US Dollar making strong ground

Last week started off with the news that the government of Abu Dhabi is stepping in to bail out its faltering neighbour Dubai.

This is an ongoing saga and one which hasn't reached a conclusion yet, but the bailout was unsurprisingly taken as a positive signal by equity markets and in pre-market trading the Dow Jones rose almost 100 points.

Once again it traded above the 10,500 level and recorded a new yearly high. But as has been the case each time the Dow breached the 10,500 mark over the past month, it was unable to hold above this level, and over the course of the day lost most of its gains.

Monday set the tone for the rest of the week and while the Dow Jones did get back above 10,500 on a couple of occasions, it didn't spend too long up there. At the time of writing the Dow Jones is down more than 2% from Monday's highs. As we said the previous week, we believe that the risk-to-reward on a buy and hold strategy from these levels is not sufficient to enter such a trade, and the Dow's weakness above 10,500 is perhaps an indication that it's more than just Delta Index who believe this.

There isn't a massive degree of volatility in the equity markets at the moment, with traders presumably more focused on totting up their bonuses for the year than taking new positions. As such one can expect the equity markets to move mostly sideways over the next two weeks and within a tight range.

Currency markets have had far more pronounced moves than equities this week. Volatility on the dollar index has risen significantly above its three month average, while equity volatility has reduced over the same time horizon. The dollar index rose 1.5% from the previous Friday's close, and the euro/dollar fell almost 2% to $1.43. Since the start of the year there has been a strong inverse relationship between equity strength and dollar strength. However, over the past month this correlation has broken down, and there seems to be a shift back towards more fundamental interest rate driven dynamics. Recent speculation that the US Fed may need to increase rates sooner than many had been predicting, has caused money to flow into dollars. When the Reserve Bank of Australia, said on Thursday that it may not need to raise rates next year the AUS/USD fell 1.5% overnight. Traders are leaving the baggage of the financial collapse behind them, remembering rosier times and going back to the fundamentals of currency trading.

Whether you care about, or indeed believe in, the fundamentals of currency trading, a strengthening dollar fits our view for the forthcoming year; a year which will most likely see significant periods of equity market depreciation and a realisation that economic woes may be more protracted than most are currently pricing in. The safe haven properties of the US dollar will be a significant enticing factor for investors, allied to this is the prospect that the US may start raising rates before the Europeans do.

Crude rises despite GREENBACK strength

The price action in oil this week has been quite surprising. While the dollar has continued to strengthen, oil prices were actually up on the week. On Monday however, we initially saw a continuation of the previous week's sell off, as US light crude fell through $70/bbl. However, despite momentarily breaking through $69/bbl, oil prices rallied to the close on Monday evening. On Tuesday this rally continued, mainly due to the fact OPEC raised their world demand forecast for 2010 by 70,000bpd. Possibly it was due to Goldman Sachs mentioning in a technical note that they see crude prices rising to $82/bbl in Q1 of next year. It is worth mentioning that following Goldman Sachs "calls" on oil of late has proven to be quite costly.

Trading on Wednesday was typically volatile. Firstly the weekly oil inventory report, showed a surprise drop in crude supplies, which sent prices surging higher. However the rally was abated after the US Fed's statement, which highlighted an improving economic outlook which strengthened the dollar which in turn pushed crude prices lower.

Despite the upward correction this week, the overall technical picture is still quite bearish. A move above $76/bbl may alter our view but in the medium term we believe our target of $65 mentioned last week is still attainable.

Written By Grace Smith and Vinay Sharma traders at Delta Index