Of Euros and Yen

THE euro was the best of 1999, falling from a value of $l, 19 on Jan. I to an even buck at the close of business on Doc. 31. Even though the euro may plunge further toward the 95-cent level, I think you should be wary of trying to capitalize on the fall, to be Sure, if you buy a put option on the euro your potential toss is limited to the amount you paid for the option. But I still don’t believe the rewards justify the risks. Speculators who want to take a bearish stance on a currency should, I think, venture to the other side of the globe. Bet on the fall of the Japanese yen.

The European central bank authorities are quite unhappy with the pace of the decline in their new currency, and they may very well intervene aggressively to try to reverse the euro 's fortunes and drive its price higher. Over long periods such tactics work only if fundamental forces are in line with the intervention. But in thin market conditions, like now, an intervention’s short-term impact can be quite dramatic. Don’t be on the wrong side of one.

There has been good reason for the euro to be weak, and it has to do with capital flows. European investors have shifted more than $100 billion out of their currency in the past yen into other currencies, such as the dollar and yen. The recent political interference in German corporate activities hassimply reinforced the bearish sentiment toward the euro. To make matters worse,there is talk of imposing withholding taxes on foreign holders of euro paperthroughout the European Union. That discourages lots of people from owning the paper- - and therefore the euro,

When the euro was originally launched a year ago, investors latched onto the theme of Europe’s becoming a global economic powerhouse overnight, the reality of creating an integrated economy amid great cultural diversity is another matter. What started as exuberance has turned into a disappointment, The euro will surely recover at some point,but the last vestiges of overoptimistic expectations have to get fully cleansed first. The recent move down in the euro smacks of such a washout, so the turnis near.

In some: It’s too risky to buy puts on the euro, since there could be a government- led rally, but it’s too early to take a bullish stance, by buying call options.

Now take a look at Japan. I expect the yen to break sharply lower  against  both the euro and the dollar. The move won’tbe immediate, but patience will be rewarded. Several primary factors drove the yen higher in 1999. First, the Nikkei benefited from huge investment flows from global equity funds that had been under- weighted in Japanese stocks. These investors had to buy yen to make their stock purchases, and their flows were so large that they had a significant impact on the currency. The other factor was the widescale reduction in Japanese investors’ foreign holdings.

I think both of these trends are largely played out, so the tremendous demand for yen that they engendered is behind us. I also expect that a more balanced appraisal of Japanese economic growth prospects will cause some large capital shifts back out of the yen into other currencies,

Japanese economic prospects are uncertain at best, despite the giant government spending packages. The recent yen appreciation will prove to be a heavy drag on exporter profitability, corporatere structuring will inevitably lead to increased unemployment, and this will weigh on consumer sentiment. Likewise, the growing problems of an aging population that is heavily reliant on investment income will further inhibit spending and ultimately lead to the large-scale export of capital as people desperately seek alternatives to the zero returns now available in Japanese money market accounts.

Some of the $1 trillion of fixed-time-deposits maturing over the next 18 months will leave Japan in search of higher returns abroad. So, look for yen weakness ahead.

You can take a bearish position on the yen through a 115-125 dollar -yen call spread. Available through the Chicago Mercantile Exchange, among other places, this trade has you simultaneously buying a call on the dollar at 115 and selling a call a 125.Minimum contract size: 12.5 million yen, for which the trade costs you a net$700. If the yen collapses to 125 or more to the dollar, the call you bought enables you to sell 2.5 million yen for $108,696. The call you sold enables someone else to dump 12.5 million yen on you for $100,000. Of course. this is a long shot, what with the yen now near 101, but one with a big payoff: up to

$8,696 on your $700 investment.Similar trades are available involving euro-yen bets.