Dollar Slides as Pressure Increases on China to Revalue- Will it Matter? (page 1 of 2)

US Dollar - The US dollar succumbed to selling pressure today as the G7 harshened its stance on China, calling for exchange rate flexibility specifically from the Asian giant. This is eerily reminiscent of the 2003 G7 meeting in Dubai. If you recall, back in 2003, the G7 finance ministers called for "more flexibility in exchange rates." At that time, the change to the statement was the first significant move by the committee in 3 years.

It resulted in a 150 pip knee-jerk rally in the EUR/USD, but over the next four months, the dollar fell another 11 percent against the Euro (which amounted to 1100 pips), 9 percent against the British pound and 7 percent against the Japanese Yen. The long term impact was far more substantial than the market's knee jerk reaction, which is the risk that the market faces today.

Over the weekend, we had another major shift to the G7 statement. For the very first time ever, China has been mentioned directly by the G7, reflecting their increased concern over the past few months. This also raises the question of whether the US Treasury's FX report due in two weeks would also brand China as a currency manipulator. The G7 report could have paved the way for the Treasury to also take a harsher stance which given the G7 statement, would probably have less of an impact on the market. More importantly, the G7 statement is basically advocating appreciation in the Asian currencies and as a byproduct, depreciation in the US dollar.

This is a key point since it comes at a pretty important juncture. The Federal Reserve is nearing the end of its tightening cycle while reserve diversification has picked up steam. Oil prices, though lower today are still at extremely lofty levels and in the words of President Bush, "it will be a tough summer for US consumers." Consumer confidence, due for release tomorrow, is expected to be heavily impacted by the recent climb in oil.

Most of the US data due for release this week is expected to be weaker except for first quarter GDP. Therefore, the tone has been set by the G7 meeting and if history is a reliable indicator, then we could expect a bit of consolidation and then another fresh wave of selling.

Euro - The Euro is benefiting from broad dollar bearishness as well as more talk of reserve diversification. The latest central bank to talk of their demand for Euros was the governor of Qatar's central bank, who said that they have recently been buying Euros for reserve purposes and although their current reserve makeup is confidential, up to 40 percent of its currency reserves could be moved to Euros.

The UAE is also considering shifting another 10 percent of their reserves to Euros next month, which follow's Sweden's announcement on Friday that they have increased the Euro share of their reserves from 37 percent to 50 percent. On top of that, after talking down the dollar's status as the absolute reserve currency on Friday, Russia announced today that they would allow their $61 billion oil fund to invest in bonds issued not only by the US and Britain, but also by Eurozone countries.

With the breakdown of the EU Constitution well behind us, the market has feels that reserve diversification is a theme that is here to stay. Meanwhile French figures came in much stronger than expected today with business confidence rising from 106 to 108. German industrial production for the month of February was up 1.0 percent with an upward revision from -0.1 percent to up 0.4 percent the previous month.