The equity markets have taken a sharp turn south today, the consensus for the catalyst seems to be those weak consumer confidence numbers that were released today, but I suspect this is the longer term effect of the Fed’s rate hike from last week. Historically, the effect of a change in the discount rate takes much longer to see than a day. In the S&P, the market has breached the up trend that began in the beginning of February, looking like the beginning of a new downtrend in equities. If this proves to be true, look to 1000 in the S&P for support. There is the chance that this move is in anticipation of Bernanke’s testimony tomorrow, and traders are afraid of incoming rate hikes. I have stated before that I believe he will say the opposite, and rates will stay depressed for the foreseeable future, which should rally the market.

Turning to commodities, oil still trades within its current range. A break below $70 would signal a long term loss in confidence, weighing heavily on those currencies that have held up well against the dollar, namely AUD. Since gold is trading below its highs, we can see that the long term outlook remains intact.

What does all of this mean for the Forex market? Watch Bernanke’s testimony, if he maintains that rates will remain low, look for this year’s trend to continue. But if he does not, the trend could easily reverse.

In the final part of my guide to intermarket analysis, I will discuss the only market that even comes close to the global level of Forex: commodities. For the most part the relationship between the commodities and Forex markets can be seen by following oil and gold.

Gold is a great way to measure the long term inflation expectations, since gold is viewed as the quintessential store of value. As people begin to see their money devalue (i.e. inflation), they will buy more gold since its value is relatively stable.

When relating this information to the Forex market, it is key to understand what the market is expecting for inflation. The market likes a little inflation, since they will expect the central bank to increase interest rates to combat it. However, rampant, out of control inflation sends a wave of panic through the market. The gold market also gives useful information about the equities market. A rise in equity prices along with a rise in gold prices implies that the rise in equities in mainly inflation driven. While an increase in equities without a similar rise in gold implies that it is driven by growth.

Aside from being a proxy for market fear, gold has a strong relationship with the AUD. Australia has a large surplus of natural resources and are among its largest exports are metals. So, if gold begins to rise as a result of an increase in global demand, then this will increase the demand for Australian dollars and strengthen them.

The market loves growth, as long as the world economy is expanding then currencies are able to pay out consistent high interest. Oil is useful as a proxy for growth expectations. The larger that the world economy becomes the more energy that it will need, so as the demand for energy increases the price of oil will rise. The price of oil is generally positively related to the risk based currencies, since they pay the most interest.

In particular USDCAD is strongly correlated to oil since Canada is the top supplier of oil to the US. As oil becomes more expensive more Canadian dollars are need by American purchasers, which weakens the currency pair.

Commodities are most useful when taking a long term approach to your trades. While traders who keep a shorter time frame on their trades will find more useful information by watching the equity markets.

Last Friday confirmed the beginning of a down trend in unemployment in the USA, and while the employment change was still negative, the trend was improving as well.  This is important in that, from an historical perspective unemployment is highest at the end of a recession.

So why the lack of strong increase in risk appetite?  Well, the market is centered on sentiment, which is how the participants feel about the economy.  So, the fact that the unemployment numbers are signaling the beginning of economic recovery is ignored. However, to an informed trader ignored information is gold. The sentiment of the markets can turn quite slowly, however as recovery begins to take hold more and more data will come in better than expected and the market will no longer be able to ignore it. This week has many good opportunities for better than expected news so look for opportunities to buy risky currencies.

From a technical perspective, the USD is sitting at highs from last July.  While according to the stochastic oscillator it is overbought against the EUR GBP and AUD on a day chart.  In other markets, US equities are sitting at sentimental support with the DOW hovering around 10,000.  Gold has maintained it drop that began this year, showing a build up in risk pressure.

Fundamentally, growth has been signaled in the USA, while technically the USD is overbought, making for perfect condition for a rally in the risk based currencies. There are several events later this week that have potential to spark a selloff in the USD.