What is a trade-weighted currency index?
A trade-weighted currency index is a weighted average of a basket
of currencies that reflects the importance of a country's trade (imports
and exports) with these countries. Sometimes a trade-weighted currency
index is taken as a crude measure of a country's international
"competitiveness". At any rate, a trade-weighted currency index
is a useful measure to aggregate diverging trends among currencies
of a country's trading partners.
For example, Canada is trading mostly with the
United States. Thus the USD/CAD exchange rate has a weight of about 80%
in Canada's trade-weighted CAD index.
How are the indices in the chart above computed?
The index itself is the weighted sum of the exchange rate logarithms.
The chart shows the equivalent percentage changes in this
index relative to the last trading day. A positive sign indicates that
the currency has strengthened against its partner currencies, and a
negative sign indicates that the currency has weakened against its partner
currencies. The number of partner currencies are limited to the countries
that account for at least 1% of a country's total trade. Trade is defined
as the sum of imports and exports. The weights and currencies that are
currently used are shown in the table on the right.
What are those blue & yellow blobs in the table?
The charts (magnified in the table below),
are my own invention: they summarize the relative position
of an exchange rate relative to its performance over the
last year. The charts have a yellow background that indicates
the square dimension of the chart.
The white dot indicates today's position
relative to the high (top of chart) and low (bottom of chart)
of the FX index during the last 365 days. So if the white dot
is close to the top, the currency is close to its highest
valuation. If the white dot is close to the bottom, the currency
is near its lowest valuation. The blue bars indicate the
distribution of valuations over the course of one year. The
span between high and low valuation is divided into ten ranges
(ie, deciles). Then the number of days during which the
currency's valuation has been in each of these deciles is counted. The number
of days is proportional to the width of each of the ten blue bars.
Thus the position of the white dot relative to the width of the blue
bars indicates if the current valuation is a relatively common event
or a relatively rare event. For example, if the bulk of valuations
has been in the lower deciles, and the white dot is near the top where
the bars are narrow, the currency has recently moved up sharply.
These charts ("FX conifers") are a simple method of visually
summarizing the performance of a currency over the time period of one year.
One useful feature of this chart is that it automatically adjusts for
the different volatility of currencies, as the span between one-year
high and one-year low is a reflection of a currency's volatility.
Where else can I find information about trade-weighted exchange rates?
Trade-weighted exchange rates are computed by a number of statistical
agencies, governments, and supranational organizations such as the
International Monetary Fund. Many of them differ slightly in the way
they calculate the trade-weighted indices: which currencies they include
in the "basket", which weights they assign, and how these weights are
updated over time. A good place to start for the USD is with
the time series offered
by the St. Louis
Federal Reserve Bank in the U.S.