Treasury and Federal Reserve Foreign Exchange Operations.This quarterly report describes U.S. Treasury U.S. Treasury Created in 1798, the United States Department of the Treasury is the government (Cabinet) department responsible for issuing all Treasury bonds, notes and bills. Some of the government branches operating under the U.S. Treasury umbrella include the IRS, U.S. and System foreign exchange operations for the period from October through December 1998. It was presented by Peter R. Fisher, Executive Vice President, Federal Reserve Bank of New York The Bank of New York, abbrieviated to BNY, was a global financial services company that existed until its merger with the Mellon Financial Corporation on July 2, 2007.[1] The bank now continues under the new name of The Bank of New York Mellon Corporation. , and Manager, System Open Market Account. Jason J. Bonanca was primarily responsible for preparation of the report. During the fourth quarter of 1998, the dollar depreciated Depreciated may refer to:
“JPY” redirects here. For the Australian singer with the same moniker, see John Paul Young. and was virtually unchanged against the German mark. Against the yen, the dollar fell sharply, as long dollar positions in speculative accounts were unwound un·wound v. Past tense and past participle of unwind. unwound unwind in an effort to deleverage balance sheets and cover trading losses The following contains a list of trading losses which eventually forced major corporations to go bankrupt or restructure parts of their organisation. This list is not exhaustive. incurred in other markets. Later in the period, rising long-term interest rates in Japan relative to those in the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. helped to reverse a temporary dollar rebound. Against the mark, the dollar rose from early lows after relative interest rate expectations shifted in favor of the dollar, but the dollar partially retraced its gains after U.S. equity prices retreated from record highs in November. The U.S. monetary authorities did not intervene in the foreign exchange markets during the quarter. A SHARP DECLINE OF THE DOLLAR AGAINST THE YEN At the outset of the quarter, market unease regarding global financial market instability was on the rise. Although the dollar began the period at [yen] 136.50, it soon depreciated suddenly and sharply as hedge funds hedge fund, in finance, a highly speculative, largely unregulated investment device. Originating in the 1950s, the funds "hedge" by offsetting "short" positions (borrowing a security and then selling it at a higher price before repaying the lender) against "long" and other speculative accounts liquidated DAMAGES, LIQUIDATED, contracts. When the parties to a contract stipulate for the payment of a certain sum, as a satisfaction fixed and agreed upon by them, for the not doing of certain things particularly mentioned in the agreement, the sum so fixed upon is called liquidated damages. (q.v. long dollar positions in an effort to reduce risk, deleverage balance sheets, and cover losses incurred in other markets. On October 7, the dollar-yen exchange rate fell 6.7 percent, from [yen] 133.90 to [yen] 120.55--the largest percentage change in one day since 1974. Volatility in the exchange rate intensified during the following morning's New York New York, state, United States New York, Middle Atlantic state of the United States. It is bordered by Vermont, Massachusetts, Connecticut, and the Atlantic Ocean (E), New Jersey and Pennsylvania (S), Lakes Erie and Ontario and the Canadian province of trading session, with the dollar falling to a low of [yen] 111.58 but then suddenly rebounding to a high of [yen] 123.40. Many market participants The term market participant is used in United States constitutional law to describe a U.S. State which is acting as a producer or supplier of a marketable good or service. When a state is acting in such a role, it may permissibly discriminate against non-residents. ascribed the dollar's burst of strength to rumors of central bank intervention Central bank intervention The buying or selling of currency, foreign or domestic, by central banks in order to influence market conditions or exchange rate movements. or market inquiries by monetary officials. Others noted that the exchange rate's rebound occurred only after the market achieved a reasonable degree of confidence that no official intervention had taken place. Still, many market participants noted persistent interest in selling dollars in the range around [yen] 120, largely because of concerns that levels above this range would spark a fresh round of position unwinding. The rapidity and magnitude of the price movements contributed to a decrease in direct interbank in·ter·bank adj. Relating to, involving, or connecting two or more banks: interbank borrowing; an interbank network of automated teller machines. dealing, and bid--ask spreads quoted by some banks were several times wider than typical levels. In contrast, an increase in electronic trading  This article or section is in need of attention from an expert on the subject.Please help recruit one or [ improve this article] yourself. See the talk page for details. activity served to concentrate available liquidity in a transparent pricing environment. This shift in market volume to the electronically brokered medium may have influenced the price action during the dollar's depreciation. The transparency afforded by electronic brokering allowed dealers to observe prices at which actual trades were being executed. Thus, as the market digested new information, traders were not obligated ob·li·gate tr.v. ob·li·gat·ed, ob·li·gat·ing, ob·li·gates 1. To bind, compel, or constrain by a social, legal, or moral tie. See Synonyms at force. 