Dollar Index is down. Does that mean your portfolio will go up?

Dollar index, also known as DXY in the world of finance, is a widely tracked number. It has recently corrected from a peak. Experts believe that this can change investor sentiment. Here is what you should be aware of.

Dollar Index is a measure of the value of the US Dollar in comparison to a basket of six foreign currencies – Euro, Japanese Yen, Pound Sterling, Canadian Dollar, Swedish Krona, and Swiss Franc, with varying weights to each of these currencies. If the dollar index goes up, then it is considered a sign of strength for the US dollar. And vice versa.

The Dollar index went up to 114.106 on 27 September 2022 from a low of 89.436 recorded on 5 January 2021. However, it came down subsequently to a low of 106.292 on 11 November 2022.

Dollar index and global stability

The Dollar index goes up when money chases the US dollar, dumping other asset classes in search of safety of capital. This is an indicator of fall in risk appetite of investors. Something similar happened after the Covid-19 pandemic hit the world and geo-political tensions, such as the Russia-Ukraine and China-Taiwan issue, reared their heads in emerging markets. Even the energy crisis in Europe made investors weary and the resultant flight to safety ensured that the greenback strengthened. Over the last one year, the US Federal Reserve hiked interest rates to curb inflation, which made holding dollars attractive. This has been supportive of the US dollar strength.

However, things are seen changing in the last one month. The dollar index has shown some quick down move. Relief in the energy crisis in Europe, expectations of the US Fed going slow on interest rates hikes, and expected political stability in the UK, among other factors, can be attributed to the cause of this down move.

What does dollar index tell you?

When the dollar index goes up, investors are seen dumping other asset classes. That is considered a negative for prices of all other risky assets, including commodities, and equities, especially of emerging markets. However, when the dollar index goes down, money flows out of the US, which helps prop up the prices of stocks, commodities and other emerging market assets, other things remaining the same.

Movement in the dollar index provides an indication of what to expect in future. Many experts try to predict such a future scenario. However, a point to note here is that the movements are not linear like those of other securities. Such zig-zag moves can bring in a lot of intermittent volatility, especially when things are at crossroads, as they are now.

Ritesh Jain, Co-founder of Pinetree Macro, says, “The current fall in dollar index should be construed as a correction in an uptrend we have seen earlier this year. The dollar index may re-test the earlier high again in the next couple of months, before going down.”

Also, there is a possibility of further upward movement in DXY.

Rohit Srivastava, Founder of IndiaCharts, expects the dollar index to make a new high of around 118-120 points in the next six to 12 months.

But whichever way the dollar index moves in the short term, the broad framework of macro-economic variables indicates the possibility of a decisive down move in the medium term. The key reason for this would be the expectation of a pause in interest rate hikes by the US Fed in the near term.

Jain expects the US Fed to stop the aggressive increase in interest rates when unemployment numbers show a spike.

Alok Singh, Chief Investment Officer, Bank of India Mutual Fund, says, “Fear of an uncertain future made money move into dollar, which propped up the dollar index. Since the fear factor is behind us (now), the dollar index should move down, though some bounce of a technical nature cannot be ruled out in the near future.”

How to invest?

Investors need to stay diversified across asset classes taking into account their asset allocation, which is based on their financial goals and risk appetite. Do not base your investment decisions on the movement of one factor.

The movement of DXY can offer some help while choosing investments for your portfolio.

Singh says, “When the dollar index moves down, money will start flowing into those asset classes from where it has come. For example, investors may start looking at emerging market stocks, and metals. However, the allocations may change to countries and asset classes.”

The dollar index also provides clues on whether we should invest in gold and silver.  A weak dollar typically, means strong commodity prices, including of gold and silver. “Relatively high inflation and high unemployment make a good environment for gold prices. Gold may touch $2,400 in the next two to three years. Silver prices too, should play catch up with gold prices,” says Jain.

Though a high target on gold prices in dollar terms may nudge you to place a buy order, it is the rupee prices that should matter to investors in India. When the dollar was getting stronger, and gold prices came down, the weak rupee ensured that the value of gold in rupee terms did not fall as much. In the last one year, gold has given 6.3 percent returns in rupee terms. Even if gold prices go up in dollar terms as the dollar weakens, because of a strong rupee the returns may be muted to the extent of rupee appreciation.

When the dollar is weak and interest rates begin to go down, equities in general tend to do well. Jain prefers diversified equity portfolios such as S&P 500 index in the US and portfolios with allocation to small- and mid-cap stocks in India.

But do not jump with all your money into small- and mid-cap funds. There can be a period of intermittent volatility. The dollar index may take longer than expected to move down.

Srivastava says, “Though over the long period of five to 10 years India is a growth market, in the short term, investors should be focused on protecting their gains than investing aggressively, as the risks pertaining to inflation and interest rate hikes are not yet over.”

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Indians have developed some comfort with investing in shares listed in the US, though some of them have burnt their fingers with their exposure to tech stocks. As the dollar is expected to weaken in the medium term, some investors may want to explore other emerging markets. However, given the uncertainties around China, Taiwan, Russia and other emerging markets, it is better to go slow there.

This is the time to continue your investments in equity funds through systematic investment plans (SIPs). If stocks turn volatile, consider it to be an opportunity. Keep lumpsum money ready for additional deployment on big falls, provided you have a minimum timeframe of five years.

Do not chase returns by sacrificing your asset allocation just because a particular asset class has fallen off the cliff and is available at a throwaway price.