G-7 Says Economy ' Strong,' Urges Asian Currency Gains

April 22 (Bloomberg) -- The Group of Seven said the world economy is in "strong" shape and called on some Asian nations, especially China, to allow their currencies to appreciate.Finance ministers and central bankers from the group said prospects for continued economic expansion are favorable, even as oil prices climb to a record. Stronger Asian currencies and less reliance on exports for growth can help reduce imbalances that jeopardize that encouraging outlook, the officials said. "The global economy is in the best shape it's been in a long, long time with strong growth, high productivity, inflation well-contained," U.S. Treasury Secretary John Snow said at a press conference after the G-7 meeting in Washington yesterday.

The world economy is on its surest footing since the start of the decade as growth in Japan and the euro region picks up, while the U.S. probably enjoyed the fastest quarterly expansion in more than two years. In a separate statement, the G-7 said it's "critical" China let the yuan advance and some oil producing nations allow more fluctuation in their currencies. "In emerging Asia, particularly China, greater flexibility in exchange rates is critical to allow necessary appreciations, as is strengthening domestic demand, easing reliance on export- led growth strategies, and actions to strengthen financial sectors," the statement said.

New Language

The language is a departure from the words the G-7 usually uses to address China's exchange rate. Past communiqués have referred only to the need for more flexibility without saying whether the yuan should strengthen or weaken.Officials bolstered the language because they felt China's efforts to increase the flexibility of its currency have been too slow, a Japanese finance ministry official told reporters in Washington late yesterday on the condition of anonymity."They have clearly started to apply more pressure," Lara Rhame, a currency strategist at Credit Suisse in New York, said in an interview. "They have singled out China and the rest of the emerging market economies." Asian currencies will probably rally when markets open on April 24, Rhame said. French Finance Minister Thierry Breton said Japan may let the yen advance as its economy rebounds and deflation ends. "It's a positive story for Asian currencies, especially with these kind of statements," said Irene Cheung, an economist and strategist at ABN Amro Holding NV in Singapore. "If we see the yuan and the Korean won head higher on Monday then that will set the mood and most other Asian currencies will move higher too."

"Not the Message"

The G-7 remarks on exchange rates aren't an invitation to sell the dollar against currencies outside Asia, said European Central Bank President Jean Claude Trichet. "This is certainly not the message," Trichet told reporters after attending the meeting. "It would be a mistake" to interpret it as a de-facto call for a stronger euro, he said. The euro has climbed 4.2 percent versus the dollar this year.The G-7 gathering followed a meeting between President George W. Bush and Chinese President Hu Jintao at the White House that did little to narrow differences over China's managed exchange-rate system. The yuan has gained 1.2 percent since a revaluation in July.The U.S. trade deficit with China widened to a record $202 billion last year, a quarter of the current account shortfall, which reached an unprecedented $805 billion. The current account is a measure of trade, services, tourism and investments. Snow is under pressure from the U.S. Congress to brand China a currency manipulator for keeping the yuan artificially low to boost exports.

Oil Prices

The International Monetary Fund this week raised its forecast for global economic growth in 2006 to 4.9 percent from a September prediction of 4.3 percent. At the same time, the G-7 said it's worried about rising oil prices, protectionism and imbalances reflected by the U.S. current account deficit and China's surplus. The G-7 represents almost two-thirds of the world economy, comprising the U.S., Japan, Germany, the U.K., France, Italy and Canada. Snow, European Central Bank President Jean-Claude Trichet and Japanese Finance Minister Sadakazu Tanigaki are among officials who signed off on the statement.With oil jumping to an all-time high of $75.35 a barrel on the New York Mercantile Exchange yesterday, energy prices remain "a risk" to the economic outlook, the G-7 statement said. Carl Weinberg, chief economist at High Frequency Economics in Valhalla, New York, calculates each $10 increase in the price of oil knocks 0.5 percentage point off growth in the G-7. To correct imbalances, the U.S. must reduce its budget deficit, Japan and Europe must boost domestic demand and Asian nations must loosen the tethers on their currencies, the G-7 statement said, repeating language from previous meetings. At least part of that prescription is starting to come true. Japan's economy will expand 2.8 percent in 2006, the most since 2000, and the euro area's gross domestic product will increase 2 percent this year, according to this week's IMF growth forecasts.The separate statement on imbalances also called on oil- producing countries to accelerate investment in production capacity and to diversify their economies, and for other "current-account surplus countries" to boost domestic consumption and investment.Following their formal meeting, the G-7 held a working dinner with China, Saudi Arabia, Russia and the United Arab Emirates. China is the world's second-largest consumer of oil after the U.S., and Saudi Arabia, Russia and the UAE are the world's biggest, second-largest and sixth-largest oil exporters.

