EUR/JPY...The Carry Trade is ready for a South Reversal.

The Eurp/Jpy Monthly after G7 is moving into a South Reversal.

G7 warns markets against yen-shrinking bets

ESSEN, Germany (Reuters) - The G7 industrial powers, under pressure to address a decline of the yen, warned investors on Saturday that they could get burned betting in one direction when Japan's economy was continuing to strengthen.The Group of Seven also repeated appeals to China to relax the state grip on the yuan's exchange rate by calling for more currency flexibility and citing the world's fourth-biggest economy by name. And they commissioned a report on hedge funds.The main innovation at a meeting dominated by currencies and market risk came in a declaration of confidence in the recovery of Japan's economy and warnings from top officials against the carry trade -- an investment play that compounds yen weakness.In a statement issued after talks in Essen, Germany, the G7 said the U.S. economy was solid and Europe rebounding broadly."Japan's recovery is on track and is expected to continue. We are confident that the implications of these developments will be recognized by market participants and will be incorporated in their assessments of risks," it said.The yen recently hit a 21-year low on a trade-weighted basis and has shed four times as much versus the euro in the past year than versus the dollar, sparking concern that European exporters will suffer disproportionately in competition on world markets.

European Central Bank President Jean-Claude Trichet added a layer of warning against the practice of borrowing vast amounts in low-yield currencies such as the yen to reinvest for a profit elsewhere -- carry trades, as they are called. "We want the markets to be aware of the risks of one-way bets, in particular on the foreign exchange market," Trichet told a news conference, adding that he was not talking only about yen-based carry trades."One-way bets in the present circumstances would not be, it seems to us, appropriate. We want the markets to be aware of the risks they contain," he said.Japanese Finance Minister Koji Omi appeared to be singing from the same song book. "This means that G7 countries think that markets, particularly forex markets, should recognize the risk of moving in one direction too heavily," he said."I think we have come to the appropriate conclusion."How effective the warnings would be was far from clear.Marco Annunziata, chief economist at UniCredit investment bank, said the G7 was clearly trying but still unlikely to reverse market trends."It's nice of them to send a warning on one-way bets ... but it still sounds like cheap talk," he said, adding that markets were well aware of Japan's economic recovery story but also that the country had yet to nail the coffin on a decade of deflation. Moreover, he added, the G7 had also said the global economy was doing nicely. "That's a great backdrop for putting on even more carry trades," he said.

International Monetary Fund chief Rodrigo Rato, also at the G7 talks, said he expected another year of global economic growth of around 5 percent in 2007.The Essen talks involved finance ministers and central bank bosses from the G7 -- the United States, Japan, Germany, France, Italy, Britain and Canada -- and their counterparts from China, whose economy is now bigger than many in the rich nations club.The G7 renewed calls for efforts to strike a deal in stalled free-trade talks.As concern over global warming moves up the global agenda, their statement endorsed the pursuit of energy efficiency and said alternative energy sources were increasingly important.

CHINA CLUB
U.S. Treasury Secretary Henry Paulson had dismissed Europe's yen complaints and was among the only ones who refused to be drawn on carry trades when pressed by journalists in Essen.He said the yuan rather than the yen was the problem because the Chinese currency was controlled by the Chinese authorities and remained too weak. The G7 statement repeated a call for greater flexibility in currencies and said this was especially the case for China."In emerging economies with large and growing current account surpluses, especially China, it is desirable that their effective exchange rates move so that necessary adjustments will occur," the G7 communiqué said.China, given red-carpet treatment by G7 president Germany and invited for the first time to take part in the strategic part of G7 discussions, issued a statement of its own but said nothing of the renewed appeal on the yuan."We continue to strengthen macroeconomic adjustments," said Finance Minister Jin Renqing, who was unhappy with the hotel put on for G7 VIPs in Essen and checked into another one.

HEDGING
The other target of G7 attention was the burgeoning hedge fund industry, on which the ministers commissioned a report by the so-called Financial Stability Forum, a panel of top-level officials set up to monitor issues of global market solidity."Given the strong growth of the hedge fund industry and the instruments they trade, we need to be vigilant," the statement from the G7 said.Germany lobbied hard for a discussion of potential systemic risks to the stability of the world capitalist system from hedge funds, which are less regulated than many other funds, though the G7 said the funds had also improved market efficiency. In addition to special treatment for China, G7 host Germany invited representatives of other major emerging market economies to Essen, from Brazil, India, Mexico, Brazil and South Africa.German Finance Minister Peer Steinbrueck said on Friday he would like to see the G7, founded in the 1970s, embrace key emerging economies.As the finance chiefs negotiated in a well-guarded building, anti-globalization protesters gathered in the city center to voice their disapproval. Police said about 700 of them had gathered in a damp and chilly downtown Essen.

