BUSINESSWEEK ONLINE : FEBRUARY 21, 2000 ISSUE
ECONOMICS The Currency Game Has Brand-New Rules It's not every day that you can see just how currency markets work in the New Economy. Feb. 3 was one such day, though. When the European Central Bank hiked euro zone rates a quarter point at 11:30 a.m., the euro defied convention and dropped against the dollar. But when news emerged later that British mobile giant Vodafone AirTouch PLC was about to prevail in its $183 billion takeover of Germany's Mannesmann, the euro advanced nearly 2.5 cents against the dollar to 99.5 cents. The euro's big move was the most striking indication yet that foreign-exchange traders are following new clues in determining whether to invest in a currency or not. For as long as anyone can remember, a central bank's move on interest rates dictated a currency's strength and directly affected foreign investors' appetite for sovereign debt. ''The smart money used to play these rate differentials via bonds,'' says Alfonso Prat-Gay, currency strategist at J.P. Morgan & Co. in London. Thus, in the early and mid-1980s, record-high interest rates attracted billions in foreign capital to U.S. Treasuries, and the dollar soared. Sure, long-term trends in a country's economic health and investment history eventually asserted their influence. But over the short haul, rates mattered most to the traders. TRANSFORMATION. In the last twelve months, though, traders have latched onto other factors in their daily game of fixing a currency's value. Today equity flows from stock investments in foreign countries and cross-border merger deals are increasingly important. ''There was a major transformation of the foreign-exchange markets last year,'' says Jim O'Neill, chief currency economist at Goldman, Sachs & Co. in London. ''Equity has taken over.'' Thus traders at their desks pore over the merger news now with as much alacrity as they follow the dictates of a Greenspan or a Duisenberg. The thinking: If foreign companies look set to pull off major takeovers in a market, they will drive up demand for the currency--a forex buy signal if there ever was one. And traders can play the deal-driven surge in currencies by taking long positions in the currency they think is about to pop. The impact of deals and stock prices on currencies became powerfully apparent last year. The Bank of Japan has been keeping interest rates close to zero for months, hoping to revive the economy. Those low rates would argue for a weak currency. Instead, the yen has strengthened since May, 1999, from 124 to the dollar to about 109 now. That's because traders chose to ignore Japan's low rates and focused instead on stocks and deal news that showed a surge of foreign investors coming into Japan. The opposite effect has occurred in the euro's case, where strategists such as O'Neill say the new foreign-exchange game accounts for much of that currency's 17% decline against the dollar last year. When the euro was launched in 1999, investors and even the Continent's own executives were still down on the region's economy and far more attracted to deals and portfolio investments in Japan and the U.S. So while the euro zone ran a $60 billion current-account surplus, its companies spent some $120 billion on mergers and other direct investments elsewhere, driving down demand for euros. Now traders tracking equity flows think the time may be coming to go long on the euro. The Vodafone-Mannesmann deal could trigger a slew of cross-border takeovers in Germany and France, and lure record amounts of yen, dollars, and sterling into the region. Officials of the European Central Bank, of course, get to keep their jobs. But maybe the deal artists can give them a little hand. By Stanley Reed in London _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Riding the New Economy CHART: Strong Productivity Growth...Is Fueling the Economy...Despite Tightening by the Fed The Currency Game Has Brand-New Rules INTERACT E-Mail to Business Week Online

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