2. To cause to be grateful or indebted; oblige. to deal in order to discover current prices, reducing the need to shed undesired positions that might have been accumulated as a consequence of such dealing. As a result, price movements may have been steeper but less erratic, given that individual market participants were more able to refrain from transacting until rates reached levels they considered attractive. Through early November, the dollar traded in a less volatile manner, largely between [yen] 115 and [yen] 120. Despite the dollar's stabilization after the sudden decline, many market participants continued to believe that leveraged investors were holding long dollar positions that they wished to unwind Unwind 1. The closure of an investment position. 2. The reconciliation of an error previously unseen by a brokerage house. Notes: 1. Sometimes referred to as closing out a position. and that a significant possibility of a new round of heavy dollar selling remained. Option prices throughout the quarter reflected this anxiety regarding investor positioning. One-month implied volatility Implied volatility The expected volatility in a stock's return derived from its option price, maturity date, exercise price, and riskless rate of return, using an option pricing model such as Black-Scholes. , while having subsided from an all-time high of 40 percent on October 8, continued to trade between 15 percent and 23 percent. Meanwhile, risk reversals Risk Reversal 1. In commodities trading, it is a hedge strategy that consists of selling a call and buying a put option. This strategy protects against unfavorable, downward price movements but limits the profits that can be made from favorable upward price movements. 2. partly reflected a desire to protect against further downward moves in the dollar, with the premium for dollar puts in the one-month maturity reaching an all-time high of 3.6 percent on December 14. Late in the period, movements of the dollar against the yen were increasingly influenced by events in Japan, as volatility in the Japanese government bond (JGB JGB Jerry Garcia Band JGB Japanese Government Bond JGB Just Got Back JGB J Geils Band JGB JG Ballard (science fiction author) ) market increased markedly. On December 22, the Trust Fund Bureau of the Japanese Ministry of Finance announced that it would significantly reduce its purchases of Japanese government securities. This event, juxtaposed jux·ta·pose tr.v. jux·ta·posed, jux·ta·pos·ing, jux·ta·pos·es To place side by side, especially for comparison or contrast. with pre-existing market anxieties regarding increased bond supply, helped the benchmark JGB yield to rise from 0.77 percent to 2.01 percent over the period. Over the quarter, the interest rate differential between ten-year JGBs and U.S. Treasuries declined 102 basis points, to end at 263 basis points. Increasing concern over the growing U.S. current account deficit placed some further pressure on the dollar. Finally, market participants noted that the yen derived some further support from expectations that the slump in Japanese economic growth might have reached its nadir. The dollar finished the quarter toward the bottom of its period range, at [yen] 112.80. SWINGS IN ASSET PRICES BEFORE FEDERAL RESERVE EASING At the outset of the period, global financial market conditions were tumultuous, with investors concerned that turmoil in emerging markets was beginning to exercise increasing influence on the developed markets. Many market participants were disappointed with the magnitude of the September 29 easing by the Federal Reserve and believed that the Federal Reserve would not continue to ease aggressively in the face of heightened market volatility. The concerns of market participants persisted after the meeting of the Group of Seven (G-7) finance ministers and central bank governors on October 3-4, with many observing that concrete policy measures to confront the global financial turmoil had not yet materialized. With this deterioration de·te·ri·o·ra·tion n. The process or condition of becoming worse. in sentiment, asset prices reflected a mounting aversion a·ver·sion n. 1. A fixed, intense dislike; repugnance, as of crowds. 2. A feeling of extreme repugnance accompanied by avoidance or rejection. to risk. European share prices fell sharply, with the DAX slipping to a 1998 low on October 8. Moreover, throughout the first two weeks of the quarter, market participants became particularly concerned with the health of the financial sector, especially with respect to institutions believed to have sizable exposures to hedge funds or to have incurred significant losses as a result of the volatility in financial assets Financial assets Claims on real assets. . On October 7, the S&P Investment Bank and Brokerage Index dropped to a twenty-one-month low. Shortly thereafter, a trend of steepening government yield curves emerged in both the United States and Europe, as investors herded cash into short-term government debt and as expectations for monetary easing as a response to the situation began to emerge. Therefore, while flight-to-quality flows had helped to push the thirty-year Treasury Thirty-Year Treasury A U.S. Treasury debt obligation that has a maturity of 30 years. The 30-year Treasury is the benchmark U.S. bond and one of the world's most closely watched financial instrument. bond yield to an all-time low of 4.72 percent on October 5, two-year Treasury notes outperformed the thirty-year bond during the second week of October. By October 13, the