Tomorrow (Friday Apr. 11) at 1400 NY time, the finance ministers and central bank heads of the G7 nations (US, UK, Canada, Japan, Germany, France and Italy) will convene in a regular quarterly meeting that will overlap with the spring meetings of the International Monetary Fund (IMF) and World Bank over the weekend. US Treasury Sec. Paulson is scheduled to deliver a press briefing later Friday at 1845 NY time on the outcome of the G7 talks. The following is our outlook for the results of the G7 meeting and the likely impact on Forex market developments:
Going into the G7 meeting, FX markets are not expecting major changes to the currency section of the official communique. But it would not be a normal G7 meeting if there were not speculation of shifts affecting currencies. As to the timing of the release of the communique itself, based on past experience, a draft version of the final communique is likely to be in circulation before the G7 talks actually convene, perhaps as early as the NY opening or sooner. Such drafts have frequently proven to be the final version.
The primary basis for expecting no significant changes to the G7 statement on currencies is the absence of any public shift by US officials over the plight of the USD. That said, USD weakness is clearly an issue for other members of the G7, but without US agreement, there is likely no consensus to adjust the language. The other basis for expecting no changes to the currency statement is that the G7 is most concerned with stabilizing global financial market confidence and addressing liquidity issues to prevent an even larger impact on the global economy. Stirring up the currency pot at this juncture might produce heightened FX volatility, aggravating financial market stability in the short-term. Should the G7 maintain the prior language on currencies, I expect markets to return to prior existing themes, namely 1) selling USD, and other 'slowing' currencies like GBP and CAD, on deteriorating economic outlooks and 2) risk aversion/seeking trades (selling JPY-crosses/buying JPY-crosses) as stock markets undulate.
The speculation that the G7 may 'tweak' its FX statement stems from the extreme weakness of the USD and the potential for a catastrophic collapse in USD assets and a 'run on the USD.' If there has been a behind-the-scenes shift by US officials, the G7 language on currencies could be altered to express such displeasure. While there is no way of knowing exactly what form the language change might take, the more specific they are about the USD, or any currency for that matter, the greater the perceived market impact. An explicit reference might look like "Recent exchange rate movements have been excessive in light of long-term fundamentals, particularly in the value of the USD." A more oblique indication of G7 displeasure might be confined to strengthening the language in the "Excess volatility and disorderly movements in exchange rates are undesirable for economic growth" sentence. If they do alter such language, the G7 is implicitly referring to USD weakness, even if they do not mention a currency specifically. This sensitivity to potential shifts supporting the USD is partly responsible for the sharp rebound in the USD on Thursday-in general traders do not want to go into the G7 excessively short USD due to the risks of a shift in the G7 statement.
Should the G7 alter its language to indicate USD weakness has become excessive or otherwise undesirable, I would look for a substantial recovery in the USD on the order of 3-5% initially. Such a USD rebound would likely embolden risk appetites, so I would also look for gains in USD/JPY to outpace declines in EUR/USD, leading to overall higher JPY-crosses in the process. But make no mistake, if the G7 addresses USD weakness, I believe the impact will be substantial.
The other change that may be made would involve toning down, or removing completely, the explicit mention of China as needing to allow faster appreciation of its currency, in recognition of recent Yuan gains.
The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
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