This is how bombs and peace affect the currency market

Oil prices are plummeting as it becomes clear that US bunker bombs are not leading to an escalation of the Middle East conflict. However, the lukewarm reaction on the currency market suggests it is too early to declare real peace.

The U.S. attack on nuclear facilities and other targets in Iran could theoretically have added fuel to the fire in the sweltering Middle East. Instead, oil prices have plummeted in recent days. The same barrel of Brent crude that was trading at over $77 on Friday was priced at just $66 at midday on Tuesday. The sharp drop in oil prices is largely a result of Iran's muted response to the U.S. bombing and President Donald Trump's announcement that the two countries have agreed to a ceasefire.

Fragile peace
According to Trump, the ceasefire would have gone into effect on Tuesday morning at 6:00. However, both parties accuse each other of having carried out attacks after that time. The currency market is also giving a very clear signal that the peace is very fragile. Oil currencies such as the Canadian dollar and the Norwegian krone are both slightly higher on Tuesday than before the weekend. Between early March and mid-June, these currencies have already risen by 7% and 14% respectively against the US dollar. For Canada and Norway, it is not such a disaster that the loonie and the nokkie – as these currencies are also called – are taking a step back.

The downside of a powerful coin
A strong currency is often less attractive than it seems. It may be cheaper to import products, but the exchange rate shift to less highly valued currencies means that products from Norwegian and Canadian manufacturers are becoming a bit more expensive abroad. This makes it more difficult for companies from these countries to compete on the international playing field. This is a particularly unpleasant development for Canada, as the country has a fairly open economy. In order to give its own economy a boost and keep the loonie under control, the Canadian central bank has almost halved the policy rate in just over a year, from 5% to 2,75%. Last week, the Norges Bank implemented its first interest rate cut in over five years.

Playing the trump card
However, the interest rate hikes of central banks are worth little if tensions flare up again. Because Iran is virtually powerless in military terms, there is still the risk that the country will play its most important trump card. If Israel increases the pressure too much, it can close the Strait of Hormuz to shipping. As much as a quarter of all oil finds its way through this narrow strait. In the past, the mere threat of a closure was enough to push the oil price up by 10% to 20%. As long as this scenario is not off the table, a quick step back for the loonie and nokkie is not likely.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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