yield spread between thirty-year and two-year Treasuries had increased from its period open of 73 basis points to 98 basis points. Over the first weeks of the period, spreads between some on-the-run and off-the-run Treasuries Off-The-Run Treasuries All Treasury bonds and notes issued before the most recently issued bond or note of a particular maturity. These are the opposite of "on-the-run treasuries". increased to several times typical levels, suggesting a heightened investor demand for liquidity. On October 15, the Federal Reserve announced a reduction of 25 basis points in the targeted federal funds rate Federal Funds Rate The interest rate at which a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight. , from 5.25 to 5.00 percent, noting "growing caution by lenders and unsettled conditions in financial markets more generally." The change in the target, which was the second easing by the Federal Reserve in about as many weeks, came sooner than many market participants had expected. Over the following weeks, many financial asset prices recovered from their lows. Sentiment was also boosted by speculation that international financial institutions and monetary authorities would provide more financial support to Brazil than had previously been expected. Other policy developments around this time also encouraged market recovery. On October 21, the U.S. Congress passed legislation funding the increase in the U.S. quota in the International Monetary Fund and the New Arrangements to Borrow. Further, on October 30, G-7 leaders, finance ministers, and central bank governors issued statements laying out an immediate action plan to strengthen the international financial system and a broader agenda going forward. Nevertheless, the trend of market recovery was uneven throughout the rest of the quarter. Concern over the Brazilian government's commitment to fiscal reform surfaced intermittently and led to bouts of weakness in relatively risky financial assets. Declining oil prices weighed on petroleum-related stocks and on currencies viewed as commodity sensitive. In addition, sentiment toward emerging markets was adversely affected by renewed declines in commodity prices more broadly. By late November, the Commodities Research Bureau commodity price index had reached a new historic low and continued to trend weaker throughout the rest of the period. On November 17, the Federal Open Market Committee (FOMC See Federal Open Market Committee. FOMC See Federal Open Market Committee (FOMC). ) announced a reduction of 25 basis points in the targeted federal funds rate, to 4.75 percent. In the statement issued with its decision, the Committee said that "although conditions in financial markets have settled down materially since mid-October, unusual strains remain." In the aftermath of this ease, many asset prices consolidated the trend of recovery begun earlier. In addition, the International Monetary Fund announced a $41.5 billion assistance package for Brazil on November 13. As part of this international financial support program, the U.S. Treasury announced that, through the Exchange Stabilization Fund The Exchange Stabilization Fund (ESF) is a branch of the United States Treasury Department which manages a portfolio of domestic and foreign currencies for the purpose of foreign exchange intervention. , it would participate in a substitution agreement to guarantee up to $5.0 billion of the $13.28 billion Bank for International Settlements Credit Facility for Brazil. Shortly thereafter, the average Brady bond's stripped yield Stripped Yield The implied sovereign yield of a bond, or the theoretical yield of the non-collateralized portion of a bond. Notes: Because many Brady bonds have built-in interest features and principal guarantees to attract secondary-market investors, stripping out these spread to Treasuries, as measured by the J. P. Morgan Emerging Markets Bond Index, fell to a period low of 944 basis points. Toward the end of the quarter, trading in most instruments grew increasingly thin, with many investors reluctant to establish new risk positions before the year's end. RELATIVELY SUBDUED sub·due tr.v. sub·dued, sub·du·ing, sub·dues 1. To conquer and subjugate; vanquish. See Synonyms at defeat. 2. To quiet or bring under control by physical force or persuasion; make tractable. 3. DOLLAR TRADING AGAINST THE MARK Early in the quarter, the dollar traded in a relatively volatile fashion at the bottom of its 1998 range, between DM 1.61 and DM 1.66. During this period, the dollar was pressured by the increase in risk aversion risk aversion The tendency of investors to avoid risky investments. Thus, if two investments offer the same expected yield but have different risk characteristics, investors will choose the one with the lowest variability in returns. in global financial markets and increasing expectations that the Federal Reserve was more likely to reduce interest rates than the Bundesbank. However, this trend began to reverse after the reduction in interest rates announced by the Federal Reserve on October 15. Following the announcement, many market participants began to anticipate that European interest rates were also likely to fall. These expectations were supported by weak business sentiment data from Germany as well as downward revisions to market forecasts for European growth. As a result, expectations for future interest rate differentials between the United States and Europe moved in the dollar's favor after the Federal Reserve's action, and the implied yield spread between the March Eurodollar and Euromark contracts rose. The dollar reached its quarter high of DM 1.7145 on