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 July through September 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 third 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 7.8 percent against the German mark (charts 1 and 2). Against the mark, the dollar continued to trade in relatively narrow ranges during the first half of the period. Subsequently, however, the dollar dropped sharply amid increasing turmoil in global financial markets and shifting expectations for economic growth and interest rate policy. Against the yen, the dollar steadily appreciated throughout the first half of the quarter, reaching new eight-year highs, as 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. reacted pessimistically pes·si·mism n. 1. A tendency to stress the negative or unfavorable or to take the gloomiest possible view: "We have seen too much defeatism, too much pessimism, too much of a negative approach" to political uncertainty and financial-sector difficulties in Japan. Later in the period, the dollar's gains were more than reversed as market participants unwound un·wound v. Past tense and past participle of unwind. unwound unwind short yen positions in an environment of increasing 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. . The U.S. monetary authorities did not intervene in the foreign exchange markets during the quarter. [CHARTS 1-2 OMITTED] HEIGHTENED RISK AVERSION RESULTING FROM TURMOIL IN EMERGING MARKETS During the first half of the quarter, market participants expected that near-term U.S. interest rate policy would remain unchanged. The economic slowdown in Asia was expected to counterbalance ongoing, if moderating, strength in U.S. domestic demand. However, continued financial and economic weakness in Japan and developments in emerging markets--particularly the deteriorating financial situation in Russia--helped to support U.S. Treasury prices during the first weeks in the quarter. Until the middle of August, 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 traded consistently below 5.80 percent, near the bottom of its 1998 range (chart 3). [CHART 3 OMITTED] Investor 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 intensified sharply after Russia's declaration of a debt moratorium A debt moratorium is a delay in the payment of debts or obligations. The term is generally used to refer to acts by national governments. A moratory law is usually passed in some special period of political or commercial stress; for instance, on several occasions during the and an effective devaluation devaluation, decreasing the value of one nation's currency relative to gold or the currencies of other nations. It is usually undertaken as a means of correcting a deficit in the balance of payments. of the ruble on August 17. Losses in Russian markets and a dramatic widening of risk premiums led to successive waves of selling in emerging-market assets. Dollar-denominated, emerging-market yield spreads over Treasuries rose to their highest levels since early 1995, and sales of emerging-market currencies ensued as investors shed positions in local markets. These outflows led to increasing pressures on other markets, particularly those with fixed exchange rate regimes. Mounting strains on the Hong Kong dollar Noun 1. Hong Kong dollar - the basic unit of money in Hong Kong dollar - the basic monetary unit in many countries; equal to 100 cents led to speculation regarding another series of currency devaluations Currency devaluation A deliberate downward adjustment in the official exchange rates established, or pegged, by a government against a specified standard, such as another currency or gold. in Asia. Meanwhile, increasing capital outflows Capital outflow is an economic term describing capital flowing out of (or leaving) a particular economy. Outflowing capital can be caused by any number of economic or political reasons but can often originate from instability in either sphere. from Brazil, as well as devaluations in Colombia and Ecuador, raised concerns about stability in Latin America Latin America, the Spanish-speaking, Portuguese-speaking, and French-speaking countries (except Canada) of North America, South America, Central America, and the West Indies. . Sensitivity to the risk of sovereign events was exacerbated by Malaysia's announcement of capital controls and a new fixed exchange rate regime on September 1, as well as Hong Kong's decision to intervene in its equity market. In this environment, demand for U.S. Treasuries soared, with the thirty-year bond yield declining, to as low as 4.96, on September 30. Meanwhile, U.S. equities began to post sharp declines, responding to mounting turmoil in emerging markets and weaker-than-expected corporate earnings. European shares also weakened; the German DAX declined 24.2 percent over the period. The sharp downward adjustment in asset prices in emerging markets accelerated as leveraged investors were forced to liquidate To pay and settle the amount of a debt; to convert assets to cash; to aggregate the assets of an insolvent enterprise and calculate its liabilities in order to settle with the debtors and the creditors and apportion the remaining assets, if any, among the stockholders or owners of the positions to meet margin calls. Risk aversion grew, as market participants anticipated that rapidly accruing losses might lead to a contraction of credit within the investment community. Further, the speed of the declines led