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Treasury and Federal Reserve Foreign Exchange Operations.

This report, 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, describes the foreign exchange operations of the U.S. Department of the Treasury and the Federal Reserve System for the period from October 2000 through December 2000. Ryan Faulkner was primarily responsible for preparing the report.

During the fourth quarter of 2000, the dollar appreciated 5.7 percent against the yen and depreciated Depreciated may refer to:
  • Depreciation, in finance, a reference to the fact that assets with finite lives lose value over time
  • Depreciated is often confused or used as a stand-in for "deprecated"; see deprecation for the use of depreciation in computer software
 6.4 percent against the euro. On a trade-weighted basis, the dollar ended the quarter 1.0 percent weaker against an index of major currencies. Movements in the major currency pairs were largely influenced by changes in market expectations for economic growth 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. , Europe, and Japan. Questions about the pace of Japan's economic recovery pressured the yen against the major currencies, while the dollar declined against the euro in December amid signs of slower U.S. growth. U.S. monetary authorities did not intervene in the foreign exchange markets during the quarter.


During the fourth quarter, releases of economic data in the United States indicated continued low inflation and a slowdown in the pace of U.S. economic growth. Earlier in the quarter, 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.  had expected a steady near-term U.S. interest rate policy, given the price pressures emanating from high energy prices and tight U.S. labor markets labor market A place where labor is exchanged for wages; an LM is defined by geography, education and technical expertise, occupation, licensure or certification requirements, and job experience . On November 15, the Federal Open Market Committee (FOMC See Federal Open Market Committee.


See Federal Open Market Committee (FOMC).
) left the target 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.
 unchanged at 6.5 percent and maintained its statement that the balance of risks was weighted toward inflationary in·fla·tion·ar·y  
Of, associated with, or tending to cause inflation: inflationary prices; inflationary policies.

Adj. 1.

By early December, however, there was a sharp downward shift in U.S. interest rate expectations, prompted by (1) increasing signs of slower U.S. growth, (2) comments by Federal Reserve Chairman Alan Greenspan Alan Greenspan

Dr. Greenspan is Chairman of the Board of Governors of the Federal Reserve System. Dr. Greenspan also serves as Chairman of the Federal Open Market Committee (FOMC), the Fed's principal monetary policymaking body.
 that were interpreted as suggesting the possibility of lower rates, and (3) weaker financial market conditions. Among the economic data released during this period were weaker-than-expected third-quarter GDP GDP (guanosine diphosphate): see guanine.  data (advance release), November consumer confidence and National Association of Purchasing Managers A Purchasing Manager is an employee within a company, business or other organization who is responsible at some level for buying or approving the acquisition of goods and services needed by the company.  (NAPM NAPM National Association of Purchasing Management
NAPM National Association of Pharmaceutical Manufacturers
NAPM National Academy of Popular Music
NAPM National Association of Photographic Manufacturers
NAPM National Association of Punch Manufacturers
) surveys, October durable goods durable goods

Goods, such as appliances and automobiles, that have a useful life over a number of periods. Firms that produce durable goods are often subject to wide fluctuations in sales and profits. Also called consumer durables.
 data, and November retail sales figures sales figures nplcifras fpl de ventas . As expectations for more moderate growth solidified so·lid·i·fy  
v. so·lid·i·fied, so·lid·i·fy·ing, so·lid·i·fies
1. To make solid, compact, or hard.

2. To make strong or united.

, many market participants also continued to lower their U.S. earnings forecasts. During the fourth quarter, the S&P 500 and Nasdaq Composite The Nasdaq Composite is a stock market index of all of the common stocks and similar securities (e.g. ADRs, tracking stocks, limited partnership interests) listed on the NASDAQ stock market, meaning that it has over 3,000 components. It is highly followed in the U.S.  equity indexes, on balance, fell 8.1 percent and 32.7 percent, respectively, with some of their sharpest daily losses occurring in December.

[Graphs Omitted]

From November 28 to the end of the quarter, the implied yield on the March federal funds Federal Funds

Funds deposited to regional Federal Reserve Banks by commercial banks, including funds in excess of reserve requirements.

These non-interest bearing deposits are lent out at the Fed funds rate to other banks unable to meet overnight reserve
 futures contract Futures Contract

An exchange traded agreement to buy or sell a particular type and grade of commodity for delivery at an agreed upon place and time in the future. Futures contracts are transferable between parties.
 declined 40 basis points to 6.0 percent. Over the same period, the yields on the two-year Treasury note and 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 fell 76 and 24 basis points, respectively, leading the two- to thirty-year coupon curve to return to a positive spread for the first time since January 2000. On December 19, the FOMC left its target for the federal funds rate unchanged, while moving its assessment of the balance of risks away from inflationary pressures and to one "weighted toward conditions that may generate economic weakness."

In Europe, expectations for further interest rate increases moderated over the period, in response to signs of slower euro-area growth, the recovery of the euro's exchange value, and a decline in oil prices. At the outset of the quarter, on October 5, 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,
 (ECB See electronic code book. ) raised its minimum bid on its refinancing Refinancing

An extension and/or increase in amount of existing debt.
 operations 25 basis points to 4.75 percent. In the press conference that followed the rate announcement, ECB President Duisenberg explained that the rate hike was aimed at containing inflationary pressures "stemming from oil prices and the foreign exchange rate of the euro." After this decision, market participants were divided over the possibility of additional rate hikes by the ECB. German and Italian business confidence surveys for September and October suggested a modest decline in industrial production, but euro-area aggregate inflation and money supply reports over the same period continued to show modest upward pressure on prices. In addition, the euro remained at relatively low levels against other major currencies, and oil prices continued to climb.

