:

USDX = 50.14348112 × EURUSD -0.576 × USDJPY 0.136 × GBPUSD -0.119 × USDCAD 0.091 × USDSEK 0.042 × USDCHF 0.036

Source: ICE

The six currencies that comprise the dollar index are freely traded foreign currency instruments from politically stable countries. There is no regularly scheduled rebalancing or adjustment in the dollar index. The ICE exchange monitors the index methodology. The index calculation occurs in real-time from a multi-contributor feed of the spot prices of the Index’s components.

The dollar index reached an almost two-decade high in March 2020

In March 2020, at the height of the risk-off price action caused by the global pandemic, the dollar index spiked higher. The US dollar’s role as a reserve currency makes it a safe-haven during turbulent market periods. Source: CQG

As the chart highlights, the ICE dollar index rose to a high of 103.96 in March 2020, the highest level in eighteen years since 2002. While the index exploded higher during the week of March 16, it turned lower the next week.

A falling knife led to price consolidation

The dollar index entered a bear market after reaching its highest level in nearly two decades. Source: CQG

As the weekly chart illustrates, the index moved from an eighteen-year high to its lowest level since February 2018 as it fell steadily through 2020 and into early 2021. The most recent low was at 89.165, only 1.015 above the early 2018 bottom, which was the lowest level since late 2014.

Interest rate differentials play a leading role in the value of one currency versus another. The short-term Fed Funds rate dropped to zero percent as the financial fallout from COVID-19 gripped markets, narrowing the rate difference between the dollar and the euro currency. As the yield benefits of the dollar declined, it sent the US currency lower.

Moreover, as Europe settled the Brexit issue in late 2020, it lifted the cloud of uncertainty hanging over the euro and British pound. The two currencies account for 71.2% of the dollar index.

After dropping from 103.96 to 89.165 or 14.2% in nine months, the dollar index has traded in a narrow range. Source: CQG

The daily chart shows that the ICE dollar index futures contract has traded between 89.165 and 91.605 in 2021, a narrow 2.44 range after falling 14.795 points. The index remains not far from the low, but it is consolidating and has yet to challenge its critical technical support level at the 88.15 low from February 2018.

Bearish sentiment is a dark cloud over the dollar for three reasons

The trend in the dollar index remains bearish since the March 2020 multi-year high. Three compelling factors are weighing on the dollar as it consolidated near the downside target at 88.15.

  • Short-term US interest rates remain only 50 basis points higher than short-term euro deposit rates. The narrow differential continues to support the euro as the yield difference collapsed from pre-pandemic levels.
  • The US Fed continues to inject record liquidity into the financial markets, increasing the US money supply. Government stimulus to stabilize the economy has caused the US deficit to soar over the $28 trillion level. The tidal wave of liquidity and tsunami of stimulus weigh on the dollar’s purchasing power.
  • The technical trend in the dollar remains lower. The trend is always your best friend in markets as it reflects the wisdom of the crowd. Crowds tend to make better decisions than individuals.

The dollar remains the world’s reserve currency, but that does not mean it will not continue to lose value versus other world currencies. A break below the February 2018 88.15 low in the dollar index could cause technical traders and speculators to pile in on the index’s short side. Meanwhile, central banks, monetary authorities, and governments tend to manage the foreign exchange market via coordinated intervention that provides stability by reducing volatility. Currency trends can last for prolonged periods. At the beginning of March 2021, the dollar’s trend remains lower.

Negative Commodity Prices – Causes and Effects

In commodity markets, we have seen markets move to levels where those holding long positions wind up paying other market participants to close positions. This can occur in the futures as well as the physical markets. The payment is not just market differences between the purchase and sale price. There have been instances where a purchase at zero turned into a losing proposition.

In the 1950s, the US regulators closed the onion futures market on the Chicago Mercantile Exchange as the price of the root vegetable fell into negative territory. At the time, trading in onions accounted for around 20% of the volume on the exchange. Market manipulation caused the price volatility in onions that have not traded in the futures market since 1958.