to substantially illiquid Illiquid An asset or security that cannot be converted into cash very quickly (or near prevailing market prices). Notes: A house is a good example of an illiquid asset. See also: Cash, Liquidity Illiquid In the context of finance. trading conditions, which exacerbated volatility in already unsteady markets. Anxiety over the health of the financial sector intensified as market participants began to speculate that Long-Term Capital Management Long-Term Capital Management (LTCM) was a hedge fund founded in 1994 by John Meriwether (the former vice-chairman and head of bond trading at Salomon Brothers). On its board of directors were Myron Scholes and Robert C. , a major hedge fund 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" , had incurred large losses. During the final weeks of the period, tension in global financial markets eased somewhat in response to growing expectations for official policy responses (chart 4). The September 14 statement by the Group of Seven (G-7) Finance Ministers and Central Bank Governors, in addition to President Clinton's speech to the Council on Foreign Relations The Council on Foreign Relations (CFR) is an influential and independent, nonpartisan foreign policy membership organization founded in 1921 and based at 58 East 68th Street (corner Park Avenue) in New York City, with an additional office in Washington, D.C. , prompted increased market talk about plans for international financial stabilization and possible coordinated interest rate cuts. On September 29, the Federal Open Market Committee (FOMC See Federal Open Market Committee. FOMC See Federal Open Market Committee (FOMC). ) cut its 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. target 25 basis points, to 5.25 percent. [CHART 4 OMITTED] DECLINE OF THE DOLLAR AGAINST THE MARK Early in the period, the dollar traded in its year-to-date range of DM 1.75-1.85, guided by stable expectations for gradual but steady growth in both 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. and Germany. Market expectations regarding monetary policy in the two countries reflected anticipation of steady policy in the United States and the possibility of a rate increase in Germany before the beginning of the European Economic and Monetary Union (EMU emu or emeu (both: ē`my  ), common name for a large, flightless bird of Australia, related to the cassowary and the ostrich. ) in January 1999. Alter the events of mid-August,
however, market participants became increasingly persuaded that the
turmoil in emerging markets and ongoing weakness in Asia would have a
more significant effect on the U.S. economic outlook than had previously
been expected. The concomitant concomitant /con·com·i·tant/ (kon-kom´i-tant) accompanying; accessory; joined with another. concomitant adjective Accompanying, accessory, joined with another tumble in U.S. equity prices served as an initial catalyst for dollar sales against marks; between August 26 and 31, the dollar declined from DM 1.8068 to DM 1.7547 against the mark as the Dow Jones Industrial Average Dow Jones Industrial Average The best known U.S. index of stocks. A price-weighted average of 30 actively traded blue-chip stocks, primarily industrials including stocks that trade on the New York Stock Exchange. fell 11.6 percent. The dollar's decline coincided with the emergence of expectations that the Federal Reserve would ease monetary policy in an effort to address the possible consequences for U.S. growth prospects posed by the strain on financial markets. In an address on September 4, Chairman Greenspan said. "... it is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress." Many market participants interpreted the Chairman's speech as a signal that the FOMC had abandoned its bias toward a tightening and was leaning toward an ease as its next move. Over the following week the implied rate on the October federal funds Federal Funds Funds deposited to regional Federal Reserve Banks by commercial banks, including funds in excess of reserve requirements. Notes: These non-interest bearing deposits are lent out at the Fed funds rate to other banks unable to meet overnight reserve contract declined 17 basis points and subsequently reached a period low on September 25, of 5.15 percent. During the period, the increasing scope of global financial stress helped to reduce expectations that the Bundesbank would raise rates as part of the process of European convergence; the implied yield on the December 1998 Euromark contract declined 37 basis points, to 3.55 percent. However, market participants appeared increasingly convinced that the Bundesbank was relatively less likely to ease policy than the Federal Reserve. Continued signs of European growth, the Bundesbank's call for the gradual convergence of European interest rates, and perceptions that the European economy was relatively insulated in·su·late tr.v. in·su·lat·ed, in·su·lat·ing, in·su·lates 1. To cause to be in a detached or isolated position. See Synonyms at isolate. 