Financial Times; Mar 29, 2001
By ALISON BEARD

When the Federal Reserve made its surprise interest rate cut in January, the US dollar should have declined. Economists, strategists and analysts had been predicting a fall for months. But many currency speculators have been betting - correctly - on the opposite effect.

Today, the European Central Bank decides whether to cut rates in the euro zone. And hedge funds that trade on global macroeconomic trends may make the same, seemingly contrarian call.

"We'll be watching the ECB very closely," said Blair Baker, director of foreign exchange research for Global Capital Investment. "Before January, it was all a euro story - everyone hoping the euro would appreciate. (But) then the Fed surprised the world by lowering rates There's a general perception that the Fed is . . . more in touch with what's going on."

To put it simply, currency traders such as Mr Baker are ignoring traditional economic indicators and instead focusing on the moves of the central banks.

"The foreign exchange market is in utter disagreement with what the economists are telling us," said Bruce Steinberg, chief economist at Merrill Lynch. "The dollar is probably seeing one of the strongest showings since the mid 1980s, (and) that may indicate that many global investors remain sceptical regarding the longer-term viability of the euro. The Fed is a seasoned veteran and the ECB is an upstart . . . In times of rising uncertainty people are more comfortable putting their assets in dollars."

Mr Baker admitted that betting on the dollar was "an asymmetric response" to growth predictions that had Europe well outpacing the US this year. But he added: "Now it seems like the euro-zone won't grow as fast as it started to, (so) I don't really see (our call) as being a contrarian view."

As of March 1, global macro hedge funds had returned more than 11 per cent, putting the strategy in fourth place for the year, according to the CSFB/Tremont Hedge Fund index.

Much of that profit also came from long dollar/short yen trades, according to Virginia Parker, who runs Parker Global Investments, a fund of funds. "I think a lot of the hedge funds were surprised by the extent of the strength of the dollar against the yen, but . . . from 108 (cents per yen) to the 122-plus range, we've seen many of the managers be on that trade and have good profits," she said. The Bank of Japan has lacked direction, so the yen has been easier to call than the euro, she added.

Now Ms Parker sees more indecision. "A lot of managers are still long the dollar against the yen, although some have moved to the sidelines because they are concerned about a correction," she said. As for the dollar/euro trade, "we see people on both sides."

As recently as March 16, strategists at Citibank told clients to ease out of their long dollar/short yen option. In a report released on Monday, they said the dollar could be nearing a peak.

But they also said that tight monetary policy continues to be "the final support" for the dollar. And yesterday, Robert Sinche, Citibank's head of global currency strategy, recommended re-establishing long dollar exposure.

Mr Baker expects the dollar to get a big boost in April, when the Japanese fiscal year ends and managers reallocate their money, probably into foreign markets.