November 27. Late in November, the dollar retraced some of these gains after U.S. equity prices retreated from newly established historic highs; profit warnings from major U.S. corporations and year-end profit taking contributed to this move in share prices. In addition, commentary from European monetary officials led to doubts regarding the likelihood of reductions in continental interest rates, lending more support to the mark. The dollar's weakening trend ended shortly after the December 3 announcement that the monetary authorities of the eleven countries participating in the European Economic and Monetary Union had reduced interest rates in a coordinated move. Toward the end of the year, expectations for future interest rate spreads continued to move against the mark and helped to lift the dollar to levels near DM 1.68, where it finished the period. TREASURY AND FEDERAL RESERVE FOREIGN EXCHANGE RESERVES Foreign exchange reserves (also called Forex reserves) in a strict sense are only the foreign currency deposits held by central banks and monetary authorities. The U.S. monetary authorities did not undertake any intervention operations during the quarter. At the end of the quarter, the current values of the German mark and Japanese yen reserve holdings totaled $19.8 billion for the Federal Reserve System and $16.4 billion for the Exchange Stabilization Fund. The U.S. monetary authorities invest all of their foreign currency balances in a variety of instruments that yield market-related rates of return and have a high degree of liquidity and credit quality. A significant portion of these balances is invested in German and Japanese government securities held directly or under repurchase agreement Repurchase agreement An agreement with a commitment by the seller (dealer) to buy a security back from the purchaser (customer) at a specified price at a designated future date. . As of December 31, outright holdings of government securities by the U.S. monetary authorities totaled $7.6 billion. Japanese and German government securities held under repurchase agreement are arranged either through transactions executed directly in the market or through agreements with official institutions. Government securities held under repurchase agreement by the U.S. monetary authorities totaled $9.4 billion at the end of the quarter. Foreign currency reserves are also invested in deposits at the Bank for International Settlements and in facilities at other official institutions. RECIPROCAL CURRENCY ARRANGEMENTS On November 17 the FOMC voted unanimously to reauthorize Federal Reserve participation in the North American North American named after North America. North American blastomycosis see North American blastomycosis. North American cattle tick see boophilusannulatus. Framework Agreement (NAFA), established in 1994, and the associated bilateral reciprocal currency ("swap") arrangements with the Bank of Canada Bank of Canada Canada's central bank, established under the Bank of Canada Act (1934). It was founded during the Great Depression to regulate credit and currency. The Bank acts as the Canadian government's fiscal agent and has the sole right to issue paper money. and the Bank of Mexico The Bank of Mexico (Spanish: Banco de México), abbreviated BdeM or Banxico, is Mexico's central bank and lender of last resort. Banco de México is autonomous in exercising its functions. . Likewise, the Secretary of the Treasury authorized au·thor·ize tr.v. au·thor·ized, au·thor·iz·ing, au·thor·iz·es 1. To grant authority or power to. 2. To give permission for; sanction: , on December 7, the renewal of the Treasury's participation in the NAFA and of the associated Exchange Stabilization Agreement with Mexico. Because of the formation of the European Central Bank European Central Bank (ECB) Bank created to monitor the monetary policy of the countries that have converted to the Euro from their local currencies. The original 11 countries are: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and in light of fifteen years of disuse dis·use n. The state of not being used or of being no longer in use. disuse Noun the state of being neglected or no longer used; neglect Noun 1. , the bilateral swap arrangements Swap arrangements Short-term reciprocal lines of credit between the Federal Reserve and 14 foreign centeral banks as well as the Bank for International Settlements. Through a swap transactions, the Federal Reserve can, in effect, borrow foreign currency in order to purchase dollars of the Federal Reserve with the Austrian National Bank, the National Bank of Belgium The National Bank of Belgium (Nationale Bank van België in Dutch, Banque nationale de Belgique in French, and Belgische Nationalbank in German) has been the central bank of Belgium since 1850. It is a member of the European System of Central Banks. , the Bank of France, the German Bundesbank, the Bank of Italy Bank of Italy may refer to either :
The names of the institution in the four official languages of the country are: German: , and the Bank for International Settlements to lapse in light of their disuse and present-day arrangements for international monetary cooperation. [CHARTS OMITTED] 1. Foreign currency holdings of U.S. monetary authorities based on current rates, 1998:Q4
Millions of dollars
Balance,
Item Sept. 30, 1998
FEDERAL RESERVE
Deutsche marks 12,688.6
Japanese yen 5,663.8
Total 18,352.4
Interest receivables(4) 95.1
Other cash flow from investments(5) ...
Total 18,447.5
U.S. TREASURY
EXCHANGE STABILIZATION FUND
Deutsche marks 6,423.4
Japanese yen 8,106.0
Total 14,529.4
Interest receivables(4) 48.6
Other cash flow from investments(5) ...