2. from weakness in Latin America all contributed to this belief. The implied yield spread between the December Eurodollar and Euromark contracts narrowed from a high of 195 basis points to a low of 146 basis points, illustrating the degree to which interest rate expectations had shifted against the dollar; during the same period, the dollar declined more than 12 pfennigs against the mark, falling from DM 1.7993 to DM 1.6718 (chart 5). [CHART 5 OMITTED] Throughout the period, the dollar-mark exchange rate also reflected steady demand for selected European financial assets Financial assets Claims on real assets. stemming from expectations for tow regional inflation and confidence in the EMU. These flows helped to push the benchmark German bond yield to a record low on September 30, of 3.87 percent (chart 6). In addition, anxiety among some market participants regarding prospects for impeachment impeachment, formal accusation issued by a legislature against a public official charged with crime or other serious misconduct. In a looser sense the term is sometimes applied also to the trial by the legislature that may follow. proceedings against President Clinton appeared to weigh on weigh on Verb to be oppressive or burdensome to: the expectations that weigh so heavily on diplomats' wives Verb 1. the dollar. [CHART 6 OMITTED] During the final weeks of the period, the pace of the dollar's depreciation subsided amid mounting anticipation of G-7 aid to Latin America and increasing evidence that expectations for a Federal Reserve rate cut had become largely discounted by market participants. These factors partially fueled a rally in U.S. share prices: The Dow Jones Industrial Average rose 4.0 percent from a low of 7539.07 to finish the period at 7842.62, helping to reinforce improved sentiment toward the dollar (chart 7). [CHART 7 OMITTED] RETREAT OF THE DOLLAR FROM EIGHT-YEAR HIGHS AGAINST THE YEN Despite reaching fresh eight-year highs against the yen on August 11, the dollar declined more than 2 yen against the Japanese currency during the quarter. Over the same period, one-month volatility implied by option prices rose from 18 to 18.85 percent. Initially, market participants sold yen on doubts that a new financial reform package introduced on July 2 would be sufficient in scope or timeliness to deal with Japan's banking crisis. The lack of any further fiscal stimulus measures also weighed on the yen. Moreover, the defeat of Japan's ruling party in parliamentary elections on July 12 and the subsequent uncertainty regarding the direction of Japanese economic and foreign exchange policy deflated de·flate v. de·flat·ed, de·flat·ing, de·flates v.tr. 1. a. To release contained air or gas from. b. To collapse by releasing contained air or gas. 2. hopes for an early resolution of Japan's problems. Lastly, Japanese economic data that were weaker than expected contributed to negative sentiment throughout the period; second-quarter gross domestic product declined 1.6 percent year-over-year. In the aftermath of the Russian devaluation, however, investors increasingly took profits on long dollar positions against the yen in a bid to offset losses in emerging markets or simply to reduce risk in an increasingly volatile financial environment. Many believed that the climb in volatility had led to a slower pace of capital outflows from Japan than had been expected previously, a development that lent further support to the yen. This trend was reinforced by perceptions of Japanese investor repatriation Repatriation The process of converting a foreign currency into the currency of one's own country. Notes: If you are American, converting British Pounds back to U.S. dollars is an example of repatriation. flows before the September 30 end of the fiscal half-year in Japan. Finally, growing anticipation that the Federal Reserve would ease policy also contributed to the dollar's decline. The dollar reached a low of 130.65 [yen] on September 11, after having fallen 11.1 percent from its intraperiod high of 147.33 [yen]. In the final weeks of the period, the dollar partially retraced its losses, rising to finish the quarter at 136.50 [yen]. Market pessimism pessimism, philosophical opinion or doctrine that evil predominates over good; the opposite of optimism. Systematic forms of pessimism may be found in philosophy and religion. regarding Japan's economic and financial prospects remained in place after the September 4 meeting in San Francisco San Francisco (săn frănsĭs`kō), city (1990 pop. 723,959), coextensive with San Francisco co., W Calif., on the tip of a peninsula between the Pacific Ocean and San Francisco Bay, which are connected by the strait known as the Golden between Treasury Secretary Rubin and Japanese Finance Minister Miyazawa. The Bank of Japan's September 9 announcement of a monetary ease and renewed uncertainty regarding the prospects for banking reform in Japan also contributed to yen softness. 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 this quarter. At the end of the quarter, the current values of the German mark and Japanese yen reserve holdings totaled $18.4 billion for the Federal Reserve System and $14.6 billion for 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. . 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 that 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 September 30, outright holdings of government securities by U.S. monetary authorities totaled $7.3 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 $11.7 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. 1. Foreign exchange holdings of U.S. monetary authorities based on current exchange rates, 1998:Q3
Millions of Dollars
Quarterly changes in balances by source
Impact
Balance Net purchases of
Item June 30, 1998 and sales(1) sales(2)
FEDERAL RESERVE
Deutsche marks 11,652.0 0 0
Japanese yen 5,589.8 0 0
Interests receivables(4) 80.5 ... ...
