FOREX.com's Market Outlook for Upcoming G7 Meeting

As is usually the case, much adieu will be made of this upcoming G-7 meeting in Tokyo especially at a time when it seems that just about everyone in all parts of the world are clinging to every economic news event as if their life depends on it. Simply put, this is what happens when ordinary people worry about losing their homes and that is precisely what the subprime crisis has done.

In years past, the rhetoric (both pre and post meeting) has predominantly focused on two major issues: (1) inevitable USD weakness (due to the gaping Trade Deficit) and (2) gradual CNY and JPY strength (most of this talk came from US and European exporters to level the playing field). We happen to think that this year's focus may be vastly different than in years past, and are on the lookout for some big market movements, most notably in the currency markets.

Where to begin? Let's start right here in the United States.

When it comes to the dramatic plight of the USD these past 5 years, you don't hear much complaining from either US officials or your average "man in the street". The weakening USD has gotten plenty of attention from the international media and the local business networks but, two key factors have quieted the western front: (1) most US companies have benefited from the swooning buck and (2) 90% of US travel remains domestic.

What about our European counterparts?

The exploding EUR/USD and EUR/JPY exchange rates have driven the European exporting sector (i.e Daimler, BMW) up the proverbial wall. But given the ECB's (European Central Bank) reluctance to ease interest rates (even in the subprime environment) as well as the repatriation aspect of the subprime fallout, the EUR/USD still seems poised to take out the key psychological 1.50 barrier no matter how much their exporting community bellyaches.

Finally, what about the pseudo members of the G7: China, Russia, and the Middle East? These countries own several trillion USDs worth of US assets and debt (especially China and ME) and historically have benefited greatly from their investment. But that was before the housing and credit bubbles burst. Now, US creditors need not only contend with a USD that has depreciated close to 40% in the past few years (and currently sits right near its all time lows) but also with some stinky real estate and bond investments that must look anemic at best in the current environment. Not good.

What do we expect will happen?

We believe this G7 meeting could get the ball rolling for a USD comeback. There are a multitude of fundamental reasons to support a stronger dollar including - recoupling, repatriation and a new US President in 2008. We speculate that these foreign creditors of the US must be up in arms with their "double whammy" predicament and therefore will implore US officials to do something about the weak USD. Keep in mind, the subprime crisis is still very much in its infantile stages and the actual losses may take years to figure out so there isn't much anyone can do about the sinking US housing and equity markets. But the USD problem can be fixed. Or, at least the forces that can actually "try" to do something about it instead of continuing their pattern of benign neglect.

Are we suggesting a coordinated intervention? Not yet (maybe if EUR/USD hits 1.60). But we do expect the "jawboning" to sway in the favor of the USD instead of against it - which would bring about a significant change in 2008. As a final note, keep in mind that in years past the USD traded down as the DJIA went up, but this year the reverse has occurred. If the G7 expresses concern of the USD weakness, we may be in for a significant reversal - as much as 20-25% is not out of the question.


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