Recap of data and methodology

To maintain its trade-weighted dollar index (http://www.federalreserve.gov/releases/H10/Weights/), the Federal Reserve must keep track of the changing use of various currencies the U.S. receives in return for its exports and pays for its imports. In these charts, export weights are depicted in blue and import weights in green.

These weights are calculated on an annual basis and, of necessity, after the fact. Because the Federal Reserve is unable to license its dollar index for commercial purposes, many traders are unfamiliar with this data.

Also, these currency weights reflect their use in bilateral trade with the U.S. and do not reflect total bilateral trade. This is critical for countries from whom the U.S. imports large quantities of goods priced in dollars, such as crude oil and various metals.

Annual data are of little trading use in a continuous market such as currencies. We can create smoothed series of import and export weights via a statistical technique called “cubic spline interpolation.” This technique is used twice in the charts below — once to create quarterly series from the annual numbers and a second time to create monthly numbers from the quarterly results.

The resulting interpolations are far easier to absorb than the annual numbers, but as they involve two separate data transformations, we did not attempt any further statistical analysis against monthly currency values. In addition, please be advised all currencies are displayed in the “USD per” convention familiar to traders of the euro, the British pound, and currency futures. The currency scale is inverted for currencies commonly expressed as “per USD,” so a rising red line always conveys strength vs. the dollar and a falling red line always conveys weakness.

Even though the principal advocate of floating exchange rates, the late Milton Friedman, was the antithesis of a protectionist, his arguments have been seized by this faction to the extent that the notion a weaker currency should stimulate exports and reduce imports will be referred to as the “protectionist argument.”