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Market Commentary

Currencies, the G7, G20, and Japan
February 15, 2013 Bill Witherell, Chief Global Economist

Tuesday the G7, which comprises the leading developed economies, sought to calm talk of a "currency war" by issuing a public statement. Unfortunately, as the day progressed, a "clarification" by an un-named G7 official (quite possibly from the US) ended up muddying the waters and signaling there well may be divisions within the G7 that will appear when it meets with the G20, the broader grouping that includes major emerging countries, this coming weekend in Moscow.

The G7 statement reiterated its long-standing commitment to market-determined exchange rates. In other words, the G7 countries do not and will not target exchange rates. Fiscal and monetary policy should be directed to domestic policy objectives, it said. US Treasury Undersecretary Brainard stated that "The US supports Japan's efforts to boost growth and end deflation.” The IMF made similar comments. At this point the markets understood that Japan was not being criticized by the leading economies for its recent policy moves and statements. The yen started to move even lower.

Then we find an anonymous G7 official saying that the market was "misinterpreting" the G7 statement, that it was meant to indicate concern about the "excessive" decline in the yen. The yen immediately strengthened. British officials issued their own clarification that the statement was not directed at any individual country. The end result was a complete muddle. A consensus statement by the G7 has no value when the participating officials follow up with divergent "clarifications." We should not expect greater clarity to come from the forthcoming G20 meeting, where countries like Brazil, which has been sharply criticizing the G7 countries for their expansionary monetary policies, Russia, and China will be added to the discussion.

What is evident is that Japan is not being given a free pass by the G7. It will be under some pressure to avoid further efforts to talk down the yen and any moves that appear to be specifically targeting the exchange rate. The Japanese will not be discouraged from monetary and fiscal stimulus moves, even though these will likely have a negative effect on the yen. It is unclear whether they will feel free to pursue proposals for a substantial program of buying foreign bonds, which would appear to fall under the category of measures specifically targeting the exchange rate. We think Japan's government would like to see the yen weaken further, but it may well seek to achieve this mainly through monetary easing, which has the primary objective of promoting growth in the domestic economy. A yen-dollar rate of 100 or more still looks attainable.

Despite any outside pressures, the Japanese government clearly has staked its political future on engineering a sustainable economic recovery. We continue to expect the Japanese economy to strengthen this year and its equity market to continue to advance. Our Japanese equity positions in our International and Global Multi-Asset Class portfolios are now second only to those of the US. Because a declining yen has a negative effect on returns from Japanese equities when translated into US dollars, we are now using the Wisdom Tree Hedged Japanese Equity ETF, DXJ. It incorporates a hedge against variations in the yen-dollar rate. The effect of the hedge is evident in DXJ’s 6-month performance of 27.4%, as compared with the widely used but unhedged iShares Japan Equity ETF, EWJ, for which the 6-month performance is 8.8%.

Bill Witherell, Chief Global Economist

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