Other cash flow from 10.5 ... ...
investments(5)
Total 17,332.8 ... ...
U.S. TREASURY
EXCHANGE STABILIZATION
FUND
Deutsche marks 5,898.2 0 0
Japanese yen 8,000.1 0 0
Interest receivables(4) 42.0 ... ...
Other cash flow from 17.9 ... ...
investments(5)
Total 13,958.2 ... ...
Currency
Investment valuation
Item income adjustments(3)
FEDERAL RESERVE
Deutsche marks 102.0 934.4
Japanese yen 4.2 69.8
Interests receivables(4) ... ...
Other cash flow from ... ...
investments(5)
Total 106.4 1,004.2
U.S. TREASURY
EXCHANGE STABILIZATION
FUND
Deutsche marks 52.3 472.9
Japanese yen 5.7 100.2
Interest receivables(4) ... ...
Other cash flow from ... ...
investments(5)
Total 58.0 573.1
Interest
accrual (net) Balance,
Item and other Sept. 30, 1998
FEDERAL RESERVE
Deutsche marks 0 12,688.6
Japanese yen 0 5,663.8
Interests receivables(4) 14.6 95.1
Other cash flow from -10.5 ...
investments(5)
Total 4.1 18,447.5
U.S. TREASURY
EXCHANGE STABILIZATION
FUND
Deutsche marks 0 6,423.4
Japanese yen 0 8,106.0
Interest receivables(4) 6.6 48.6
Other cash flow from -17.9 ...
investments(5)
Total -11.3 14,578.0
(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 for 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 until interest is paid. (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:Q3 Millions of dollars
U.S. Treasury
Federal Exchange
Period and item Reserve Stabilization
Fund
Valuation profits and losses on
outstanding assets and liabilities,
June 30, 1998
Deutsche marks 39.9 -388.6
Japanese yen -18.2 -20.2
Total 21.7 -408.8
Realized profits and losses
from foreign currency sales,
June 30, 1998-Sept. 30,1998
Deutsche marks .0 .0
Japanese yen .0 .0
.0 .0
Total
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
3. Currency arrangements, September 30, 1998 Millions of dollars
Institutions Amount of Outstanding
facility Sept. 30, 1998
Federal Reserve
Reciprocal Currency
Arrangements
Austrian National Bank 250 0
National Bank of Belgium 1,000 0
Bank of Canada 2,000 0
National Bank of Denmark 250 0
Bank of England 3,000 0
Bank of France 2,000 0
Deutsche Bundesbank 6,000 0
Bank of Italy 3,000 0
Bank of Japan 5,000 0
Bank of Mexico 3,000 0
Netherlands Bank 500 0
Bank of Norway 250 0
Bank of Sweden 300 0
Swiss National Bank 4,000 0
Bank for International Settlements
Dollars against Swiss francs 600 0
Dollars against other authorized
Europeans currencies 1,250 0
Total 32,400 0
U.S. Treasury
Exchange Stabilization Fund
Currency Arrangements
Deutsche Bundesbank 1,000 0
Bank of Mexico 3,000 0
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