G7 offers little support for the US dollar

The G7 Statement out of Boca Raton, Florida, did not surprise, but it certainly came with a twist at the end. The Statement really came in two parts:

1) Exchange rates should reflect fundamentals and undesirable FX volatility would not be tolerated. This should provide the appropriate cover for the Bank of Japan to keep intervening and comfort the European politicians as well. The initial response proved successful with the euro selling down to 1.26. Ultimately, however, we do not believe there is anything substantive in the statement to reverse the dollar's decline in H1.

2) "We emphasise that more flexibility in exchange rates is desirable for major countries or economic areas that lack flexibility". When ECB President Trichet was pressed whether he meant China he responded by saying "The various currencies that are not flexible will recognise themselves...There is not only one, there are quite a few". US Treasury Secretary Snow responded to a similar question by saying the statement "is written in fairly plain English. It speaks for itself."

The second part of the statement will motivate markets to pursue Asian currency appreciation. Note, also that an unconfirmed China Business Daily story claims that China will go for a 5% revaluation this March and then adopt a 10% appreciation in 2005. This is the second such story from the paper and this time around the PBOC has chosen to respond with a firm denial. The Europeans are said to be happy with the outcome as they get to point their finger at Asia. Still, in Trichet's own press conference he went on to talk about building a solid Euro and that this would not require any change in ECB monetary policy.

What does this mean for Asia currencies? It is likely to mean that USD/JPY will break 105 this week, even with intervention by the Bank of Japan. China 1-year Non-Deliverable Forward's will also feel the revaluation heat, as will the TWD. BoK will come out swinging, as JPY/KRW is too close to 11.00 for them to allow any slippage on USD/KRW. In fact, Korean officials responded on Monday by saying that the call for greater FX flexibility did not relate to them. HKD spot could throw the markets again, especially as the Hang Seng continues to benefit from the reflation play and another wave of property sector stock buying late last week (up 18% year-to-date). The Singapore dollar is the most obvious candidate for appreciation in SE Asia and the most correlated to the yen and could prompt a test of 1.6800. That said, USD/THB is just on the psychological edge of 39.00 to trigger another move lower.

If there is anything surprising in the media and market response this morning it will not be the defensive reaction against the G7 statement, but rather the headlines in the Asia section of the Straits Times, "Hiring on the upswing". It has been a long time since a recovery in jobs has been discussed. The new buzzword is the Asian expat - "the upwardly mobile, talented Asian who finds his skills in demand in nations other than his own". Asia may become more tolerant of currency appreciation once these jobs truly materialise. The report came under the section heading Asian Agenda - Jobs, Jobs, Jobs.