Total 14,578.0
Quarterly changes in
balances by source
Item Net purchases Impact of Investment
and sales(1) sales(2) income
FEDERAL RESERVE
Deutsche marks 0 0 111.3
Japanese yen 0 0 5.0
Total 0 0 116.3
Interest receivables(4) ... ... ...
Other cash flow ... ... ...
from investments(5)
Total ... ... 116.3
U.S. TREASURY
EXCHANGE
STABILIZATION FUND
Deutsche marks 0 0 58.7
Japanese yen 0 0 7.4
Total 0 0 66.1
Interest receivables(4) ... ... ...
Other cash flow from ... ... ...
investments(5)
Total ... ... 66.1
Quarterly changes in
balances by source
Interest
Currency accrual Balance
valuation (net) Dec. 31,
adjustments(3) and other 1998
Item
FEDERAL RESERVE
Deutsche marks 24.1 0 12,824.0
Japanese yen 1,178.1 0 6,846.9
Total 1,202.2 0 19,670.9
Interest receivables(4) ... -12.3 82.8
Other cash flow ... 14.8 14.8
from investments(5)
Total 1,202.2 2.5 19,768.5
U.S. TREASURY
EXCHANGE
STABILIZATION FUND
Deutsche marks 12.3 0 6,494.4
Japanese yen 1,686.0 0 9,799.4
Total 1,698.3 0 16,293.8
Interest receivables(4) ... -4.3 44.3
Other cash flow from ... 21.4 21.4
investments(5)
Total 1,698.3 17.1 16,359.5
NOTE: Figures may not sum to totals because of rounding. (1.) Purchases and sales include foreign currency sales and purchases related to official activity, swap drawings and repayments, and warehousing. (2.) Calculated using marked-to-market exchange rates; represents the difference between the sale exchange rate and the most recent revaluation Revaluation A calculated adjustment to a country's official exchange rate relative to a chosen baseline. The baseline can be anything from wage rates to the price of gold to a foreign currency. In a fixed exchange rate regime, only a decision by a country's government (i.e. exchange rate. Realized profits Realized profit (or loss) A capital gain or loss on securities held in a portfolio that has become actual by the sale or other type of surrender of one or many securities. and losses on sales of foreign currencies computed as the difference between the historic cost-of-acquisition exchange rate and the sale exchange rate are shown in table 2. (3.) Foreign currency balances are marked to market monthly at month-end exchange rates. (4.) Interest receivables of the ESF (1) (Extended SuperFrame) An enhanced T1 format that allows a line to be monitored during normal operation. It uses 24 frames grouped together (instead of the 12-frame D4 superframe) and provides room for CRC bits and other diagnostic commands. are revalued at month-end exchange rates. Interest receivables for the Federal Reserve System are carried at average cost of acquisition and are not marked to market until interest is paid. Interest receivables for the Federal Reserve system is net of unearned interest Unearned interest Interest that has been received on a loan, but that cannot be treated as a part of earnings yet, because the principal of the loan has not been outstanding long enough. collected. (5.) Cash flow differences from payment and collection of funds between quarters. 2. Net profits or losses (-) on U.S. Treasury and Federal Reserve foreign exchange operations, based on historical cost-of-acquisition exchange rates, 1998:Q4
Million of dollars
Federal U.S. Treasury
Period and item Exchange
Reserve Stabilization
Fund
Valuation profits and losses on
outstanding assets and liabilities,
Sept. 30, 1998
Deutsche marks 974.3 84.3
Japanese yen 51.7 80.0
Total 1,026.0 164.3
Realized profits and losses
from foreign currency sales,
Sept. 30, 1998-Dec. 31, 1998
Deutsche marks 0 0
Japanese yen 0 0
Total 0 0
Valuation profits and losses on
outstanding assets and liabilities,
Dec. 31, 1998
Deutsche marks 998.5 96.6
Japanese yen 1229.8 1766.0
Total 2,228.2 1,862.7
Net profits or losses (-) on U.S. Treasury and Federal Reserve foreign exchange operations, based on historical cost-of-acquisition exchange rates, 1998:Q4 3. Currency arrangements, December 31, 1998
Millions of dollars
Institution Amount of Outstanding,
facility Dec. 31, 1998
Federal Reserve
reciprocal currency
arrangements
Bank of Canada 2,000 0
Bank of Mexico 3,000 0
Total 5,000 0
U.S. Treasury
Exchange Stabilization Fund
currency arrangements
Bank of Mexico 3,000 0
Total 3,000 0
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