Which Currencies Benefit from Tensions of War?

11/24/2010 12:01 am EST

Focus: FOREX

Kathy Lien

Managing Director and Co-Founder BKForex LLC, BK Asset Management

Geopolitical tensions and continued worries about European sovereign debt troubles pushed investors into the safety of the US dollar. The Spanish spread with Germany widened to record levels on concerns that Ireland's problems will spread to the fourth largest economy within the euro zone. Portugal will likely fall first, but investors could turn on Spain shortly thereafter.

Stronger-than-expected US economic data also helped to lift the dollar with third-quarter growth revised significantly higher. Between July and September, the US economy expanded by 2.5%, up from a previous forecast of 2.0%. The pickup in growth was driven entirely by stronger consumer consumption, which was revised up from 2.6% to 2.8%. Consumer demand fueled most of the growth in the third quarter and will be central to continued growth in the fourth quarter. US retailers are already starting to heavily discount their products with the hope of driving as much sales as possible in this soft economic environment. Although existing home sales and the FOMC minutes are still due for release this morning, it will be difficult for the data to overshadow geopolitical risks. Investors are nervous and US economic reports will do little to reassure them, even if the data is good.

Meanwhile, Canada's latest economic reports explain why the central bank is stuck between a rock and a hard place. According to the consumer price report, inflationary pressures are on the rise, but retail sales are slowing. CPI rose 0.4% in October, pushing the annualized pace of growth to 1.8% from 1.5%. Consumer spending growth, on the other hand, slowed to 0.6% in September from 0.7% the previous month. Excluding purchases of autos, demand was even weaker. Recent economic data from Canada has been very depressing, with employment, retail sales, and manufacturing activity all receding. Therefore, despite the uptick in inflationary pressures, the Bank of Canada will keep interest rates on hold for the rest of the year.

Beneficiaries of the North and South Korea War

Finally, the big story (on Tuesday was) the exchange of artillery fire between North and South Korea. Investors never respond well to geopolitical tensions, and in the case of forex, they usually react to geopolitical risks by dumping the currencies of the countries in question. As a result, the South Korean won has fallen more than 3% against the US dollar. Investors also tend to bail out of any risky, high-yielding currencies and move into the safety of lower-yielding, safe-haven currencies. In the current market environment, the low yielders are the US dollar, Japanese yen, and Swiss franc, which are all up strongly. However, Japan is only a stone’s throw from South Korea, and they have demanded a firm response by the US, Japan, and South Korea. By putting themselves in the middle of battle, they have effectively made the yen a less attractive safe-haven currency compared to the US dollar and Swiss franc. When the news first broke, the Japanese yen actually sold off aggressively in response.

If tensions brewing between North and South Korea escalate into a full-fledged war, there will be global ramifications. South Korea returned fire, but has yet to launch their fighter planes. The main beneficiaries of a war between North and South Korea will be the US dollar and Swiss franc. Despite low yields in the US, dollar-denominated investments are still the most liquid in the world, providing a good shelter for safety. Switzerland is also geographically removed from Korea and is a traditionally neutral country that still moves alongside gold, making it an incredibly attractive haven for safety.

By Kathy Lien of KathyLien.com

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