Middle East Tensions Ratchet Up the Oil Price

Yesterday’s trading stayed on theme with what I wrote in the Pfennig, with the currency markets running a bit scared about the unrest in the Middle East. The dollar continued to fall versus most of the major currencies with the commodity-based currencies of South Africa, Australia and New Zealand posting the largest gains. We have got a lot to cover today, so let’s get right to it.

The currency markets continued to be focused on events in the Middle East, as Iranian state-run television said that the nation will send two warships through the Suez Canal to bolster its Syrian ally. The price of crude oil moved to a 30-month high overnight as at least four protesters were killed in Bahrain as tanks entered the capital. According to a news story in the UK Telegraph this morning, “the situation is fraught with risk since a Sunni monarchy rules a Shia majority with mixed Iranian ancestry.” Sounds a lot like the situation in Iraq! So the killings in Bahrain are concerning not because it is a major Middle East power, but because they could easily trigger intervention by Saudi Arabia. Events in the Middle East will continue to hold the attention of the currency markets over the next few weeks, and any escalation of conflict would likely push the price of oil even higher. The opposite is also true, as a calming of tensions would allow oil prices to settle back down.

So what does all of this mean for the currencies? Well the conflict has rallied the traditional safe haven currency of the Swiss franc (CHF), which is up about 2% versus the US dollar over the past week. And the increase in the price of oil has pushed the Norwegian krone (NOK) and British pound higher (GBP). Finally, the crisis has rallied the price of gold, bringing up the value of the South African rand (ZAR) and Australian dollar (AUD). Gold rose to a one month high as the mid east concerns combined with inflation concerns to propel the price of the shiny metal toward $1,400. Surprisingly, the US dollar was not sought out as a safe haven, and has been drifting lower over the past week. It feels as if investors are concerned with the Middle East, but aren’t fully convinced the tensions will escalate into a full-blown war.

Traders here in the US had a lot to focus on other than the Middle East yesterday, as we got a plethora of data releases. CPI came in a bit higher than economists had expected (Chuck has more on this later) and the weekly jobs data showed a fairly large jump in the number of people filing for unemployment. Continuing claims for unemployment also increased and is ticking back up toward the 4 million number, which the administration definitely wants to avoid. The employment information was followed a little later with the release of the Leading Indicators, which stayed positive (but just barely!) at 0.1%. Finally, the data was rounded out with the MBA Mortgage Foreclosure and Mortgage Delinquencies numbers, which both showed that the housing market is still not out of the woods. Mortgage delinquencies were reported at 8.22%, which is an improvement, but still too high to support any sort of rebound. The foreclosure numbers weren’t as pretty, as they ticked back up to 4.63%, matching the all time high hit in March of 2010. Many felt the number of foreclosures here in the US had peaked, but this latest data indicates this may not be the case. The double whammy of the sluggish housing market and stubbornly high unemployment numbers will continue to hang over the US recovery prospects; and when you add higher consumer prices into that mix, you are risking stagflation.

As I indicated earlier, Chuck sent me his thoughts on the US CPI numbers:

US consumer prices increased by 0.4% in January, beating market expectations for a 0.3% increase, and the annual inflation rate rose to 1.6%… And that’s using the government’s numbers, folks. Yes, this indicates that by using the government’s numbers we have a mild rate of inflation in the US economy… But, if we step back, and don’t use the government’s numbers… Well… Our friend over at Shadow Stats, John Williams prefers to not use the government’s numbers and prefers to use the pre-1990 way of calculating inflation… You know, before the infamous Boston Commission made their recommendations to Big Al Greenspan, and the president at that time, who’s name I will not mention, to “substitute” and use “weighting” in their calculations of inflation, which would then allow the CABAL (Fed) to keep rates low, or even lower them, in order to facilitate housing for the masses…

Oh… BTW… John Williams has US inflation running at nearly 6%. Now… That feels more like it, eh?

