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Monday April 14, 2008 - 15:52:38 GMT
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G7 FX Communiqué Papers Over Large Differences on Dollar

As Reuters points out below, the G7 agreement to change the language in the communiqué on FX allegedly followed 2 hours of heated discussions to iron out and represented a concession to European officials, especially France (no wonder Lagarde is all over the wires calling the change significant), by the more laissez-faire US, UK and Japanese officials who are inclined to let markets set exchange rates.  The statement noted that exchange rate movements in major currencies (read dollar, euro, yen, C$ and pound) had recently become excessive and a threat to financial and economic stability.  Well looking at a chart of any of these major currencies versus the dollar, the volatility really was compressed to the first half of March in and around the collapse in Bear Stearns and the Fed’s response (75 basis point rate cut as well as extraordinary liquidity measures including opening the discount window to primary dealers – security houses – for the first time since the Great Depression).  I would be shocked if major currency pairs were not volatile in this period of time in light of the significance of the news and the broader market uncertainty.  What is not particularly excessive is the pace of appreciation since the February G7 meeting - more like a steady but orderly dollar retreat outside the first half of March.

It is worth noting that G7 always states that currencies should reflect fundamentals and unless I am half baked on this, there is no suggestion in the G7 communiqué that current levels do not reflect fundamentals.  If markets do not have the levels way out of whack with fundamentals – IMF is still calling the dollar overvalued – what is G7 talking about?

I also find it incongruous that the ECB is alarmed about inflation but does not want a stronger euro…and in a period when commodity prices (dollar priced) are the main source for inflation.  It seems to me that the ECB is looking for more free put options on a recession from a lower euro…if only the market’s bought the inconsistency.  The other free put option on growth that the ECB enjoys in its cult-like fight against inflation is the fact that the Fed easing to date is an offset to a sharper US slowdown which would drag Europe’s economy down more than if the Fed were easing less aggressively.  Again it is a free pass on growth to battle inflation only.  ECB’s Mersch today said he did not expect a rate cut this year.  No kidding, why should he if the Fed takes the funds rate to 1-2% range soon?

I would argue that the change in language in the G7 statement demonstrates weakness not strength on signaling opposition to the dollar decline much less arresting the currency’s decline.

From what I have heard and read there was no appetite at G7 for currency intervention.  And European authorities are no fan of unilateral currency intervention.  So the new language reflected a compromise and again highlights dysfunction not coordination.

Is it any wonder that China only came around to letting the yuan rise at a faster pace when it was clear that inflation was becoming a growing problem and China’s interest rate (capital market) is not an effective policy transmission mechanism.  G7 impact on China?  I wonder who is laughing.

I don’t want to be totally dismissive of where G7 is unified on the dollar…no one wants a freefall and with the US current account deficit in the danger zone on absolute and relative comparisons, this outcome is not easily dismissed, especially in light of the spate of events hitting credit market assumptions (models).

I find little surprise in the reversal in dollar gains at the London open and expect to see euro/dollar trade above 1.60 soon as markets test G7 commitment to stabilizing the dollar.  Frankly I don’t see it until it is clear the Fed is done easing and the ECB is ready to cut and saying as much.  That could be late summer before this unfolds.

David Gilmore  


13:18 13Apr2008 G7 forex shift came after heated discussion-sources

    By Sumeet Desai

    WASHINGTON, April 13 (Reuters) - The Group of Seven's new warning on excessive fluctuations in major currencies was only agreed after long and heated arguments between members of the rich nations club, G7 sources have told Reuters.

    After their meeting on Friday, G7 finance ministers and central bankers issued a statement saying they were concerned by the sharp moves in foreign exchange markets in recent weeks -- code for worries that the dollar was falling too fast.

    While policy-makers put on a united front at news conferences in Washington after the joint communique was issued, G7 sources say the change in language -- the first major shift in four years -- represented a victory for euro zone delegations.

   European policy-makers, and the French in particular, have been worried that the euro's surge to record highs against the dollar is robbing their businesses of competitiveness and have long been demanding the G7 show concern on the dollar's slide.

    For the most part, however, the United States, Britain and Canada have preferred to take a laissez-faire approach to currencies, arguing that levels are a matter for markets.

    But the wild gyrations in recent weeks at a time when all financial markets are especially volatile because of a global credit crunch was enough to convince policy-makers that some show of concern was needed.

    Britain was one of the main obstacles to reaching a quick deal, according to one G7 delegation.

    Another source said the common wording was only agreed after two hours of protracted and heated exchanges between the deputies who draft the communique. Usually, the discussion takes about half the time.

    France, the source said, led the charge to change the wording. Its policy-makers have been very vocal on the damage the euro's strength is doing to their economy. Germany was also on side while Britain and Canada were initially opposed.

    The United States and Japan, however, were convinced by the high degree of volatility in currency markets. "No one likes disorderly movements," said another G7 source.

    Asked on Friday what had led the United States to change its mind and back a shift in the communique's language, European Central Bank President Jean-Claude Trichet said he did not want to comment on what were "touchy" negotiations.

    Like other policy-makers, he said the statement spoke for itself -- "like a poem."

    While some have suggested the United States backed the new language because the Federal Reserve is worried about the weak dollar pushing up its domestic inflation, the first G7 source pointed out the U.S. central bank was not responsible for the communique draft.

    Traditionally, only the U.S. Treasury speaks about policy on the dollar.

    "It's because of all the volatility," the source said.

    But opinion is divided over what the statement will actually achieve -- coordinated intervention in currency markets appears a long way off for now.

    "We do not believe that coordinated intervention to support the dollar is imminent, but the sharp change in language does indicate that policy-makers are increasingly uncomfortable with the recent pace of dollar weakening," said Sue Trinh, senior currency strategist at RBC Financial Markets in a research note.

    "Euro-dollar is vulnerable to a short-term correction before resuming its uptrend," she said.

 (Editing by Andrea Ricci) Keywords: G7/CURRENCIES SOURCE

    Sunday, 13 April 2008 13:18:14RTRS [nL13233054] {C}ENDS


 

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