Euro rally catches out short sellers Caught short has just taken on a new meaning. For the many forex dealers and hedge funds that have bet on a slide in the euro, the single currency's rise to a four-month high this week above $1.29 against the dollar has been as uncomfortable as it has been unexpected. First, Mario Draghi set out plans for European Central Bank action to support the sovereign bond markets of Spain and Italy. Then Germany's constitutional court removed the last big hurdle to the eurozone's permanent bailout fund, the European Stability Mechanism, a ruling some believe will prove to be a turning point in the region's debt crisis. Equities and the bonds of "peripheral" eurozone countries have duly rallied. But it is the gains in the euro that have caught out investors, many of whom still have overwhelmingly short positions on the single currency. Indeed, the most recent data from the US Commodity Futures Trading Commission, regarded as a proxy for hedge fund activity, show euro shorts actually increased before last week's ECB action and remain at elevated levels. Hedge fund and longer-term investors were expecting the euro to fall, say traders at investment banks. There are very few people out there that are outright bullish on the euro. Most hedge funds are so bearish they can't see straight," says Bob de Groot, global head of forex spot trading at BNP Paribas. For those investors who have been bearish on the single currency for many months, unwinding those positions could take some time. Such positioning also helps to explain the pessimistic tone among many City analysts, whose banks" own books are full of short positions on the euro. Valentin Marinov, forex strategist at Citigroup, estimates it would take a move above $1.30 for the bank's clients to even move to neutral positions overall on the single currency. The rise in the euro has also come as an unwelcome surprise to European exporters, many of whom had not hedged much of their overseas currency exposure this year because they expected the euro to fall in value. A recent survey by Commerzbank found that German companies became less negative on the euro's short-term value in August. However, they still expected it to fall by the end of the year. That has led European exporters to stay out of the markets in recent days. "The current levels for exporters are not attractive - some were caught by surprise and they are waiting for a correction," says Gerald Dannhaeuser, global head of forex sales at Commerzbank. By contrast, the euro's rally has been a boon for European importers and US and Asian exporters, who are natural sellers of the euro and have been taking advantage of the move higher to lock in profits, according to Bernie Sinniah, global head of corporate sales at Citigroup. The rise in the euro has wrongfooted investors elsewhere in the currency market, too. The Swiss franc, which had been a popular choice among those betting the eurozone crisis would worsen, has been one of the surprise movers in the past week. Traders say hedge funds using the franc as a euro break-up hedge started closing those positions the day before the ECB's pledge to buy bonds last week. That has helped the euro to finally pull away from the limit of SFr1.20 at which Switzerland stands ready to weaken the franc, to rise above SFr1.21. Beat Siegenthaler, forex strategist at UBS in Zurich, thinks that if Spain applies for aid, removing another lingering concern in the minds of investors, the euro could move as high as SFr.1.24 against the franc as demand for the haven continues to wane. "People have taken the euro break-up hedge off the table," says Kayhan Mirza, global head of forex options trading at JPMorgan. FX Concepts, the currency macro hedge fund based in New York, told investors this week the euro could now rise to $1.33 against the dollar as early as October. The hedge fund is keeping a close eye on demand for peripheral debt, however, on the assumption that the easy money has been made already. Currency investors also say it is hard to tell how far the rise in the euro has been down to the ECB's action, albeit it verbal so far, and how far it is due to a weaker dollar. Expectations the Federal Reserve would ease monetary policy this month mounted in the weeks leading up to Thursday's meeting. The dollar index, which weights the dollar against a basket of other currencies including the euro, fell to its lowest level since May before the Fed confirmed on Thursday it was adding to its programme of monetary easing. Others are cautious. Stephen Jen, manager of currency hedge fund SLJ Macro Partners, believes the recovery in the euro will be limited because investors who earlier switched from peripheral bonds to "core" assets, such as Bunds, will simply reverse those flows, limiting the impact on the currency itself. The magnitude of the recovery of the euro will not be as much as people think as the flows will be the unwind of those earlier ones. Right now we're in the phase of unwinding the shorts," he says.