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NOVEMBER 28, 2001  SPECIAL REPORT: THE AGE OF THE EURO By Will Rugg, S&P MMS A Joyless New Year for Euro Bulls? Europe's freshly minted notes and coins will hit the streets on Jan. 1, but S&P's Will Rugg sees little hope of gains against the greenback Though such a transformation is unprecedented in market history, foreign investors seem unlikely to experience a sudden surge in appetite for euro assets once the currency is fully fledged at the end of February next year. The absence of a tangible currency has never been among the myriad reasons investors list for shunning the flagging euro. RED HERRING. Furthermore, the main causes cited for chronic euro weakness -- lack of investor confidence in the eurozone's fiscal and monetary policy, slow progress on economic and financial market reforms, and the region's comparatively sluggish growth -- will not disappear after E-Day simply because notes and coins will be in circulation. After a brief rally against the U.S. dollar to its highest level of 118.99 cents in its first week of existence, the euro suffered an almost uninterrupted decline of more than 30% to a record low of 82.25 cents in October, 2000. Currently at around 88 cents, it's not far off its lowest point against the greenback -- despite overwhelming evidence that the U.S. economy is now in recession. Yet, according to weekly data from the Commodities & Futures Trading Commission, which tracks speculative contracts on the Chicago futures exchange, euro buyers have outweighed sellers for all but a handful of weeks throughout its history. The implication is that the euro's stubborn weakness has come without the aid of speculative selling. Ultimately, traders' aggressive bets have merely helped drive euro losses as the bullish positions inevitably came unwound. Even at the euro's record low, speculative sellers only outweighed buyers by a slim majority. Despite the bullish trend of speculative positioning over the euro's history, it has yet to enjoy a sustainable rally. This is because the directions of longer-term investment and capital flows have been overwhelmingly out of the eurozone. If speculative selling were to turn more aggressive, new record lows seem inevitable. EURO EVASION. Another concern in the near term comes from black- or gray-market cash sitting around in legacy currencies that will cease to be legal tender after E-Day. Estimates for the total, both inside and outside the eurozone, vary widely -- from 15 billion euros to 70 billion euros. Even at the low end of these estimates, there is a threat to the euro if a significant portion of the holders -- ranging from organized crime to tax evaders -- decide to convert it into tried-and-true hard currency such as Swiss francs, British pounds, or U.S. dollars. This would be tantamount to selling euros. Some of this pressure may have already contributed to the euro's decline from its January highs of 95.94 cents to around 88 currently. Meanwhile, any short-term bulls may be encouraged to sell their euros, rather than take the risk that something could go wrong with the huge and complex task of substituting some 75 billion euros worth of legacy notes and coins. Bears who want to bet that something will go wrong may sell more. Long-term investors are probably assuming (or at least hoping) that no major glitches will occur. If all goes smoothly, holders of the currency may breathe a sigh of relief, but it would hardly be a ringing endorsement to rush out and buy. FADING ENTHUSIASM. The arguments for a euro rally on a successful conversion consist of intangibles -- bolstered consumer confidence and a more closely integrated single European market with increased efficiencies. It will take some time to assess whether these benefits are realized, and foreign investors' lack of confidence is likely to continue in the meantime. Even in the eurozone, enthusiasm is at a low ebb as E-Day approaches. A recent FT Deutschland poll showed only 33% of Germans welcomed the euro, down from 36% in July. If any serious problems arise during the changeover, this could deal fragile euro sentiment yet another blow.  Rugg is S&P MMS' managing currency analyst Standard & Poor's MMS real time analysis of the global fixed income, forex and emerging markets is available on the Web at www.GLOBALMARKETS.COM Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | NOVEMBER |
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