Oil prices are above $120 a barrel on geopolitical tensions and fears that Tropical Storm Fay will make landfall for the third time, which is an extremely rare occurrence.

The correlation between crude prices and the US Dollar has been greater than 70 percent since the beginning of the year. This correlation is evident in the following chart of oil prices and the USD/EUR. The sharp drop in crude prices single handedly triggered the sharp dollar rally between July and mid August. Now that oil prices are creeping higher once again, it would only make sense to see the US dollar slip as well.

Although I think that we have not seen the end of dollar strength, the combination of weaker economic data, troubles in the financial sector and rising oil prices should lead a further correction in the dollar this week. The biggest risk in the markets right now are the financials. Lehman Brothers must be hiding some big write downs if they held secret meetings to sell up to 50% of the company to South Korean or Chinese parties. This follows talk early this week that they plan on selling their asset management arm. Also don’t forget about Fannie Mae and Freddie Mac who have seen their shares plummet. The threat of nationalization or serious government intervention is posing big problems for their shareholders.

If oil prices move back above $130 a barrel, the 30 cent drop that we have seen in gasoline prices could reverse, bringing back concerns about inflation and the outlook for the US economy. For the time being, the US dollar is still at the whim of oil prices. The biggest beneficiary of the rise in oil is the Canadian dollar which is up significantly against the greenback today.