BUSINESSWEEK ONLINE : FEBRUARY 21, 2000 ISSUE
INTERNATIONAL -- FINANCE A Whole New Currency Game (int'l edition) Traders now take their cue from stocks and merger news 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 in the day that British mobile giant Vodafone AirTouch PLC was about to prevail in its $183 billion takeover of German rival 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 short-term strength or weakness 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 on a currency. But over the short haul, interest 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 strengths. Today, equity flows--including stock investments in foreign countries and cross-border merger deals--are becoming 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 in the last year. Just look at Japan. The Bank of Japan has been keeping interest rates close to zero for more than a year, 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. Traders chose to ignore Japan's low rates and focused instead on stocks and deal news. They liked what they saw: Renault bought 35% of Nissan, GE Capital snapped up Japanese financial assets, and Britain's Cable & Wireless purchased a Japanese telecom company. As foreigners bought control of Japanese companies in record numbers, they had to exchange dollars, euros, and pounds for yen to close their deals. Meanwhile, portfolio investors from the U.S. and Europe snapped up Japanese shares, betting a long stretch of restructuring would eventually drive corporate profits up. All told, a net $95 billion in equity went into Japan last year, driving the yen to its current strong position and pushing the Nikkei stock average up more than 40% since January, 1999. The opposite effect has occurred in the euro's case, where strategists such as O'Neill say the new forex game accounts for much of that currency's 17% decline against the dollar last year. When the euro was launched at the start of 1999, money gurus gushed over its prospects as ''a new reserve currency.'' But those who bet big on the euro got fleeced. They didn't realize that investors and even the Continent's own executives were down on the region's business conditions and prospects and were far more attracted to the possibilities of 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. An additional $60 to $70 billion left European financial markets in pursuit of higher returns in the U.S. and Japan. That left what O'Neill calls Europe's ''basic'' balance of payments deep in the red. Meanwhile, across the Channel, the deals were flying fast and furious. British companies were the targets of $139 billion in deals by foreign investors last year, such as Mannesmann's acquisition of cell-phone operator Orange PLC, and Wal-Mart Stores Inc.'s purchase of the Asda food-store chain. Outsiders liked Britain's clear takeover rules, rebounding corporate sector, and emerging shareholder culture. Foreign takeovers of German companies, however, amounted to only $54 billion. No wonder sterling has appreciated some 13% against the euro since January, 1999. RULE OF THUMB. That equities are important is thus becoming a rule of thumb on trading floors in London. The dollar, for instance, closely matched the Standard & Poor's 500-stock index in recent months. Few traders are willing to bet against the greenback when U.S. stocks are rising. Perhaps the most surprising of the new equity patterns is a link between Nasdaq in the U.S. and the Japanese yen. Foreign-exchange traders have come to see the yen as both a restructuring and a technology play, thanks to the emergence of such hot tech stocks in Tokyo as Softbank Corp. and wireless phone operator NTT DoCoMo. So when the technology-heavy Nasdaq outperforms the S&P, says J.P. Morgan's Prat-Gay, the yen tends to rise against the euro. Now, strategists are examining the money flows to forecast how currencies will move this year. O'Neill thinks that despite its current difficulties, Japan's economy will eventually strengthen. A rise in consumer spending will reduce its current-account surplus, while richer stock prices on the Nikkei will encourage local investors to seek better values in foreign exchanges. That, he figures, will trigger a greater flow of yen out of the country and prevent Japan's currency from rising much against the greenback. Traders tracking equity flows also think the time may be coming to go long on the euro, which is widely seen as undervalued. The Vodafone deal could signal a sea change, for several reasons. Analysts figure that equity investors will spend about $5 billion on additional German stocks to fill out their European portfolios once Mannesmann is acquired. That will create more demand for euros. More important, the Vodafone-Mannesmann deal could signal a major shift in Continental attitudes toward cross-border takeovers. If a slew of such big deals in Germany and France follows and attracts more funds from Japan, Britain, and the U.S., the result could be a reversal of the capital flows that have brought the euro down. ''I have spent a lot of time analyzing the exchange rate spin-off from M&A flows,'' says Neil MacKinnon, senior currency strategist at Merrill Lynch & Co. in London. ''This is having an increasing influence on currency movements.'' The officials of the European Central Bank, of course, will keep their jobs. But maybe the deal artists can give them a little hand. By Stanley Reed in London _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS A Whole New Currency Game (int'l edition) TABLE: Strong Markets, Strong Currencies INTERACT E-Mail to Business Week Online

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