By Sean Hyman, Currency Analyst
www.worldcurrencywatch.com

As of yesterday, Iceland is facing an outright political crisis. (The Prime Minister was forced to resign in the aftermath of their financial crisis, and he doesn’t have a replacement.)

But strangely, the krona doesn’t seem to be responding to the added turmoil like it should. Let me explain…

The Krona Is Holding Its Own – Even Without a Prime Minister

Normally, all of that economic and political instability would be enough to cause the currency to go into a tailspin.

So why didn’t the currency sell off when the news broke that Iceland will live without a Prime Minister until May?

After all, Iceland’s economic crisis is far from over. The last time I wrote about Iceland, Iceland’s authorities were trying to secure a loan from the IMF, which is still pending. The IMF gave them certain stipulations before they would give Iceland any funding. The loan is up for revisions every three months and you can bet that the next guy in the prime minister office will likely try to work a revision.

However, with all of this going on, today traders are scratching their heads because the Icelandic krona is holding its own. In fact, any Forex trader who placed “sell short” orders for the krona yesterday were disappointed. (In the Forex market, you would short the krona by buying the USD/ISK pair.) The pair broke its uptrend the very same day!

Check out a daily, 1 year chart of the USD/ISK below. The panic in the krona coupled with the defensive play that the U.S. dollar was enjoying put a double whammy on the krona until Monday.

So let’s look at why the krona actually gained strength. You see, when the Prime Minister (Geir Haarde) resigned that day, the market got some hope that change could now come.

While currencies usually hate any major changes, it’s a bit different when those changes promise to fix a broken economy. In other words, Forex traders believe a new political situation in Iceland could actually help the economy. And the krona benefited from this belief.

All the Crisis Was Already Priced Into the Krona Anyway

See, everyone already knows about Iceland’s credit crisis, banking woes, etc., so all this bad news was already priced into the krona’s low price. So when the news broke yesterday that Iceland was facing a political crisis on top of everything else, nobody panicked.

In fact, it seems many traders took this as a sign of relief because it showed the markets that change can begin in Iceland.

Also, the fears are starting to calm down in the markets. When that happens, it will work against the U.S. dollar and benefit higher yielding currencies as money becomes a bit more risky and ventures back into currencies like the krona.

Now, I’ll readily admit that I wouldn’t be investing in the krona right now. I’d check into Norway’s currency or even Turkey’s currency before diving into this one. At least those currencies handled the credit crisis a bit better than the Icelandic krona.

But it’s important to note that many investors will eventually creep back into the krona at these beaten-down levels – especially now that IMF has given Iceland a loan. In fact, some are starting to tiptoe back in even now. That’s why the uptrend in the USD/ISK is likely broken.

Ask Yourself: “Does the Market Already Know About This Bad News?”

Iceland isn’t fully out of the woods yet. They still have to follow the guidelines of the IMF or they won’t receive their US$6 billion loan. Their credit rating hangs one notch above the level to lose “investment grade” status. So they’ve got to be careful here.

One thing that you always have to ask yourself about a currency is, “Does the market already know what’s happening to this currency and if so, has it had time to discount it and factor it in?” If not, then the market will most likely react to the new information.

So I’ll admit that a country without a political leader would usually kill a currency’s value. But Iceland is a special case right now. This soap-opera currency has endured so much already, that a new political situation is actually helping.

Iceland’s usual political situation leaves the door open for new thinking to come into that country and possibly help Iceland’s currency and economy. And that’s why the currency didn’t collapse when this latest crisis hit the news. 

Best Regards,
Sean