Chandler: What to Expect—And Not Expect—From G7

The G7 meeting begins shortly. Although often little more than photo opportunities, this meeting is attracting some attention. The risk, however, is disappointment to anything but the most base expectations.

What to Expect:

1. Some strongly worded objection to the volatility in the foreign exchange market. It is something everyone can agree with. Implied volatility of the euro and yen (against the dollar) remain higher than during the 9/11 period and historical, that is actual volatility is even higher. There may be a directional implication of the lower volatility. Specifically, a lower vol environment would likely correspond to a weaker yen and a stronger euro, in the current context.

2. Some strongly worded statement urging countries not to resort to protectionism. This is important in light the US "buy America" component to the fiscal measures and in light of some concern about French protection of its auto sector.

3. It is possible that the yen is singled out, as it was in the special G7 statement issued in Oct. However, it some observers' claim that the G7 will agree to push the yen down might be a bit over the top.

What Not To Expect:

1. Do not expect intervention, to support the yen or otherwise. Leaving aside theoretical issues about the merits of intervention, the practical problems are sufficient to prevent it. If the yen is to be sold, what is to be bought? The Japanese have nearly $1 trillion in reserves. My argument nearly a year ago that officials there should consider giving giving 25 percent of its reserves back to its citizens to support the economy does not seem as far fetched as it may have then, though this is not to say it is likely. The IMF opposed my proposal in part because it did not think Japan needed fiscal stimulus. Before the ink on the G7 statement is really dry, Japan will report a sharp, roughly 12 percent annualized contraction in Q4 08. Intervention would see Japanese reserves increase. The Fed, though its swap lines, made dollars available to Japan. Using those dollars to intervene with is probably not what officials had in mind. The statement in Oct seems to demonstrate a reluctance to intervene and arguably nothing recently has altered this calculation.

2. Do not expect sterling to be cited. The UK Telegraph piece today asserts that "French and German ministers are expected to confront the Chancellor over sterling's weakness...". It does not cite the source of those expectations. The French finance minister has already complained about sterling's weakness, but her views seemed not to have been repeated by any other G7 country. Last month, there were reports of an "unnamed" G7 source saying that sterling would be discussed at the G7 meeting, but it is not too cynical to suggest that it most likely was the French finance ministry's office again in thinly veiled disguise. Sterling has outperformed the euro by nearly 5% thus far this year and sterling's decline is largely fundamentally driven. And sterling's valuation is not far from fair value as measured by the OECD's purchasing power parity measures. The US would likely side with the UK over the machinations of the French. Floating exchange rates are an important transmission mechanism of monetary policy, especially during this crisis when other transmission channels are not functioning properly.

3. Do not expect fresh new bold international initiatives. While the G7 will cooperate, it is difficult to really have much true international coordination. It seems that even within the eurozone itself, coordination efforts are strained. Look at what Sarkozy's comments have done, even though the auto support measures do not seem as radical as the President's remarks, it has caused some consternation.

Anticipated Currency Impact: The yen has sported a softer profile, partly as a function of expectations that the will be cited or more. If the yen is not cited the yen may be bought back. However, the Q4 GDP release may temper this though weak economic news from Japan has not consistently weighed on the yen. Sterling seems more vulnerable to a buy the rumor sell the fact. A two month trend line comes in just below $1.50 now, but cable appeared to run out of steam near $1.46 today before the poor UK banking news hit. The general tone of the dollar will likely be more a function of external market developments.

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Marc Chandler is the global head of currency strategy for Brown Brothers Harriman. He has been analyzing, writing and talking about the foreign exchange market for more than 20 years. He is a regular guest on CNBC and his essays have been published in numerous economic and business publications. He previously served as the chief currency strategist for HSBC Bank USA and Mellon Bank.