The commodities have certainly been rallying, and they carried the commodity-based currencies with them. The Canadian dollar (CAD) reached its strongest level in two years versus the US dollar as crude oil neared a 2-year high, but the gains were tempered by the poor economic data released in the US. Higher oil prices have also been good news for the Norwegian krone (NOK), which had been slipping versus the US dollar after GDP growth in Norway slowed. Data from both Norway and Sweden, two of our faves, disappointed the markets and showed that Swedish consumer prices fell, while the nation’s unemployment rate was greater than estimated. But the underlying economic numbers in both of these Nordic powerhouses are still better than most others in the G10, so missing a couple of expectations isn’t going to have a long term negative impact.

Norway in particular has been in the news, as their Central Bank Governor Øystein Olsen said he wouldn’t set policy according to the value of the krone. “We don’t want to take the responsibility for the currency level nor the overall competitiveness of the manufacturing industry,” Olsen said yesterday in an interview in Oslo. This was a change in direction for Olsen, who had previously said he would keep a closer eye on asset price bubbles when setting policy. He now is solely concentrating on keeping inflation at bay, which is exactly what a good central banker should do! This news should be good for the Norwegian krone, as inflation is definitely moving higher, and will likely force another rate increase by the Norges bank in mid-2011. The Norwegian krone continues to be one of my favorite currencies as Norway has it all going in the right direction: Incredibly solid economic fundamentals, an economy which is growing, a central bank which has pledged to keep inflation at bay, and oil exports.

Our SVP and General Counsel at EverBank, is a regular reader of the Pfennig as he is a fan of the currency markets (and I’m sure he also wants to keep an eye on what Chuck is saying!). He occasionally sends me and Chuck articles, and one he sent earlier this week spoke about a currency that I rarely talk about: the Indian Rupee (INR). The rupee is heading for the best week in 2 months as higher yields and solid economic growth has sparked overseas interest. The Indian government forecast that the economy will expand 8.6% in the year ending March 31, the fastest pace since 2008. But the article sent by our top lawyer pointed to two critical factors that could decide the rupee’s near-term fortunes against the US dollar.

Inflation is a concern globally, and food inflation is a major concern in India, which has a history of supply shortfalls. India could combat inflation with higher rates, but these higher interest rates will invariably attract foreign investors who will pump more capital into the Indian economy stoking further inflation. It is a vicious cycle that is being repeated in a number of developing countries, including Brazil.

The second risk facing India is its growing current-account deficit. India, like the US, is a net importer and reliant on foreign capital. While higher rates are currently easing the burden of funding this deficit, global markets can be fickle, and India definitely needs to bring the current account deficit, which stands at 3.5% of GDP, down. India is constantly compared to China, as both have put together an impressive record of economic growth. But China has the advantage of being a net exporter, and is therefore in a much better position than its smaller counterpart. India is a popular investment with WorldMarket investors due to their strong growth rate and high interest rates, but as with any currency investment, there are always associated risks.

And finally, something Chuck spotted on the news wires early this morning (yes, even when he doesn’t write the Pfennig he is still up early and looking at the markets!):

Chris, I saw this tidbit this morning and my conspiracy blood started boiling!! “The Federal Reserve ordered the 19 largest US banks to test their capital levels against a scenario of renewed recession with unemployment rising above 11 percent, said two people with knowledge of the review.” What does this tell us? Well, if you have conspiracy blood like me, it tells you that The Fed/CABAL “is scared”… Now… If that’s how they feel… Why not tell us, instead of in their minute meetings, or press conference, or testimony before lawmakers? OK, this could be nothing more than a tempest in a teacup… Or…

To recap: Middle East tensions sent the price of oil higher and investors took safe haven in the Swiss franc. Gold is also seen as a safe haven, protection against both global uncertainty and inflation! US inflation ratcheted higher, and housing and employment are still drags on the US economy. Norway is set to post nice gains, and a couple of concerns were raised regarding India.

Chris Gaffney
for The Daily Reckoning