Equity traders watch currencies, oil traders watch the
dollar and lately everyone watches the price of oil. The relationship between
the price of crude oil and the value of the dollar has been unusually close in
the past year and especially so following the peak crude oil price on July 14th.The inverse correlation has been strict, as
the dollar rose oil fell. Even the dates for the reverses in each market mimic
each other.The dollar reached bottom
against the euro the day after oil reached its apogee. July 15th ,the day of the dollarâ€™s plunge the Dow closed
at 10,962.54.Since then oil has fallen
more than 20%, the dollar has gained 8.5% against the euro and the Dow has
returned 5.3%, (all dated to the Friday close).
The effect of a lower
oil price has been much less pronounced on equities than on the dollar. This is
odd because oil acts on the currency markets and the equities in much the same
manner:through its effects on the US economy.
What insight can we gain from comparing the behavior of the three markets since
the oil bubble was punctured in mid-July?
That oil was in a bubble has been clearly demonstrated by
its behavior since the peak.When
Hurricane Gustav became a potential threat to American oil and natural gas
production in the Gulf of Mexico the price of
crude rose more than seven dollars on world exchanges.When the Federal Government announced that
oil would be released from the Strategic Petroleum Reserve to counter any
shortage created by the storm the price of crude fell back almost to its
starting point.That is a normal
commodity market reaction not a bubble induced lunge.
On July 14th President Bush lifted the executive
order prohibiting drilling on the US continental shelf and challenged
Congress to do the same with its own prohibition.Oil began its long fall that day, the dollar
its month long rise the next.There is
no coincidence in these dates. Oil traders know that 70% of the American
population supports drilling for oil in American territory. The congressional
ban on offshore drilling expires on September 30th.Congress must act to renew the prohibitory
regulation or the ban will lapse. Traders were betting that in an election
year, with a very close presidential race the Democrats will be forced to
permit drilling or risk seriously damaging the fortunes of their nominee Barack
What was obvious then is even more obvious now that the
Republican presidential candidate John McCain has chosen Sarah Palin the
Governor of Alaska as his vice presidential running mate. The Republicans
clearly intend to make energy policy and specifically drilling for oil a major
topic in the election. Sarah Palin is both pro-drilling and well versed in
energy politics. As the campaign progresses, the pressure on oil prices from
the potential for increased supply will intensify.
The dollar has been boosted by several factors: the US
economy out-performed the European Monetary Union (EMU) by a wide margin in the
second quarter; the Fed rate reduction of 325 basis points has given the US
economy the edge on recovery and the ECB has provided no stimulus for the
European economy; the next rate move by the Federal Reserve is likely to be a
hike and the ECB will probably cut;the
belief that the US is ahead in the economic cycle having fallen briefly into
negative growth in the fourth quarter of last year while the EMU did not shrink
until the second quarter of 2008.
US equity markets have several factors leaning against any
prolonged upward move.The residue of
the sub-prime and asset backed securities problems are proving much more of a
threat to the financial system and the resumption of normal credit markets than
many anticipated.The financial system
will be hard pressed to resume normal functioning until the housing market has
stabilized.As long as the underlying
market continues to decline, assets based on valuations from that market will
continue to fall as well.
The best hope for a
sustained US recovery now
rests with the US
consumer.US exports, for many months
the driving force behind GDP growth, will begin to wane as the dollar
rises.Consumer spending as given by
real Personal Consumption Expenditures (PCE) was only 0.7% higher in July over
the previous year.There is little doubt
that rising oil prices -- headline inflation was 5.6% in July -- is one of the
primary stops on US
consumer spending and sentiment.If
lower oil prices can help bolster the US
consumer and transfer some economic growth from exports to domestic
consumption, the US
economy stands a good chance of avoiding a prolonged period of slow or negative
In a very accurate sense the American voter has identified
the one factor that has the greatest chance of preventing a painful decline in
economyâ€”lower oil prices.It is also the
factor that will do the most to press the rise in the dollar.
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future results. FX Solutions, LLCÂ® believes that customers should be aware of
the risks associated with over-the-counter, spot Forex. Forex trading is highly
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