Strong Dollar Policy in Time for G20

The US dollar is mixed today and the real feature is the euro’s strength. Asian central bank reserve diversification and model-driven leveraged accounts appeared to help drive the euro higher. News that US Treasury Secretary Geithner suggested that the major currencies were in rough alignment sparked a short lived dollar bounce, with the greenback rising toward JPY81.85 and the euro slumping below $1.3900. Participants sold into that dollar bounce aggressively.

Sterling continues to be a laggard. Dollar weakness has concealed sterling’s soft underbelly. Speculation that the BOE is not far from its own version of QEII and the rise in European core interest rates has pushed sterling to six month lows against the euro. Ideas that the G20 can hammer out the basis for a truce in the so-called currency wars kept Asian regional currencies mostly bid.

US Treasury Secretary Geithner has further articulated the strong dollar policy over the past couple of days. He has indicated that the US would not seek a depreciation of the dollar to boost exports. This is important. It was needed to be articulated in light of the accusations by some G20 members. This was the “original intent” of Rubin’s strong dollar policy—to differentiate his stance from Lloyd Bensten and James Baker who had used threat of dollar depreciation in negotiations with Japan and Germany, respectively. The US dollar policy is that markets should determine its value and that it is the consequence of the pursuit of monetary and fiscal objectives.

Geithner also reportedly indicated that the major currencies were roughly aligned. This is important too. It sets the basis for a united G7 front at the G20. The G7 grouping has been downgraded to a caucus within the G20.

A draft version of the G20 communique has been leaked and seems largely a reiteration of boilerplate diplomatic-speak: competitive devaluations should be avoid (easy enough, leaving aside the Hong Kong dollar, most Asian currencies and emerging market currencies in general have appreciated against the dollar, euro and sterling this year), markets should determine exchange rates and excessive volatility is counter-productive. This last part is the cover for potential BOJ intervention, but rumors that the BOJ has told local banks to be prepared for such seems wide of the mark. While there apparently is no line in the sand being defended, players may turn cautious as the JPY80 is approached.