The following charts of the EUR/USD and USD/JPY shows the power of G7 meetings. As you can see, their announcements have frequently marked a top or bottom in the currency pairs. Sometimes this happens immediately and other times it takes a while longer. Judge for yourself what will happen this time around:
G20 Finance Ministers and Central Bankers are gathering in Korea right now talking about currencies. There has been a lot of speculation about whether or not a statement will released on Saturday that show a unified view on currencies. In my article G20 Wildcard, I wrote extensively about the possible language that the G20 could agree on and other topics that are being debated at the meeting as we speak.
However as currency traders, what we really care about is how it impacts currencies. The following monthly chart shows how the EUR/USD traded after the G7 changed the language in the currency portion of their communique (fancy word for official statement). This will be the first G20 statement on currencies because in the past, these big announcements would be made at the G7/G8 meetings. As you can see in the chart, the language changes have marked both short and long term tops in the EUR/USD. Since this is a monthly chart, even the small reversals have been more than 1000 pips or roughly to 7 to 10 percent.
Any coordinated message on currencies will look more like the Plaza Accord, which was aimed at weakening the dollar than the Louvre Accord which supported it.
Take a look at how the EUR/USD traded after the G7 changed the currency portion of their communique:
The British pound hit a high of 1.4605 this morning after falling to a low of 1.4137 yesterday. Although we have a mild improvement in risk appetite that is helping to propel the GBP, CAD, AUD and NZD higher, 2 stories making the wires are responsible for the volatility in the British pound.
Story #1 : Darling to Get Attacked Over Sterling Slide
The main story behind the British pound rally during the early European trading session was talk that European finance ministers will be attacking UK Chancellor Darling over the sterling’s slide. Over the past 6 months, the British pound has fallen more than 20 percent against the Euro and close to 30 percent against the US dollar. The most dramatic slide has been seen in GBP/JPY which dropped 55 percent.
Story #2: HBOS Expected to Report a GBP8.5 billion Loss
However some of the gains in the British pound were erased beginning around 8:40am this morning after news broke that Lloyds Banking Group expects HBOS to report a GBP8.5 billion loss. Remember that the UK government owns 43% of Lloyds so a loss for Lloyds means a loss for UK taxpayers.
Impact on British Pound
The threat of criticism at the G7 meeting should limit any further losses in the British pound. However, once the G7 meeting is over, we could see short term weakness in the pound. The Quantitative Easing that the BoE is expected to undertake should drive EUR/GBP towards parity.
The G7 meeting begins tomorrow. Take a look at how the EUR/USD traded after the G7 changed the currency portion of their communique (What to Expect for the G7 Meeting in Rome).
The US dollar is on steroids this morning as the sell-off in global equities sends the dollar to a 2 year high against the Euro. The EUR/USD is within 3 percent of its fair value of 1.20 while the GBP/USD and USD/JPY are now undervalued on a purchasing power parity basis. However PPPs matter little in a market environment that is driven by fear. The currencies have overshot their PPP levels for years and there no is reason why they can’t undershoot them as well. We still believe the dollar is nearing a top as the stock market attempts to stabilize, but bear market sell-offs can last for far longer than what may seem logical.
Central banks are having a very tough time dealing with the sharp moves in both the equity and currency markets. Investors continue to bail out of the funding currencies of high risk investments like carry trades, stocks, bonds, real estate, emerging markets and commodities.
Risk of G7 Intervention
The G7 released a statement on the Japanese Yen this morning, but it was all talk and no action which suggests that the Japanese are having a hard time convincing their US and European counterparts to join in on any physical intervention to sell the Yen. It is certainly not in the US’ best interest to engineer further strength in the dollar. The Japanese will have to act alone if they plan on engaging in physical intervention because the ECB will not back Yen intervention either as a weak EUR/JPY is good for exports.
Coordinated Rate Cuts
A higher probability scenario is another round of coordinated interest rate cuts by major central banks. The strength of the US dollar and Japanese Yen have been driven entirely by the weakness in global equities. Another coordinated rate cut could stabilize stocks which would help to take some of the steam out of the US dollar and Japanese Yen.
At minimum, the latest rally in the US dollar will give the Federal Reserve a stronger reason to cut interest rates by 50 instead of 25bp. Fed fund futures are currently pricing in a 68% chance of a half point rate cut and 32% of a 75bp rate cut. A quarter point rate cut has been completely discounted by the markets. To deliver anything less than a half point cut would be a big disappointment.