A raw material market can fall below zero

Negative commodity prices are nothing new, as other raw materials have declined to levels where sellers pay buyers to take a commodity off their hands. While some markets have seen zero or negative prices, others never experienced the phenomenon.

Aside from onions, another futures market has traded at or below a zero price. The power or electricity market is a use-it or lose-it market. The electric power runs along transmission lines, and if not consumed by a party that holds a long position, it becomes worthless or can even trade at a negative price.

April 20, 2020, was a day to remember in the crude oil market

Before April 20, 2020, the all-time modern-day low for the price of NYMEX crude oil was $9.75 per barrel, the 1986 bottom. In late April 2020, the price fell through that low and reached zero.

Source: CQG

The quarterly chart highlights the decline to a low that few traders, investors, and analysts thought possible.

Some market participants likely purchased nearby futures at or near zero, assuming that they were buying at a price that was the sale of the century. They turned out to be tragically wrong. Crude oil fell to a low of negative $40.32 per barrel on April 20. The problem in the oil market was that there was nowhere to put the oil as storage facilities were overflowing with the energy commodity.

Historically, oil traders with access to capital purchased nearby futures and sold deferred contracts at times when contango, or the future premium, was at high levels. The theory behind owning the nearby contract and selling the deferred contract is that those who can store and finance the energy commodity gain a risk-free profit.

Holders of the spread hedge the price risk with the sale of the deferred contract and own the physical in case the market tightens, which is a call option on the spread. Meanwhile, speculators often synthesize the cash and carry trade using nearby and deferred futures without the ability to store the energy commodity. When nearby futures dropped to over negative $40 per barrel, the unexpected losses for those holding synthetic positions were staggering.

Storage capacity is the critical factor

Supply capacity is the crucial factor for any market participant holding a long position in a nearby futures contract. Without the ability to take delivery and store the commodity, there is a potential for negative price levels. Assuming that the downside is limited to zero is wrong. Another market that could face a similar fate in the future is natural gas, where storage capacity is finite, and the price could venture into negative territory at some point.

Without the ability to store and finance a commodity, the downside risk is theoretically as unlimited as the upside.

Negative commodity prices may seem irrational, and it is always tempting to buy something for zero. In the world of commodities futures and some of the physical markets, zero could turn out to be a high price as the oil market taught us on April 20, 2020.

Breakeven Crude Oil Production Costs Around The World

If the market price of a raw material is higher than its cost of extracting it from the crust of the earth or any other form of production, it leads to increased output. A profitable production process provides an incentive for output.

When the cost of production is higher than the market price, output declines as it becomes a losing proposition. The price cycle in commodities causes prices to rise to levels where production increases. Higher output leads to growing inventories. As a market becomes more expensive, the elasticity of demand causes consumers to look for substitutes and buying declines, leading to price tops and reversals to the downside.

When the price of a commodity falls below the cost of production, output slows. The demand tends to increase as consumers take advantage of lower prices, and inventories begin to decline, leading to price bottoms. The price cycle in a commodities market can change because of exogenous events, but it tends to be efficient. High prices lead to glut conditions, and low prices often create shortages, over time. Production cost is one of the critical variables that fundamental analysts use to project the path of least resistance for market prices.

In the crude oil market, output costs vary according to the production location. Saudi Arabia, Russia, and the United States are the three leading oil-producing nations in the world, and each has different sensitivities to output costs.

Saudi Arabia- Think turning on a garden hose

Over half the world’s crude oil reserves are in the Middle East, and Saudi Arabia is the leading producer in the region. The Saudis have long been the most potent force within OPEC, the international oil cartel. Saudi Arabia’s vast reserves make production as easy as turning on a garden hose in our backyards for the country.

