Last Weekend's G20 Meeting

The leaders of the G20 countries met in Washington over the weekend. Collectively, their economies make up 90 percent of global GDP and consequently, are more representative of the global economy than the G8, which no longer has the economic and political dominance it did when the name was formally coined in 1997 upon the inclusion of Russia.

Expectations were low for a meaningful outcome and the outcome largely matched those expectations. The statement that followed their five-hour meeting on Saturday called for a broader policy response to recent events and made a plea for lower interest rates, lower taxes and more government spending in the weeks and months ahead. Each country was asked to respond to their individual set of conditions as they saw fit.

Other "noteworthy" items included: a call for more ammunition and a larger toolkit for the International Monetary Fund (IMF), a promise not to erect new trade barriers, a March 31, 2009 deadline for new recommendations on greater market oversight and regulation, tighter accounting standards and improved functioning of the credit derivatives market. They said they would meet again in April to review their progress on decisions made on November 15. Several countries including France were pressing for explicit steps towards a centralized global authority to oversee financial markets, but the U.S. was not supportive. Faced with a choice between more market support and greater controls, the group chose to mention both, with slightly greater emphasis on supportive measures in the near-term.

While the list of action items and expressions of harmony and cooperation sounded impressive, the statement has no real teeth, nor was it ever likely to. Mr. Bush brings new meaning to the phrase "lame duck president", given his approval ratings and the election results. Mr. Obama stayed away, even though his lieutenants were sent to keep an eye on the proceedings. It is more than likely that he will put his own stamp on global coordination shortly after January 20. It is also likely that if financial markets implode again, some of the emerging markets represented at the table (Russia, India, China, Brazil, Mexico, Saudi Arabia, South Africa, Turkey, South Korea, Argentina and Indonesia) will take unilateral action that might well fly in the face of Saturday's communiqué.

Finally, with a dominant and increasingly vocal Democratic majority, an economy in a downward spiral, an automobile industry on life support and our trade deficit with China continuing to soar, it may not be long before protectionist sentiment rears its head once again. The Doha Round of the World Trade Organization was given verbal support, but it is doubtful whether it will ultimately yield meaningful results.

The road ahead

The dollar and JPY rallied towards the end of last week, as weakness in the equity markets undermined sentiment. Heightened risk aversion benefited those two currencies, following the pattern established in recent months. Overall, the dollar's pace of appreciation has slowed, but not the direction. In my opinion, the dollar's strength is increasingly only a function of position liquidation and risk aversion now, and not a reflection of underlying fundamentals.

Earlier, it was helped by a downward repricing of European growth and a realization that even Asia was vulnerable. Most forecasts now see a deep recession in the UK, with rates falling to one percent (currently three percent) and Europe falling into recession as well, with the ECB likely to cut rates to below two percent (currently 3.25 percent). Currency positions probably reflect these revised forecasts or soon will. Therefore, once the deleveraging process ends, there is likely to be little fundamental support for further USD gains. I suspect most hedge fund liquidation to fund 2008 redemptions will end shortly; other flows will depend on the performance of equity markets.

Predicting the timing of a trend reversal for the dollar is difficult, as it depends on many factors. However, with financial markets appearing to be on the path to (relative) stability and global economic forecasts converging gradually towards a consensus view of subpar 2009 growth for the global economy (and negative growth for the major economies for the first time since World War II), equity volatility should abate over the next few months. I expect the dollar to turn in the first quarter of 2009, but the pace and magnitude is likely to vary by currency.

The GBP has been especially hard hit and there are reasons for GBP weakness to continue in the short-term: a deep recession, deleveraging of the most leveraged consumer society outside the U.S. and lower rates. However, there is also reason to expect the economy to recover somewhat sooner, thanks to a proactive Bank of England. The euro's fall has been less severe, but it is likely its rebound will be slower, as the European Central Bank is behind the curve and needs to play catch-up. In my opinion, the stronger Asian currencies will lead the pack as their banks are largely unscathed, reserves remain adequate and economic growth (and interest rates) should rebound sharply once global demand recovers. The JPY is stronger than its economic fundamentals justify and will probably underperform as risk appetite returns and equities stabilize.

Overall, I expect the dollar to make new highs (or retest recent highs) over the next couple of months. I think it will be weaker by the end of 2009 - just barely vs. the euro, more sharply vs. some of the Asian currencies and somewhere in between for most others. In my opinion, any dollar gains between now and the end of 2009 will be limited to the JPY and some of the weaker emerging market currencies, whose economies will continue to suffer from the fallout of the financial crisis.