By the end of this month, the Federal Reserve will have completed its asset purchase program, bringing its second round of Quantitative Easing to an end. As QE2 draws to a close, it is worthwhile to consider how the dollar could react. When the first round of Quantitative Easing came to an end, we saw a massive dollar rally (see EUR/USD chart below). USD/JPY did not participate in the rally because of lingering concerns about the need for more stimulus (second chart). The dollar index on the other hand rallied as much as 10 percent as the greenback strengthened against high yielding currencies (third chart) – this suggests that once QE2 ends, we could see a more significant dollar rally.
The exchange of artillery fire between North and South Korea is the biggest story in the financial markets today. 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 percent against the U.S. dollar. Investors also tend to bail out of any risky, high yielding currencies and move into the safety of low yielding safe haven currencies. In the current market environment, the low yielders are the U.S. dollar, Japanese Yen and Swiss Franc, which are all up strongly today. 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 U.S. 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 have yet to launch their fighter planes. The main beneficiaries of a war between North and South Korea will be the U.S. dollar and Swiss Franc. Despite low yields in the U.S., 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 a traditionally neutral country that still moves alongside gold making it an incredibly attractive haven for safety.