Meanwhile, the Saudi economy depends on oil revenues. The rising costs of running the country have pushed the break-even level of the price of the energy commodity to over $80 per barrel on the Brent benchmark. While the nominal production cost of oil is the lowest in the world in Saudi Arabia at $2.80 per barrel, the requirements for revenues creates a wide gap between production economics and balancing the Saudi budget.

Russia- Output costs may not matter as much in the west

Russia is an enigma when it comes to the cost of production for the energy commodity. The Russians, under President Vladimir Putin, is structured as an oligarchy. A small group runs the nation’s economy. Therefore, the production cost of crude oil is an enigma and a state secret. In 2020, the Russian leader had said that he is comfortable with a Brent price around the $40 per barrel level. The statement could shed at least some light on the price level for the energy commodity that provides enough revenue to keep the system running smoothly.

The US- The marginal producer in the world

In the 1970s and 1980s, the United States was dependent on oil imports from the Middle East. Rising prices during this century, combined with reserve discoveries in shale regions, caused production to increase. Moreover, technological advances in extracting crude oil from the crust of the earth and regulatory reforms under the Trump Administration caused daily output to rise to over 13 million barrels per day, making the US the world’s leading producer and achieving the goal of independence.

The US is a marginal producer. While production costs have declined, they are still around the $30 to $40 per barrel level. The US is in a position where it is a dominant marginal producer. When the price of oil rises above production costs, the output can increase. When it falls below, the US can turn off production and import inexpensive crude oil from other nations.

In any commodity, the production cost is a critical factor when it comes to the fundamental supply and demand equation. Pricing cycles take prices above and below break-even output costs at times. Each leading producer has different requirements when it comes to prices, which makes a global analysis complicated and the worldwide break-even equation for crude oil an economic and geopolitical enigma.

What are Commodity Currency Pairs?

The currencies of countries around the world are fiat instruments, meaning that they have no backing by anything other than the full faith and credit of the nations that issue the legal tender.In the past, many currencies used gold and silver to provide support for the foreign exchange instruments, but the metals prevented countries from making significant changes in the money supply to address sudden changes in economic conditions.

Meanwhile, some countries with substantial natural resources that account for revenue and tax receipts have an implicit backing for their legal tender. The ability to extract commodities from the crust of the earth within a nation’s borders or grow crops that feed the world allows for exports and revenue flows. While those countries have fiat currencies in the international financial system, the implied backstop of commodity production makes them commodity currencies.

Commodities provide support for some foreign exchange instruments

The fundamental equation in the world of commodities often dictates the path of least resistance for prices. While demand is ubiquitous as all people around the globe are consumers of raw materials, production tends to be a local affair.

Commodity output depends on geology when it comes to energy, metals, and minerals. Soil, access to water, and climate make some areas of the world best-suited for growing agricultural products. Chile is the world’s leading producer of copper. The vast majority of cocoa beans, the primary ingredient in chocolate, come from the Ivory Coast and Ghana, two countries in West Africa.

In Chile and the African nations, the production of the raw materials accounts for a significant amount of revenues and employs many people, making them a critical factor when it comes to economic growth. Meanwhile, the Australian and Canadian currencies are highly sensitive to commodity prices as both nations are significant producers and exporters of the raw materials to consumers around the globe.

Australia and Canada have commodity currencies

Australia and Canada produce a wide range of agricultural and energy products, as well as metals and minerals. Australia’s geographical proximity to China, the world’s most populous nation with the second-leading economy, makes it a supermarket for the Asian country. Canada borders on the US, the wealthiest consuming nation on the earth. Therefore, Australia and Canada are both commodity supermarkets for a substantial addressable market of consumers.

In 2011, commodity prices reached highs, and the price action in the Australian and Canadian currencies versus the US dollar shows their sensitivity to raw material prices.

Source: CQG

The quarterly chart of the Australian versus the US dollar currency pair highlights that highs in commodity prices in 2011 took the foreign exchange relationship to its all-time high of $1.1005. The price spike to the downside during the first quarter of 2020 that took the A$ to $0.5510 came on the back of a deflationary spiral caused by the global Coronavirus pandemic that sent many raw material prices to multiyear lows.

