Annual Rebalance: Continuing Evolution of the Bloomberg Dollar Spot Index

Chief Investment Officer, Fixed Income and Model Portfolios

As we noted in a previous blog post, answering the question of what the U.S. dollar is worth can be a particularly tricky exercise. Through our research we came to the conclusion that comparing the value of the dollar against the currencies of America’s largest trading partners plus the most frequently traded currencies in the global foreign exchange (FX) markets provided a dynamic and intuitive approach to addressing this question. As we start 2014, we thought it appropriate to discuss the changes that occurred in the Bloomberg Dollar Spot Index (BBDXY) during its most recent year-end rebalance. • For 2014, BBDXY adds the Brazilian real, removes the Singapore dollar and sees the euro and Japanese yen swap a portion of their respective market share. • The distinction between the Bloomberg Dollar Spot Index and the ICE U.S. Dollar Index (DXY) grows as the global economy evolves, with weights to the Americas and Asia increasing in BBDXY versus the euro-dominated DXY. • The currencies in BBDXY comprise 81% of overall trade with the U.S. and 93.7% of the daily FX volume, compared to 42% and 79.7%, respectively, for DXY1. Looking back at our previous blog post on global FX trading, the relative trading growth of the euro (15%) has lagged the overall growth in foreign exchange volume (35%)2. However, trading in the yen has increased dramatically, growing 60% over the same period, as investors showed renewed interest in the Japanese economy. The euro remains the prominent currency in the basket, but its influence has declined from 34.3% to 31.3% for the coming year. Additionally, the Brazilian real will enter the index with a weight of 2.15%. The inclusion of the Brazilian real—a higher-carry currency—will likely increase the negative drag of interest rate differentials in the total return index (20 basis points) and provide an increase in index volatility3. The Brazilian real joins the Mexican peso and the Canadian dollar as an additional currency from the Americas in the basket. As shown in the table below, the regional composition of the basket has shifted slightly, with an increase in weight to currencies from the Americas and Asia and a small decrease in European currencies. • The real was bolstered by relative growth in trade and an increased share in foreign exchange transaction volume. • The Singapore dollar slipped to 11th place in the most recent trade volume survey. Its 13th place in foreign exchange volume fails to rank it in the top 10 of either trade partners or foreign exchange transaction volume. Bloomberg Dollar Spot Index Weights for 2014 A Broader, More Representative Approach The countries whose currencies are included in the BBDXY basket represent 81% of the overall trade with the United States. By another measure, the currencies included in the Bloomberg Dollar Spot Index comprise 93.7% of the $5.3 trillion traded each day in the foreign exchange market. By comparison, the six components of the ICE U.S. Dollar Index represent only 42% of the trade with the U.S. and barely 80% of the daily FX volume. From our perspective, when investors ask themselves what the U.S. dollar is worth, we believe this more comprehensive assessment of the dollar provides a more intuitive approach.   Bloomberg Dollar Spot Index (BBDXY) vs. ICE U.S. Dollar Index (DXY) Even after the most recent rebalance, BBDXY remains more broadly differentiated than DXY. In our view, a dynamic measure of the U.S. dollar provides a more representative approach to measuring the role the U.S. dollar plays in the global economy. 1Source: Bloomberg, WisdomTree, as of 12/31/13. 2Source: Bank for International Settlements (BIS), Triennial Survey, April 2013. 3Sources: Bloomberg, WisdomTree, as of 12/31/13.

Important Risks Related to this Article

Investments in emerging, offshore or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations. Diversification does not eliminate the risk of experiencing investment losses.

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About the Contributor
Chief Investment Officer, Fixed Income and Model Portfolios

Rick Harper serves as the Chief Investment Officer, Fixed Income and Model Portfolios at WisdomTree Asset Management, where he oversees the firm’s suite of fixed income and currency exchange-traded funds.  He is also a voting member of the WisdomTree Model Portfolio Investment Committee and takes a leading role in the management and oversight of the fixed income model allocations. He plays an active role in risk management and oversight within the firm.

Rick has over 29 years investment experience in strategy and portfolio management positions at prominent investment firms. Prior to joining WisdomTree in 2007, Rick held senior level strategist roles with RBC Dain Rauscher, Bank One Capital Markets, ETF Advisors, and Nuveen Investments. At ETF Advisors, he was the portfolio manager and developer of some of the first fixed income exchange-traded funds. His research has been featured in leading periodicals including the Journal of Portfolio Management and the Journal of Indexes. He graduated from Emory University and earned his MBA at Indiana University.