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Oil has plunged a little more than $13 over the last seven days of trading, making it the strongest pull-back the commodity markets has seen so far this year. Much of the downside action came as clear sings emerged that the global economy is not in the shape the market believed it was. 

Crude oil has a tied connection with the global business cycle, as it is used as world’s main source of energy, and business expansion is reflected in the speculative interest in crude trade. Investors gauge the world growth rate to forecast oil consumption, and based on that determine a potential price for the raw material.

On Thursday, crude oil managed to post some small gains, shortly after the IMF issued a report in which it upgraded the global growth forecast for 2010. According to the Fund, the world’s economy is going to “expand” 2.5% next year, but, as a side-note, a global growth rate smaller than 3% is seen as a contraction, TheLFB-Forex.com Trade Team notes. It also forecasts contraction to be maintained in 2009, and has the Euro-zone as the weakest major economy.

Oil’s current downturn and currency correlation has been quite interesting to observe. Most of the time, when oil retraces, it sends a strong wave throughout the forex and the equity markets, in the form of risk-aversion. However, over the last few days, a time in which crude oil has declined at a strong pace, the major currencies and equity markets, posted only limited downside action. 

This may be a sign that the market is shifting its correlation/focus towards regional earnings season updates, and less towards the global growth story; time will tell. It will be interesting to observe over the next few days if the dollar will be able to move without its close oil link.

How well correlated are the global markets, and how does one impact another?

Eur/Usd has not really lost its correlation with the two global markets, shown below, that impact dollar values and set fair value during the course of each trading session.

1. The euro makes up nearly 60% of the dollar index, and as such provides a window into Usd sentiment:

Jul

 
2. The S&P Futures market has dominated global trade, and been a reflection of global investment sentiment throughout the credit crisis:

Jul

 
3. As we can see, the Eur/S&P correlation is strong. Then add in the West Texas Intermeiate oil chart below:

Jul

We can then see that, like a spider's web, a pull on one side of the market creates a push on the other side. Global markets are elastic, they flow across one another, and they create a series of momentum waves.

There is no point trying to trade forex without knowing what is moving values as each regional market gets underway:

It is oil and equities.