Canada is a significant oil-producing nation. In 2008, the price of nearby oil futures rose to an all-time peak of over $147 per barrel.

Source: CQG

The quarterly chart of the Canadian versus the US dollar currency pair shows that the record high came in late 2007 at $1.1043 as the price of oil was on its way to the record peak. The highs in raw material prices in 2011 took the C$ to a lower high of $1.0618. The deflationary spiral in March 2020 pushed the C$ to a low of $0.6820 against the US dollar.

Both the Australian and Canadian dollars are commodity currencies that move higher and lower with raw material prices over time.

Brazil’s real also tracks the prices of some commodities

Brazil is an emerging market, but the most populous nation in South America with the leading GDP in the region is a significant producer of commodities. The price relationship between the Brazilian real and the US dollar is another example of how the multiyear highs in commodity prices in 2011 sent the value of a commodity-sensitive currency to a high.

Source: CQG

The quarterly chart of the Brazilian real versus the US dollar currency pair shows that the real reached a record high of $0.65095 against the US dollar in 2011 when commodity prices reached a peak.

While the Australian and Canadian dollar and Brazilian real are fiat currencies, they each reflect the price action in the raw material markets, making them commodity currencies. The foreign exchange instruments may not have express backing of the nation’s raw material production; there is an implied backing as higher commodity prices lift the local economies and government tax revenues. Commodity currencies can serve as proxies for the asset class as they move higher and lower with raw material prices.

How To Use Technical Analysis In Forex Markets

Charts are useful tools for investors and traders as they offer insight into herd behavior. In a book written in 2004, author James Surowiecki explained how crowds make better decisions than individuals. Markets are embodiments of Surowiecki’s thesis as the current price of an asset is the level where buyers and sellers meet in a transparent environment.

When it comes to the global foreign exchange market, buyers and sellers of currencies determine the rates of one foreign exchange instrument versus others on a real-time basis. At the same time, governments manage the level of currency volatility to maintain stability. Technical analysis can be particularly useful in the currency markets as technical levels can provide clues about levels where government intervention is likely to occur.

Technical analysis includes support and resistance levels where currency pairs tend to find lows and highs. At the same time, price momentum indicators often signal where exchange rates are running out of steam on the up and the downside.

Technical analysis can breakdown at times when black swan events occur.

Futures are a microcosm of the OTC market

In the world of foreign exchange, the over-the-counter market is the most liquid and actively traded arena. The OTC market is a global and decentralized venue for all aspects of exchanging the currency of one country for another; it is also the largest market in the world. In April 2019, the average trading volume was $6.6 trillion per day. The OTC market operates twenty-four hours per day, except for weekends.

Futures markets for currency pairs are smaller, but they reflect the price action in the OTC market. When it comes to technical analysis, the futures market provides a window into the price trends and overall state of the strength or weakness of one currency versus another.

Volume and open interest metrics provide clues for price direction

The dollar versus the euro currency pair is the most actively traded foreign exchange relationship as both foreign exchange instruments are reserve currencies.

Source: CQG

The weekly chart of the dollar versus the euro futures contract displays the price action in the currency pair since late 2017. The bar chart on the bottom reflects the weekly volume, which is the total number of transactions. The line above volume is the open interest or the total number of long and short positions.

When volume and open interest are rising or falling with the price, it tends to be a technical validation of a price trend in a futures market. When the metrics decline with rising or falling prices, it often signals that a trend is running out of steam, and a reversal could be on the horizon. Volume and open interest are two technical metrics that aid technical traders looking for signs that a trend will continue or change.

Momentum indicators are powerful technical tools at times

Stochastics and relative strength indices can provide a window into the overall power of a trend in a futures market.

