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March 20, 2017

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G20 unites on forex stance but no trade consensus

FINANCIAL leaders from the world’s biggest economies found common ground on foreign exchange at a G20 meeting on Saturday but failed to agree on trade, highlighting a global shift toward protectionism and setting a cautious tone for financial markets this week.

The Group of 20 powers meeting in the German spa town of Baden-Baden reiterated their long-standing warnings against competitive devaluations and disorderly forex markets, allaying fears that the new US administration might have opened up a chink in the G20’s united front on global currency policy.

For markets, no change to G20’s stance on forex is welcome news. Having the world’s financial and economic powers on the same page should help keep forex volatility low, a cornerstone for stable markets and rising asset prices more broadly.

But failure to agree on a commitment to keep global trade free and open will have negative consequences for financial markets, even if not dramatically so immediately.

“We may open on Monday with modest dollar weakness thanks to the failure to agree on trade, but it would have been a lot worse if there were major changes to the forex language on top of that,” said Tim Graf, managing director and head of macro strategy EMEA at State Street in London.

The US dollar has slipped recently even though the Federal Reserve has raised interest rates, because longer-term bond US yields have eased back. The dollar had its biggest weekly fall for two months last week.

Similarly, the upward momentum on Wall Street has fizzled out this month after a string of record highs, although European markets have continued to advance.

The pullback in longer-term yields despite a rise in shorter-term yields suggests investors think growth and inflation are not strong enough for the Fed to lift rates much further. This so-called “flattening” of the yield curve has weighed on stocks and the dollar.

An initial draft of the G20 communique earlier this month had removed almost all of the boilerplate language on forex from previous communiques. It had removed warnings against “excess volatility” and “disorderly” forex moves as well as a pledge to refrain from “competitive devaluations.”

They were all reinstated.

G20 and G7 communiques have long stated that stable and strong growth is best fostered by stable and calm currency markets.

The level of implied volatility in the euro/dollar exchange rate over the next month fell last week to 6.075 percent, its lowest in two and a half years. One-month dollar/yen implied volatility hit its lowest in over a year.

According to economists at JPMorgan, one of the main reasons for the depressed volatility across financial markets currently is because volatility in global growth is now the lowest in at least half a century.

Yet one sentence from last year’s G20 communique — the shortest and one of the most important — was omitted: “We will resist all forms of protectionism.”

This points to a fundamental disagreement between the US administration and the other 19 participants, particularly the Europeans, who flatly rejected any form of protectionism.

US Treasury Secretary Steven Mnuchin said the previous communique was not necessarily relevant to the current global economic climate from his point of view. He said he favored “free” trade but some agreements might need to be renegotiated.

Not immediate concerns

Yet despite the isolationist and anti-globalization rhetoric from the US administration, the implementation of protectionist policies and reality of trade wars are not immediate concerns, analysts say.

“This G20 is not really a big deal for the market, partly because the language on forex was maintained,” said Kenneth Broux, head of corporate research, forex and rates at Societe Generale.

The disagreement on trade and protectionism is new but the meeting at a later date between Chinese President Xi Jinping and US President Donald Trump could be more pertinent to where trade negotiations are headed, Broux said.

Washington may have signed up to the language on forex, but it is widely believed that it wants a weaker exchange rate. It blames the persistent US trade deficit, manufacturing decline and lack of competitiveness on the dollar’s strength.

In January, a closely watched measure of the dollar’s trade-weighted value hit a 14-year high. Trump and some of his key advisors have accused Germany, Japan and China — three of America’s biggest trading partners — of exploiting weak exchange rates to their competitive advantage.

Some analysts warn the US administration will soon bring exchange rates back to the top of its economic policy agenda.

“The US administration’s team is not yet in place, so its foreign exchange policy is not yet settled,” said Tsuyoshi Ueno, senior economist at NLI Research Institute.


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