Reporting/Market Focus from the  July 2005 Edition of the SGS Newsletter

This month, Shadow Government Statistics introduces a new concept in measuring the U.S. dollar’s value against the rest of the world. The Shadow Government Statistics’ Financial-Weighted U.S. Dollar Index provides a dollar measure that is weighted for global currency trading patterns, in contrast to the popular trade-weighted index that is weighted for trading volume in goods and services. While the financial-weighted and trade-weighted indices have similar components, but different weightings, they still are highly correlated, as would be expected. Nonetheless, the differences between the series have implications for financial market activity.
The general concept behind a trade-weighted currency index is to provide an overall measure of nation’s relative currency performance, based on component currencies weighted for respective trade volume between the involved countries. While a number of official and private dollar indices arepublished, the Federal Reserve Board’s (FRB) series are examined here.
The most broadly followed trade-weighted index of the U.S. dollar is the FRB’s Major Currency Index, which evolved from the FRB’s trade-weighted indices developed in the 1970s and is a subset of the FRB’s Broad Index.
The current Fed series were introduced at the end of 1998 to handle two circumstances. First was the looming introduction of the euro, the components of which did not coincide with the components of existing indices. Second, the trade weightings used in the earlier indices reflected trading patterns of 1973 and had not been updated in 25 years.
The FRB’s Broad Index consists of 26 currencies, where the trade weightings are revised each year, based on the latest trade data. The Fed estimates that the countries of the component currencies account for about 90% percent of total U.S. trade volume. The trade weightings also are geometric as opposed to linear (a concept now used in CPI reporting), where a currency that the goes up in value against the dollar (dollar weakening) automatically receives a lower weighting, while a currency that falls against the dollar (dollar strengthening) gets a higher weighting.
The FRB’s Major Currency Index is a seven-currency subset of the Broad Index that includes (with 2003 weighting): euro (34.3%), Canadian dollar (30.0%), Japanese yen (19.3%), British pound (9.4%), Swiss franc (2.6%), Australian dollar (2.3%), Swedish krona (2.1%). The six countries and euro area reflect about 55% of the Broad Index’s trade volume.
While trade-weighted indices are reflective of currency exchange rates balanced by trade patterns, the proportionate volume of trade in goods in services does not necessarily reflect capital market and financial flows and foreign exchange trading volume surrounding a particular currency.
The SGS Financial-Weighted U.S. Dollar Index uses currency weightings based on global dollar trading as reported by the Bank for International Settlements(BIS) in its triennial central bank surveys of foreign exchange. The SGS index reflects a financial market participant’s view of the dollar, rather than an exporter or importer’s view.
The April 2004 BIS survey showed that 88.7% of all global currency transactions involve the U.S. dollar on one side of the exchange. The SGS Index is constructed using the six largest currencies, by volume, that are on the other side of the U.S. dollar transactions. Accounting for 81.4% of all dollar transactions (100.0% of the index), here are the six SGS Index components and their respective weightings: euro (39.1%), Japanese yen (23.1%), British pound (19.1%), Australian dollar (7.0%), Swiss franc (6.1%), Canadian dollar (5.6%).
In terms of components, the difference between the SGS Index and the FRB Major Currency Index is that the SGS Index does not include the Swedish krona.
In terms of weightings, the biggest difference is seen in the Canadian dollar with an SGS weighting of 5.6% versus the FRB weighting of 30.0%. The Canadian weighting differential is spread among the other currencies, with the biggest portion going to the pound.
The SGS Index weightings are linear and are updated every three years with the release of the BIS surveys. The last change of weightings from 2001 to 2004 showed declining weights for the euro, dropping from 41.0% to 39.1%, and the yen, falling from 26.7% to 23.1%, with offsetting gains seen primarily in the pound, rising from 14.5% to 19.1%, and the Australian dollar, increasing from 5.4% to 7.0%.
The accompanying graphs show the comparative SGS Financial-Weighted and the FRB Major Currency Trade-Weighted Indices on a monthly basis. The plot of the index levels is set with both series equal to 100.0 as of January 1985 (the FRB series formally is published using March 1973 equal to 100.0). With current readings of 53.38 (SGS) and 61.13 (FRB), the financial-weighted index stands 12.7% lower than the trade-weighted measure, after 20 years. Since the dollar’s relative high in February 1985, the financial-weighted index has lost 48.6% of its value against the trade-weighted index’s 40.8% drop.


While the correlations are high both in terms of the index levels and year-to-year growth rates, some new information comes from comparing the relative annual changes. An examination of the year-to-year growth chart shows that the financial index tends to overshoot the trade index on both the upside and the downside.
To the extent the growth differences reflect speculative currency flows, the speculative extremes help to mark U.S. dollar turning points. Also, the financial index tends to indicate downside pressure on long-term interest rates when its growth is relatively stronger than the trade index, and tends to indicate upside pressure on interest when the financial growth is relatively slower than the trade growth. Though far from a perfect predictor, when used in conjunction with overall dollar index change, the relative growth differential in the indices improves the accuracy of U.S. dollar measures as financial market indicators.
Full detail of the Federal Reserve’s dollar indices is available at the Fed’s website, under statistical releases. Details of the BIS triennial central bank surveys are available from the BIS website at, underpublications and statistics.