Source: CQG

Beneath the weekly price chart, the slow stochastic is an oscillator that aims to quantify the momentum of a price rise or decline. Stochastics work by comparing closing prices with price ranges over time. The theory behind this technical tool is that prices tend to close near the highs in rising markets and near the lows in falling markets.

A reading below 20 indicates an oversold condition, while over 80 is a sign of an overbought condition. On the weekly chart of the euro versus the dollar currency pair, the reading of 31.42 indicated that the stochastic oscillator is falling towards oversold territory in a sign that the downtrend could be running out of steam.

The relative strength indicator compares recent gains and losses to establish a basis or the strength of a price trend. A reading below 30 is the sign of an oversold condition, while an overbought condition occurs with a reading above the 70 level. At 45.55 on the weekly dollar versus euro chart, the indicator points to a neutral condition in the currency pair.

Technical analysis can fail at times

Technical analysts look for areas of price support and resistance on charts. Support is a price on the downside where a market tends to find buying that prevents the price from falling further. Resistance is just the opposite, as it is the price on the upside where a market tends to experience selling that prevents it from rising further. When a price moves below support or above resistance, it often signals a reversal in a bullish or bearish price trend.

Technical analysis is not perfect, as the past is not always an ideal indicator of the future.

Source: CQG

The chart of the currency relationship between the US and Australian dollar shows that the price broke down below technical support and experienced a spike to the downside. The price movement turned out to be a “blow-off” low on the downside that reversed after reaching a significantly lower price.

Technical analysis provides a roadmap of the past in the quest for insight into the future. Many market participants use technical analysis to make trading and investing decisions, which often creates a self-fulfilling prophecy as a herd of transactional activity can create or impede a price trend. Technical analysis is a tool that foreign exchange traders use to project the path of least resistance of exchange rates.

Some of the most influential participants in the foreign exchange markets are governments. Historical price volatility in foreign exchange markets tends to be lower than in most other asset classes because governments work independently or together, at times, to provide stability for exchange rates. Therefore support and resistance levels tend to work well over time.

What are Contango And Backwardation?

Term structure, the forward curve, or time spreads are all synonymous and reflect the price differences for a commodity over time.

In some commodities, seasonality causes prices to reach lows at certain times of the year and peaks at others. Natural gas and heating oil often reach seasonal highs during the winter months, while gasoline, grains, lumber, and animal proteins can move towards highs as the spring and summer seasons approach.

Meanwhile, the price differential for various delivery dates can provide valuable information when it comes to the supply and demand fundamentals for all commodities. Contango and backwardation are two essential terms in a commodity trader’s vocabulary.

Contango is a sign of a balanced or glut market

Contango exists in a market when deferred prices are higher than prices for nearby delivery. A “positive carry” or “normal” market is synonymous with contango.


The forward curve in the NYMEX WTI crude oil futures market highlights the contango in the energy commodity. In this example, the price of crude oil for delivery in June 2020 was at $28.82 per barrel and was at $36.10 per barrel for delivery one year later in June 2021. The contango in the oil market stood at $7.28 per barrel.

The contango is a sign of oversupply. However, it also reflects the market’s opinion that the current price level will lead to declining production and inventories and higher prices in the future.

Backwardation signals tightness

Backwardation is a market condition in which prices are lower for deferred delivery compared to nearby prices. Other terms of backwardation are “negative carry” or “premium” market.

Source: ICE/RMB

The term structure in the cocoa futures market that trades on the Intercontinental Exchange shows that cocoa beans for delivery in May 2020 were trading at $2305 per ton compared to a price of $2265 for delivery in May 2021. The backwardation of $40 per ton is a sign of nearby tightness where demand exceeds available supplies. At the same time, the lower deferred price assumes that cocoa producers will increase output to close the gap between demand and supplies in the future.

Watch the forward curve

A fundamental approach to analyzing commodity prices involves compiling data on supplies, demand, and inventories. The term structure in raw material markets can serve as a real-time indicator for supply and demand characteristics. When nearby supplies rise above demand, the forward curve tends to move into contango. When the demand outstrips supplies, backwardations occur.

