October 24, 2010 / 9:42 AM / 9 years ago

FX COLUMN-Asian currencies to bask in G20 bonhomie

— Krishna Kumar is a Reuters FX analyst. The views expressed are his own —

By Krishna Kumar

SYDNEY, Oct 24 (Reuters) - The G20 meeting of finance chiefs was definitely what the doctor ordered to relieve concerns that the so-called currency war was spiralling out of control.

All the participants have left with a sense of satisfaction, perhaps surprising even the most hardened sceptics. Risky assets should benefit, and look to play gains in Asian currencies against the dollar at first and then the euro later on.

The meeting has conjured up some concrete measures: reforms in the IMF, stronger language emphasising “market determined” exchange rates and vows against competitive devaluations all while laying the groundwork for more concrete targets on current account balances at the final G20 summit. [ID:nTOE69K01G]

The breakthrough on the vexed question of power sharing in the IMF is very significant. [ID:nTOE69M01A]

The developing nations will definitely realise that enhanced power goes hand in hand with added responsibility, resulting in them sharing in the burden of resolving global economic problems instead of indulging in unilateral action.

The landmark agreement will, to a large extent, serve to restore the faltering credibility and legitimacy of the IMF, as pointed out by Indian Finance Minister Pranab Mukherjee.

IMF chief Dominique Strauss-Kahn went a step further by calling the agreement the biggest governance reform ever for the institution.

Critics may point to the lack of an agreement on numerical targets for current account balances, as proposed by the United States. They may justifiably point to the sharp words from German and Chinese officials aimed at U.S. policy and the prospect of more quantitative easing. [ID:nLDE69M02P]

Those critics have to realise, though, that the lead-up to the meeting had all the hallmarks of it degenerating into a school yard fight between wealthy nations and emerging powers.

Considering that the G20 meeting culminated in a lot of handshakes and backslapping, the final outcome has exceeded all expectations.

The initial reaction in the financial markets will be one of relief and will result in risk-on trades. Though this will benefit currencies such as the euro EUR= and the Australian dollar AUD=D4, the difference this time will be the outperformance of the EM currencies -- especially Asian currencies.

The reference to market determined rates and vow to refrain from competitive devaluations is a strong hint that the Asian central banks will drastically cut down on their interventions against rising currencies.

As long as the exchange rates are fundamentally justified and the rate of appreciation is not too rapid, the Asian central banks will desist from constant intervention in the markets.

The South Korean won KRW=KFTC, which is arguably one of the most undervalued of the Asian currency pairs, may stand to benefit the most and a test to, and a possible break of, the major 1.102 low versus the dollar this year. Immediate resistance is at 1,140 and major resistance is at 1,155.

To guard against the uncertainty surrounding the size of the quantitative easing expected by the Federal Reserve at its November meeting, it may be more prudent to consider selling euro/won EURKRW=R.

Investors can consider selling USD/KRW initially and fade the euro on an expected rally to the $1.4218/1.4375 resistance zone — the former is the low from last December and the latter is the 76.4 percent retracement of November 2009 to June 2010 euro decline.

This strategy removes the risk of a dollar rebound as a result of the Fed disappointing markets if its second round of quantitative easing is not so aggressive.

The possibility of Fed watering down QE2 is something to guard against now. A few countries have already made clear their displeasure with what they view as lax U.S. economic policies undermining the dollar.

The G20 communique made an oblique reference to the United States by saying that advanced countries — including those with reserve currencies — should be vigilant against excessive volatility and disorderly exchange rate movements.

The United States may not want to jeopardise the nascent mood of bonhomie in the G20.

Editing by Eric Burroughs krishna.k@thomsonreuters.com; +61 2 9373 1803; Reuters Messaging: krishna.k.reuters.com@reuters.net;

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