Paulson tells G7 let markets regulate hedge funds

ESSEN, Germany (Reuters) - U.S. Treasury Secretary Henry Paulson made clear on Saturday that he thinks any risks posed by lightly regulated hedge funds can be handled through market discipline without adding heavy government regulators."Market discipline, focusing on the risk management of regulated counterparties, is the most effective way to address potential systemic risk concerns," Paulson told a news conference at the close of a two-day Group of Seven finance minister's meeting in the German industrial city of Essen.He said a thriving global hedge fund industry "is in the U.S. interest" and adds liquidity to financial markets.The huge pools of lightly regulated capital, estimated to total about $1.5 trillion, cause nervousness in some quarters because of the potential for a collapse to wreak widespread economic havoc as the complicated trades they make unwind.Paulson noted a U.S. inter-agency working group that includes the Treasury and the Securities and Exchange Commission is to issue a report on methods for regulating "in the relatively near future."As the meeting wrapped up, Paulson said the global economy was healthy and predicted U.S. economic expansion will continue at an annual rate around 3 percent in 2007. That meant the U.S. was "doing its part", but he said some other regions could do more to foster growth."Europe's expansion is continuing and Japanese growth is expected to accelerate," Paulson. "But there is still ample scope in both areas to strengthen measures aimed at creating more domestic demand."Paulson continued to focus on the need for China to let its yuan currency appreciate, saying "greater flexibility in China's exchange regime is also needed as part of China's rebalancing of its economy."Later he told reporters that "it's one of my responsibilities to encourage them to move more quickly because it is in their own interest and in the global economy's interest for them to do so."A closing communiqué from the G7 -- the United States, Japan, Germany, Britain, France, Italy and Canada -- said all were committed to pursue policies that "support the orderly adjustment of global imbalances" that include the United States' huge trade deficits and the corresponding surpluses that key emerging market economies, especially China, are piling up.

NO COMMENT ON THE YEN
But Paulson rebuffed repeated efforts to draw him into a discussion whether Japan's yen was unfairly undervalued as some European countries were maintaining in the run-up to the two-day G7 session."As Treasury Secretary, as a general principle, I don't like to comment on currencies that trade in competitive marketplaces," Paulson said, effectively drawing a line between Japan's yen that he previously said was fairly determined in open markets and China's yuan.Paulson is pushing Beijing to move more rapidly toward greater currency flexibility as it develops capital markets and other financial infrastructure to support an eventual market-based currency exchange system.Paulson, who took over as Treasury Secretary last July, used the G7 to make the case that other industrial countries need to do more to clamp down financially on regimes like Iran and North Korea -- nations that the Bush administration regards as prime threats to global security."I emphasized that, to be effective, finance ministries must develop legal authorities and invest resources to apply targeted economic and financial measures against a broad range of international threats," Paulson said, citing the need to apply existing sanctions agreed in United Nations resolutions.

Foreign real estate flows brighten dollar outlook

NEW YORK (Reuters) - The chance for solid returns in the red-hot U.S. commercial real estate market has enhanced its appeal to foreign investors, lending support to the U.S. currency as capital flows into dollar-denominated assets. Unlike the slumping U.S. residential property market, prices and rents in the business and industrial property sectors continue to grow. By some measures, these are among the best performers in U.S. asset markets. Cash-flush foreign institutional investors are wise to the trend, investing some $20 billion in U.S. commercial real estate last year alone. The sector should get even more of that money again in 2007, property fund managers say. "It's going to be helpful for the dollar, although you have to place it in the context of other flows that are appearing," said Alan Ruskin, chief international strategist at RBS Greenwich Capital. Commercial property investments accounted for more than 10 percent of roughly $180 billion in foreign direct investment in U.S. assets in 2006. Those inflows are key to financing the U.S. trade deficit and are thus supportive for the dollar. There is no sign that the dollar is struggling at the moment. After falling to a 20-month low against the euro and other currencies in late 2006, the greenback has rebounded some in 2007, helped by rising U.S. Treasury yields and stronger-than-expected economic data.