Treasury benchmark may see 5.50 percent

NEW YORK (Reuters) - The brisk sell-off in bonds may take the yield on benchmark U.S. Treasury notes to as high as 5.5 percent this quarter, strategists said, particularly now that a key psychological level has been breached. The 10-year yield moved decisively above 5 percent on Thursday to its highest level in nearly four years and will probably continue to rise on the prospects for economic growth, interest-rate hikes and elevated commodities prices. Futures markets show the Federal Reserve and other global central banks will continue to raise rates, and commodities prices could feed into core inflation later in the year -- helping drive up sovereign-debt yields globally, bond strategists said.
Against that backdrop, investors may demand higher rates on U.S. bonds in order to compete with returns they hope for from stock and commodities funds, some said. Equities strategists polled by Reuters see U.S. benchmark stock indexes gaining almost 10 percent this year. The Standard & Poor's 500 Index gained 3.7 percent in the first quarter. "People are looking for extra return out there," said Bill Kohli, managing director for global specialist core fixed income with Putnam Investments in Boston, adding that the 10-year Treasury note's rise to around 5.05 percent reflects that. "People will be re-evaluating what an appropriate real rate is, given the equity (market) returns we have had in the first quarter and that commodity prices are up," Kohli said. If the 10-year note's yield, which moves inversely to price, were to rise to between 5.25 percent and 5.5 percent by the end of June, Kohli said "that wouldn't surprise me." As investors continue to shift into competing asset classes that may offer higher returns -- including speculative-grade or "junk" U.S. corporate bonds, stocks and commodities -- outflows from U.S. government debt may weigh on Treasuries prices and send yields higher.
"The 10-year above 5 percent means that the economy has been strong and people are betting it will continue to be" for the rest of 2006, said Brian Reynolds, chief market strategist at M.S. Howells, an institutional brokerage firm in Scottsdale, Arizona. "What we have seen this year is people selling Treasuries to buy corporate bonds, because the economy has been great and (companies') profits have been OK and are expected to be for a long time -- and you buy corporate bonds for the additional spreads," Reynolds said. The Federal Reserve may react to the first signs of the filtering of high commodities prices into core inflation gauges by raising interest rates more than the market currently expects, lifting bond yields, warns Jack Malvey, chief global fixed-income strategist with Lehman Brothers in New York. "The bond markets may be in for more central bank medication," Malvey said, adding that it looks increasingly likely the federal funds target rate could rise to 5.5 percent from the current 4.75 percent, and perhaps higher. Over the next three or four months, the 10-year note's yield could rise to between 5.35 percent and 5.50 percent,he said. "The big picture is that the world economy is in vigorous form, commodity prices will pass through to inflation over the balance of this year, and central banks will be on the hawkish side," Malvey said . There is no guarantee, of course, that a breach of 5 percent means a move to 5.5 percent. The 10-year yield's most recent surge above 5 percent came in March 2002. The yield topped out at 5.47 percent that month before slipping back to as low as 4.19 percent in November of that year. And there are some who expect the world's biggest economy to slow sooner rather than later and therefore don't see the benchmark note's yield moving much higher. "On a longer-term basis, I don't see a fundamental reason for it to go above 5 percent," said Keith Hembre, chief economist with FAF Advisors in Minneapolis. "There is the view that global growth would drive longer yields higher, but decelerating domestic activity in the second quarter and third quarter, and the cumulative effect from the Fed hikes," in slowing economic activity, should keep the 10-year yield below 5 percent later this year, Hembre said.