G7: FX language shift could rattle the dollar

Typically, most G7 or G20 meetings of politicians and key officials result in a communique explaining what has been agreed. On some occasions, indeed, many occasions, the lack of agreement can limit what gets included in the communique.

However, one would expect any communique from a meeting of finance ministers and central bank governors to address FX markets. Over the last eight years, the G7 FX language has looked something like: ‘We reaffirm our May 2017 exchange rate commitments’.

What were those 2017 commitments?

‘We reaffirm our existing G7 exchange rate commitments to market determined exchange rates and to consult closely in regard to actions in foreign exchange markets. We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments and we will not target exchange rates for competitive purposes. We underscore the importance of all countries refraining from competitive devaluation. We reiterate that excess volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability’.

In all likelihood, given the febrile environment in global asset markets, G7 finance officials probably will not want to rock the boat with any language changes this week.

As above, the base case is that there will be nothing for FX markets to see in this week’s communique. However, the FX market is currently very well aware of the Mar-a-Lago accord threat and the perceived view that Washington wants a weaker dollar.

In the past, more so in the 1990s and 2000s, these communiques were a key tool to express a shift in currency policy. Could the US Treasury try to lean on counterparts in the G7 to accept a rewording of the FX paragraph to somehow encourage an orderly appreciation of currencies against the dollar? Or make some changed reference to expect that currencies move more in line with external balances?

Presumably, it would be difficult to get the European Central Bank and eurozone finance ministers to sign off on any of the speculative changes outlined above – wanting to avoid a big run-up in EUR/USD, which would only compound the trade challenges. That said, we know that Washington is currently trying to secure trade deals with up to 20 countries at the moment, and we have little transparency on the amount of leverage that is being applied.

Suffice to say, we see any key FX language change in the forthcoming G7 Communique (presumably released late Thursday) as a low probability, but high impact event. This would be an event risk that could unleash another powerful bearish leg in the dollar – particularly in EUR/USD and USD/JPY given the country/bloc weights in the G7 and the liquid alternatives to the dollar offered by the euro and yen.