[Calxy]

A Reuters report from earlier this week quoted a G8 source as indicating that China had asked for discussion of the USD as a reserve currency and possible alternatives. What was new in the report was the implication that it would be on the agenda, probably when the G14 meet after the G8 meeting next week and that some mention might enter into the communiqué. Yesterday, the USD rallied on a Chinese Foreign Ministry official statement that he had not heard of any Chinese request for a reserve currency debate at G8. In addition, there were renewed comments from the Japanese finance ministry on its commitment to the USD in reserves. The Chinese comments do not amount to an outright denial, so there is a risk that as the G8/14 summit approaches, there will be more volatility in currency markets from official comments.

In the short term, moderate USD strength is likely to be in the global interest in terms of keeping long-term rates down and relieving what may emerge as commodity price pressures on inflation down the road. So while it may be early to sell USD, the fact that the discussion has become so public suggests that USD weakness would accompany a global recovery as confidence is restored in the medium and long term