Watching the movements in term structure can provide value clues when it comes to fundamental shifts in markets. Exchanges publish settlement prices for all contracts each business day. Keeping track of the changes over time can uncover changes that will impact prices.

In tight markets where backwardations develop or are widening, nearby prices tend to move to the upside. In contango markets, equilibrium can be a sign of price stability, while a widening contango often is a clue that prices will trend towards the downside.

The shape of the forward curve can move throughout the trading day. Any dramatic shifts tend to signal a sudden change in market fundamentals. For example, a weather event in an agricultural market that impacts production would likely cause tightening and a move towards backwardation. As concerns over nearby supplies rise, the curve often tightens.

Conversely, a demand shock that leads to growing inventories often leads to a loosening of the term structure where contango rises. Observing changes in a market’s forward curve and explaining the reasons can provide traders and investors with an edge when it comes to the path of least resistance of prices.

What Is A Forward Contract?

A forward contract is an over-the-counter or exchange-traded financial transaction for the future delivery of a commodity or an asset. The buyer receives guaranteed access to the asset at an agreed-upon price. The seller receives a fixed price as well as a sales outlet from the buyer.

Forward contracts can call for payment upon delivery of the asset but may also include provisions for margin or other terms expressly agreed upon by the parties to the contract. A forward can be a useful hedging tool for both producers and consumers of commodities. However, they can also be fraught with pitfalls at times.

Forwards in the over-the-counter market

In the OTC market, a forward transaction occurs on a principal-to-principal basis between a buyer and a seller. The parties to the contract obligate themselves by contractual terms with the seller assuming the credit risk of the buyer and the buyer doing the same with the seller.

In the world of commodities, there are many derivations of the forward contract. A pre-export financial transaction is a forward where the buyer pays the seller a percentage of the value before delivery. Pre-export financial transactions require the buyer to take more risk than the seller. The price for the asset tends to reflect the higher risk undertaken by the buyer. Another form of a forward transaction is a swap, where a buyer and exchange a fixed for a floating price.

In the aftermath of the 2008 global financial crisis, changes in the regulatory environment caused many forward and swap transactions to move into clearinghouses where margin requirements lowered the potential for defaults.

Forwards are very popular in the highly liquid over-the-counter foreign exchange market. Forward transactions allow for the parties to negotiate all of the terms for the purchase and sale and they are non-standardized contracts.

Forwards on an exchange

Some exchanges offer products that are forwards rather than futures contracts. The London Metals Exchange, which is the oldest commodities exchange in the world, trades forwards on nonferrous metals, including copper, aluminum, nickel, lead, zinc, and tin. While each contract represents a standard amount of the metal in metric tons, the most actively traded product is the three-month forward. Producers and consumers favor the LME contracts as they allow for delivery of the metals each business day of the year. The LME also offers forward contracts for shorter and longer terms in all of the metals.

The difference between a forward and a futures contract

The most significant difference between a forward and a futures contract is that the forward is non-standardized. Futures have the following characteristics:

  • One stated asset or commodity
  • A physical or cash settlement
  • A fixed amount of the asset per contract
  • The currency in which the asset is quoted
  • The grade or quality of the asset that is deliverable
  • The delivery month and subsequent delivery months
  • The last day of trading
  • The minimum price fluctuation per contract, which is the tick value

Futures are subject to original and variation margin. In a non-standardized forward contract, the terms of margin when it comes to a good-faith deposit and payment of market differences are subject to negotiation.

A forward contract offers less liquidity than a futures contract as the future can be offset with any other party. Many forwards can only be offset by agreement of the original parties. In futures, the clearinghouse becomes the counterpart for all purchase and sale transactions. While both futures and forwards are derivative instruments, there are tradeoffs. Futures allow for far more liquidity, while forwards often meet the needs of those buyers and sellers looking for tailor-made solutions to financial risks.