Observers expect the US dollar to weaken in the medium term.1 This, however, raises the question of whether to assess the dollar against another specific currency, perhaps the euro, or against a basket of currencies. The second approach is more appropriate to capture a broad-based change in the value of the US dollar regardless of idiosyncratic factors that may influence a bilateral exchange rate.
Investors often use the US dollar index (DXY) as a representative basket. The DXY was created in 1973 by the Federal Reserve to give an average value of the US dollar against other main currencies following the end of the Bretton Woods fixed exchange rate regime in 1971. The index was constructed as a weighted average of US dollar exchange rates against a basket of currencies, with the weights based on the relative size of both trade and financial bilateral flows with the US.2 After the launch of the euro in 1999, the weights of the DXY basket were set as shown in Table 1.