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$/Equity and €/Oil Link. Chicken or the Egg

Written by A Forex View From Afar on Monday, July 14, 2008

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Today two major events happened, the first was the bail-out of the GSE companies, (Freddie Mac and Fannie Mae), and the second was the plan to once again allow offshore drilling in the U.S.

In big-picture terms, both are ‘dollar positive’ news items;

Equities. If the bail-out creates a new bottom in equities, the same as it did the last time a bank was helped by the Fed (the Bear Stearns case), it will equate to no more flights to safety, the treasury yields will actually start once again to rise, and they in turn will start to instigate dollar buying, but only once the confidence to commit to stocks returns. If that sounds like a big ask all we have to think back to is March 16th, the day before the Bear Stearns bailout, and recall just how depressing the environment looked then. Has it got worse since?

The answer in reality is no, it has not got any worse, but neither has it got any better. That conundrum is right now creating the guessing game on the dollar valuations. Both Fundamental and Technical traders have the same issue to deal with here in trying to assess where the breaks will come from, and whether they will hold, on the major pairs.

Oil.The euro has a very strong correlation with oil; at over 93% in the last year, according to Bloomberg, it eclipses the historical Usd/Cad link. If the plan to allow offshore drilling in the U.S. is approved then over time we will see more oil contracts hitting the market, thereby restricting the speculative interest in the overly-inflated crude oil prices. This will automatically empower the dollar, and de-value the euro.

So, how low can the dollar go? If the above moves take place, not too low it seems. The real test will be the dollar index reaction to a test of 71.50. We will see it in the 4 hour charts, the ones that right now are looking a little strained under dollar selling pressure.

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Fundies and Trading
There is a constant question from some traders as to why anybody would ever need to consider the ‘F’ word when trading. Fundamentals: what is so damaging at looking at both Technical charts and having a Fundamental filter to gauge how many Lots to put on? Why is it that accepting that Technicals give us price points to trade, but Fundamentals determine the direction that we travel is so difficult for some traders to accept? Without a Fundamental Filter very few pure Technical traders would have seen this Dollar move coming today.

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