The strong rally in U.S. equity markets brought some confidence to traders on Wednesday. Previously beat-up sectors such as oil and banking helped set-off a broad-based rally. Early in the trading session it looked as if the Dollar was going to regain the strength it exhibited on Tuesday during a tough Senate questioning session of Treasury-Secretary nominee Geithner. Once the questioning moved away from personal issues and Geithner was allowed to talk about policy, the equity markets bottomed and closed near the high of the day.

A turn to the upside in the Euro coincided with the start of the rally in equities as investors gained confidence in holding the higher-yielding Euro. The markets seem to be trading on emotion at this time as no-concrete evidence exists that shows central bank and government stimulus is working to reverse the global economic slide.

Euro traders should note that although the European Central Bank has appeared as if it is dragging its feet relative to the other more aggressive central banks during the current financial debacle, it does seem to have somewhat of a plan to its activity. Plainly stated, the ECB has patiently stood by while other central banks such as the Fed and the Bank of England have cut interest rates to near-zero and thrown good money after bad assets with out any accomplishments to show. Although the Euro Zone economy is facing the same economic weakness as other industrialized nations and the threat of a debt reduction rating of three of its members, it does seem to be stable while all around is crumbling. This leads me to believe that the ECB is learning from the mistakes of others and is poised to release a powerful, more creative economic stimulus plan of its own.

Start watching the EUR USD for bottoming action as traders may begin to cover shorts in preparation for some bullish news.

Early in the trading session there was a follow through break in the GBP USD following yesterday’s massive selloff. With the Bank of England seriously considering driving interest rates to zero and the U.K. government hinting at nationalizing banks, traders had no choice but to continue to press the short side. The suggestion of flooding the markets with Pounds along with providing the BoE with enough capital to buy asset-backed and toxic assets has, no doubt, put pressure on the financial system. The U.K. government and the Bank of England are responding in an aggressive way to help alleviate the threat of an implosion of the entire U.K. financial system.

Sensing a worsening economic condition that could threaten the stability of the U.K. and Europe the G-7 nations agreed to call a meeting to discuss the U.K. banking issues. Although this may only turn into the customary photo-op for G-7 members, just the announcement that they are willing to take a look at the situation was enough to trigger a short-covering rally by the end of the day. The G-7 has no real power in this matter. It just goes to show you how emotional these markets can be. Even the shorts that are in control at this time feel threatened enough to lighten up their positions.

An unusual move took place in the USD JPY market today. While the market was trading near 90.00 and option expiration time approaching, long traders holding on to 90 strike calls decided to throw in the towel and stop supporting the Dollar. This caused an immediate drop in the USD JPY as shorts pressed the market all the way to 87.11. This move triggered the selloff in U.S. equities.

Several weeks ago the Bank of Japan warned against excessive volatility and wild speculation in the Yen. Sensing that the BoJ may be ready to intervene, shorts covered and drove the market higher the rest of the day. As the U.S. stock market gained ground, trader appetite for risk increased and the Yen weakened. Although it could not regain 90.00 or produce a positive closing price reversal, Wednesday’s action may be sending a sign that the worst is over at least in the short-run, and the USD JPY is getting ready to rally. Start watching for a follow-through rally to the upside.

The USD CHF gained substantially on Wednesday following an announcement by the Swiss National Bank that it is poised to intervene. Fearing deflation down the road, the SNB is set to sell Swiss Francs in an effort to weaken its currency. Continue to look to the long side based on this action. In addition to the threat of an intervention, the Swiss economy still remains vulnerable to the weakening Euro Zone, Eastern European, and Russian economies.

The strong rally in the crude oil market triggered a reversal top in the USD CAD. This top comes inside of a major resistance zone and may lead to the start of a 3-5 day break. Traders will get their best sign that this top is for real if the market can follow through to the downside with a break through 1.2543 tomorrow. Increased trader appetite for more risky assets such as crude oil, natural gas and gold should also help drive the Canadian Dollar higher.

The Australian Dollar rallied after investors gained confidence in buying higher-yielding, higher risk assets. Early in the trading session, the Aussie was under pressure as weakness in the global financial markets was triggering moves into less risky assets such as the Yen and the Dollar. Once the stock market bottomed about mid-session, traders gained confidence and drove the AUD USD higher into the close. Even though the Aussie rallied, this action should not cause the Reserve Bank of Australia to change its mind regarding an interest rate cut at its next meeting on February 3.

The NZD USD started the day extremely oversold following a week of selling pressure. Today’s rally in the U.S. equity markets gave shorts an excuse to bailout and take profits. Looking at the bigger picture, the Kiwi is poised to move lower especially if the S and P Corp. follows through with its threat to further cut the New Zealand credit rating. Gains could be limited to the upside over the short-run since the Reserve Bank of New Zealand is set to cut its benchmark borrowing rate by as much as 100 basis points at its next meeting on January 29. Watch the global stock markets for direction as there are still plenty of shorts left to cover.

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