Global Briefing: G7 Meeting Sets the Tone

The dollar is taking its cues from the gathering as stocks and bonds rally.
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Yesterday's U.S. equity rally and the recovery in Treasuries are setting the tone today. Major bourses are higher, largely led by technology shares. Bond yields are generally lower. The dollar is taking its cues from the G7 meeting, especially Japan's reluctance to offer a new spending program to ensure that economic recovery take hold and words from some European officials discouraging further euro weakness.

For the record, the G7 officially did not shed fresh light on the foreign-exchange market. The wording of the communique was nearly identical with the statement issued when officials last met in February. Essentially it calls for avoiding excessive volatility and significant misalignments by pursuing balanced economic polices that promote domestic growth.

Japan's finance minister, Kiichi Miyazawa, played down the need for an additional supplemental budget to spur the economy.

Treasury Secretary

Robert Rubin

did not hide the fact that the U.S. was still pressing for Japan to continue to provide more stimulus until a sustained economic recovery is in place. Despite Miyazawa's position, there still is a reasonable chance that when Prime Minister

Keizo Obuchi

meets May 3 with

President Clinton

, he may unveil new initiatives, even if they fall short of a supplemental budget.

The lack of a new spending initiative helped keep the rally in Japanese government bonds intact. The benchmark 10-year bond yield fell 7 basis points to 1.42%, the lowest yield in four months. Japanese corporates sold an estimated 60 billion yen in bonds today. The

Nikkei

eked out minor gains, but once again failed to close above the 17,000 level, despite breaching it intraday. Technology stocks and bank shares turned in a strong showing.

Bank shares rallied on what reports suggest was largely short-covering.

Short positions in Japan must be bought back within six months. Many shorts were established last October, when world markets looked to be on the verge of melting down. The remaining shorts need to be bought back and the Golden Week holiday in Japan, beginning Thursday, gives a sense of urgency to the short-sellers.

Sakura Bank

accounted for nearly 9% of the turnover today. Retail-store shares fell on news that sales by Japan's large retail stores fell in March, for the first time in three months. On a seasonally adjusted basis, sales fell 2.4% on the month and are off 7.9% on a year-over-year basis. The large retail stores account for approximately 17% of all retail sales and some 8% of household consumption.

Other regional bourses were mixed. Of note, Hong Kong's

Hang Seng

advanced 1.8%, boosted by telecommunications and technology shares. Korea's benchmark

Kospi

index rallied 2.3% to new 32-month highs. It has rallied 28% so far this month.

Korean Telecom

and

Korean Electric Power

account for about 40% of the rise. The end of the eight-day Seoul subway strike has encouraged hopes of that restructuring of state-owned enterprises will continue.

In Europe, equities and bonds are advancing.

Major European bourses are up 1%-2% near midday on the Continent. Bond yields are generally 3-5 basis points lower, as yesterday's losses are recouped. However, there are two disturbing signs.

First, using Germany as the proxy, the yield curve from two to 10 years remains steep. It stands at 118 basis points, down 2 basis points from yesterday, which was the steepest in more than a year. Since most of corporate borrowing is believed to be in the intermediate sector, the steepness of the curve does not engender economic recovery. It may also distort asset preferences and impact the much-watched measure of money supply.

Second, the spread between 10-year German bunds and U.S. Treasuries stands at around 144 basis points

, down a touch since the end of last week, when the spread was the widest in a decade. Many econometric models of the dollar against the complex of European currencies place emphasis on the bond spread.

The G7 did not address the weakness of the euro

, which has fallen persistently this year, but comments afterward encouraged a bout of short-covering that has helped lift the new currency.

Bundesbank

President

Hans Tietmeyer

and the governor of the

Bank of Italy

, Antonio Fazio, both of whom are also on the board of the

European Central Bank

, warned that although current euro levels are satisfactory, additional weakness is not desirable. Partly the comments were directed at clarifying ECB President

Wim Duisenberg's

recent remarks about the lack of exchange policy at the ECB.

The euro has firmed in response to the comments, but the upticks have been quite mild thus far. In fact, the euro marginally took out the highs set yesterday, but remains below the highs seen at the end of last week. At the end of the day, we know that among the variety of forces that move the foreign-exchange market, official desires tend not to be very powerful.

The market is well aware that the eurozone countries cannot adjust their macroeconomic policies to defend the value of the euro

-- even if they wanted to. Tighter monetary policy cannot be contemplated. Intervention is highly unlikely as officials generally recognize that fundamental factors rather than speculation per se are the driving force. Over the weekend German finance ministry lowered its official growth forecast, and today the major economic research institutes lowered their forecasts. Moreover, they warned that a

Fed

rate hike was around the corner.

For the record, at yesterday's closing prices, the July fed funds futures contract (more useful than the June contract because of the lateness of the June FOMC meeting) has about a one-in-four chance of a tightening priced in. The September contract discounts about a 45% chance of a 25-basis-point rate hike. U.S. bonds staged an impressive reversal yesterday. Initially the June bond futures contract fell below Friday's lows and then proceeded to rally and settle above Friday's high. There seems to me to be scope for another full-point advance. However, look for the bears to make a stand ahead of the 122-16 area.

The euro encounters resistance near $1.0660-80 and then $1.0720.

While these levels could be seen over the next several days, it is largely a corrective move before the market participants probe for the official pain threshold. The dollar is likely to consolidate against the yen over the near term. The likely trading range is between about 120.40 yen on the upside and 118.50 yen on the downside.

Marc Chandler is an independent global markets strategist who writes daily for TheStreet.com. At the time of publication, he held no positions in the stocks, currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at

commentarymail@thestreet.com.