What's with the Dollar, Oil and Airlines?

The Dollar, Oil and Airlines: A Nice Relationship Until The Government Steps In

By Rick Pendergraft

Over the last month, the intertwined relationships of the markets have been wacky to say the least.  It was on July 15 that the SEC announced their protection plan for Fannie Mae, Freddie Mac and 17 banks and brokerage firms.

The move by the SEC totally disrupted the natural ebb and flow of the market.  Financial stocks bottomed (for now) on July 15.  This makes sense since the government stepped in to protect their offspring (the government sponsored entities FNM and FRE).  But the next part doesn’t really make sense.  Oil peaked on July 15.  What does the U.S. government bailing out financial institutions have to do with the oil market?

I should warn you now that the rest of this article is littered with charts, but I find that the charts can tell the story better than the written word.

Let’s start with the chart of the dollar.  First, on a daily chart the dollar looks like it is in the midst of a major breakout, but before you uncork that bottle of champagne to celebrate the end of the declining dollar, look at the weekly chart below.  The trend line connecting the highs of the past four years is still in place and the dollar has yet to move above some very significant resistance in the way of the 100-week and 200-week moving averages.  And even if the dollar goes on a tear, it might not be a good thing.  Take a look at Lynn Carpenter’s article on the relationship between equities and currencies.

This rally in the dollar has dramatic effects on oil, and why not, after all it was the falling dollar that helped lift oil to record levels over the past few years.  Look at the chart of oil below and you see the incredible climb from $70 to $145 in less than a year. 

However, look at the 200-day moving average there at the $110 mark.  Now look back at the high in March and the low in May.  That’s right they are right at the $110 mark.  I look for this triple level of support to provide a bounce in oil over the next few weeks.

Now it stands to reason that if oil is falling, then airlines should be rallying.  That is just what the AMEX Airline Index has done over the last month.  Look at the daily chart below and you can see that the XAL doubled from July 15 to August 15.  It would be an incredible move for a stock to double in a month, but for an index to double in a month is almost unheard of.

The point of all this is that the SEC stepped in to protect the financial sector by issuing a directive not allowing naked short selling (an illegal practice) on Fannie Mae, Freddie Mac and 17 other financial stocks.  By interfering with a so-called free market, the SEC manufactured a rally in financial stocks, a rally in the dollar, a pullback in oil and gold, and a rally in airlines stocks.

This just goes to show you how intertwined all the different markets are and how one government intervention has ripple effects across many markets. 

All this being said, it looks like the dollar has too much resistance to get through in the near term and oil has too much support at $110 to blast right through this level at this point.  Look for a pullback in the dollar and a rally in oil over the next few weeks.  This should of course send airlines back down a little as a result.

Good luck and good trading,

Rick