Look Beyond Mid-East Conflict

03/29/2011 3:30 pm EST

Focus: FOREX

Kathy Lien

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

Conflict in the Middle East and rising oil prices are driving currencies right now, says Kathy Lien, but once the Mid-East tensions ease, inflationary pressure in the UK and euro zone stand to present good trading opportunities.

Currency traders are always following other markets including oil, especially now. Our guest today is Kathy Lien, here to talk about that. So Kathy, how is the price of oil affecting your currency decision-making these days?

Well the move in oil has been quite significant over a very short period of time, and what that has done is it’s really caused a lot of anxiety in the currency market because we have to acknowledge why are oil prices rising and the reason is because we’ve got a lot of tensions in the Middle East.

So, that tension is translating into risk aversion for currencies, meaning that the dollar is up and the Swiss franc is up. But I think it’s important for currency traders to look beyond the current events to what it means in the future. 

We had a similar spike, although a much more significant spike in the 1970’s and in 1990, and during that time oil prices rose significantly, inflationary pressures in the US had risen significantly as well.

Initially, the dollar rose because at that time a lot of people in the 1970’s thought that the Federal Reserve was going to raise interest rates in order to combat inflationary pressures, which they did, but then, when the interest rate hikes started to have a damaging impact on the US economy, the US dollar started to reverse its trend and fall significantly. 

And then in 1990, when we had a similar spike in oil, there was a very different environment where the Federal Reserve was lowing interest rates going into this oil spike and the oil spike just kind of made them more concerned about the outlook of the US economy and lowered it even further so in that scenario, we also had the dollar weaken after initial spike. 

So, I think that’s a lesson that we should take in this scenario as well, which is that first of all, we do see the dollar rising, but it’s rising because of risk aversion, but eventually the dollar will be more hurt than helped by higher oil prices because right now inflation is non-existent in the US, so that’s not going to push the Federal Reserve to do anything.

Instead, it will have more damage on the US economy and maybe on the US consumer, so as a result it will probably end up being more bearish for the US rather than bullish, and then at the same time, we’ve got other countries around the world who are at the edge of their seats in terms of raising interest rates and being worried about inflationary pressures so that two separate dynamics (are) going to be more negative than positive for the US dollar.

Alright, so if I’m an oil bull and I think it is going to $130, $150, or even higher, what currency pair would you then trade to take advantage of that?

Well I think that the best currencies to really look into right now are the ones where inflation is very, very hot and that’s in the euro zone and the UK.

Inflation is starting to be, in the euro zone, beyond their comfort zone and the UK already is, so I think that those central banks are going to get really anxious. So, once we have the Middle East tensions recede a bit, that those opportunities and those currencies will probably see further gains.

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