G7 - Did Not Stand in the Way of Carry Trades

Another year, another G7 ministers meeting has come and gone. What has improved? Nothing. The same language in the statement seems to be aimed at China’s attempt at a more flexible currency regime, as European officials still clamor for appreciation in the Japanese yen.

Another year, another G7 ministers meeting has come and gone. What has improved? Nothing. The same language in the statement seems to be aimed at China’s attempt at a more flexible currency regime, as European officials still clamor for appreciation in the Japanese yen. One thing has changed, US Treasury Secretary Henry Paulson’s tone. Previously, the former Goldman Sachs CEO had taken a more tacit and subtle approach hoping to ease Chinese officials into a more leveled currency. However, it seems that push has now come to shove leaving the US Secretary to negotiate the recent string of trade sanctions placed on one of the world’s fastest growing economies. One thing is for sure, the recent statements and conclusions being derived from the meeting are keeping the demand for carry trades intact. Albeit in the short term, investors will still be pining away for higher yielding currencies now that the event risk of a Japanese yen is out of the way.

[B]No Criticism About the Yen[/B]
Countering earlier sentiment heading into the ominous weekend, the G7 finance ministers and central bankers made no real mention of the Chinese currency. Instead, financial officials purported a maintained view that the global economy is undergoing a positive expansion. To sum it up, “Although risks remain, the global economy is having its strongest sustained expansion in more than 30 years and is becoming more balanced.” However, monetary policy figures did concede to reiterating previous statements regarding the exchange rates and the recent risk seeking attitude that has supported the carry trade theme. Simply put, exchange rates should always reflect basic economic fundamentals. Of course, these statements were quietly targeted at the Japanese yen and its recent depreciation against the US dollar and other major currencies as the market continues to sell off the Japanese yen. However, the lack of any real mention of the yen will likely keep the yen selling pressure on, reinforcing the carry attractiveness of selling the currency.

Nonetheless, subsequent comments were made in regards to the Chinese and emerging market economies, with policy makers stating that China in particular should adopt more flexible currency regimes. The sentiment was echoed by Secretary Paulson. However, the tone was surprisingly more aggressive compared to previously subtle tones issued by Paulson at the start of his tenure. “Greater exchange rate flexibility and stronger domestic demand in China are critical parts of rebalancing, and it is crucial that China move now with greater urgency.” The recent tone is seemingly a product of frustration as Chinese officials are now losing what seems to be its one friend in Washington.
[B]Don’t Expect Anything from April 16 Washington Talks[/B]
Following the G7 meeting Chinese officials are scheduled to meet with US heads, including US Secretary Henry Paulson, in their own round of talks. The aim: recent US Commerce Department sanctions regarding Chinese exports. Although previously speculated to cover generic trade talks, the meeting has shifted to address the recent spate of tariffs headed towards the way of Chinese exporters. But will a separate meeting do any good to repair already rising widening tensions. The answer is a resounding no. Ahead of the weekend, both Finance Minister Jin Renqing and Central Bank Governor Zhou Xiaochuan announced their absence from this weekend’s G7 and Washington meeting, citing domestic issues. This will leave prominent understudies, Vice Finance Minister Li Yong and central bank Vice Governor Hu Xiaolian, attending the round of Washington negotiations in their absence. The fact that notable understudies will be in attendance will support the likelihood that nothing new will emerge this weekend as both Li and Hu have limited governance in overall economic and political policy. Ultimately, this will leave many with little expectations, hoping for the next time the two sides can meet. Subsequently, both sides continue to down play the speculated trade war with the most recent comments arising from US Commerce Secretary Carlos Gutierrez. Gutierrez has recently deemed the impending conflict “way overblown” and will likely end in both sides reconciling differences
[B]Currency Market Implications[/B]
Given the lack of any real pertinent statements out of Washington this past weekend, the carry trade notion is going to persist, at least in the short term. With economic leaders not even citing recent under-appreciation in the Japanese yen, the market will likely continue to invest in higher yielding carry candidates while remaining on the yen shortside. It seems, as a result, that the Bank of Japan is the only one who can rescue the yen from continued bearish selling. But who would want to considering a lower currency is likely to boost export sector strength. The notion will comparably continue to support massive bidding for the sterling, Aussie, and Kiwi currencies. However, one caveat to near term buying will be the approaching technical tops and overextended environment. With traders on one side of the market, who’s left to push the currency pair higher? The looming bearish gloom will likely spark some concerns, rather than market fears, of a near term pullback before any further gains can be made.