[Graphs omitted]

During the second half of the quarter, the implied yield on the three-month March euribor futures contract fell 35 basis points to 4.73 percent, coincident co·in·ci·dent  
1. Occupying the same area in space or happening at the same time: a series of coincident events. See Synonyms at contemporary.

 with the appreciation of the euro against most major currencies and the decline in oil prices that began in late November. Market participants also reduced their expectations for additional ECB tightening as signs of a modest slowdown in euro-area industrial activity emerged. The November industrial confidence survey for the euro area declined for the first time in three months to levels last seen in May 2000.

In Japan, reports on economic activity during the quarter increased speculation that Japan's economic recovery was slowing. A report by the Economic Planning economic planning, control and direction of economic activity by a central public authority. In its modern usage, economic planning tends to be pitted against the laissez-faire philosophy which developed in the 18th cent.  Agency on November 10 and the release of Japan's third-quarter GDP report on December 4 indicated that although investment by large manufacturing firms remained strong, consumer spending Consumer demand or consumption is also known as personal consumption expenditure. It is the largest part of aggregate demand or effective demand at the macroeconomic level.  and export growth appeared to be stagnating. The yield on the two-year 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) 
) fell 13 basis points over the first two months of the quarter to 0.48 percent. During the first two weeks of December, short-dated Japanese yields briefly moved higher in response to funding pressures ahead of the year-end and amid related concerns about the transition to the real-time gross settlement system in January 2001. However, yields later declined after the release of the December Tankan report and the government's announcement of a smaller-than-expected 2001 fiscal budget. On balance, two-year and ten-year JGB yields ended the quarter 14 and 22 basis lower respectively.


In response to the initial shift in growth expectations for the Group of Three (G-3) economies and an overall increase in market volatility, investors reportedly adopted somewhat more neutral currency positions and were generally more risk averse Risk Averse

Describes an investor who, when faced with two investments with a similar expected return (but different risks), will prefer the one with the lower risk.

A risk averse person dislikes risk.
 during the first half of the quarter. Net speculative positions in currency futures Currency Futures

A transferable futures contract that specifies the price at which a specified currency can be bought or sold at a future date.

Currency future contracts allow investors to hedge against foreign exchange risk.
 on the International Monetary Market (IMM IMM

See: International Monetary Market
), as well as flow survey data, suggested that investors maintained a relatively small net long position in euros and a substantial net short position in yen.

Although there was little change in the reported net speculative euro position, the euro area continued to register net cross-border investment outflows but in lower amounts than previous months. According to according to
1. As stated or indicated by; on the authority of: according to historians.

2. In keeping with: according to instructions.

 the ECB, the net outflow of direct investment and portfolio investment from the euro area totaled 15.7 billion [European Dollar] and 1.7 billion [European Dollar], respectively, in October, which was less than half the total net outflows recorded in September.

Against the dollar, the euro fell to $0.825 on October 25, a new low, but then rebounded the following week, as the ECB entered the market to buy euros on November 3, 6, and 9, pushing the exchange rate to close as high as $0.876. Against the yen, the euro declined 2.4 percent during the first half of the quarter. The dollar-yen exchange rate, meanwhile, did not exhibit a noticeable trend and traded in a relatively tight range, between [yen] 109.30 and [yen] 107.00, over the first half of the quarter.

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.
 for one-month euro-dollar options, which had increased to as high as 16.9 percent on October 27, also declined after the ECB's interventions. Although the euro once again declined against the dollar in mid-November, to as low as $0.838 on November 24, market anxiety over further euro depreciation remained relatively low, with one-month euro-dollar option implied volatility fluctuating fluc·tu·ate  
v. fluc·tu·at·ed, fluc·tu·at·ing, fluc·tu·ates

1. To vary irregularly. See Synonyms at swing.

2. To rise and fall in or as if in waves; undulate.

 between 13 percent and 15 percent from mid-November to the end of the quarter. The premium for one-month euro put options over one-month euro call options, as measured by 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.

, also declined after the ECB interventions. The premium for euro puts briefly rose as high as 0.6 percent in volatility terms on October 26 and 27. However, during much of November and throughout December, there was a premium for one-month euro call options over one-month euro put options.

[Graphs omitted]


The second half of the quarter coincided with a sharp appreciation of the euro and depreciation of the yen, with investors taking more aggressive currency positions as growth and interest expectations for the G-3 economies solidified. According to data from the IMM, the number of speculative net long euro positions increased nearly three-fold in mid-December to reach its highest level since October 1999. The number of short speculative yen positions rose modestly in mid-December to its highest level since February 2000. Against the dollar, the euro appreciated 9.9 percent and the yen depreciated 4.8 percent during the second half of the fourth quarter.

Against the dollar, the euro was largely supported by reports of a narrowing in U.S.-euro-area growth and interest rate differentials after the release of weaker-than-expected U.S. economic data at the end of November. After declining just 3 basis points over the first half of the quarter, from mid-November to the end of December, the spread of the two-year dollar swap rate Swap Rate

The rate of the fixed portion of a swap as determined by its particular market. This is the rate at which the swap will occur for one of the parties entering into the agreement.
 over the two-year euro swap rate declined 21 basis points to a spread of 110 basis points.

[Graph omitted]

The yen, meanwhile, weakened weak·en  
tr. & intr.v. weak·ened, weak·en·ing, weak·ens
To make or become weak or weaker.

weaken·er n.
 sharply against the major currencies, falling 13.4 percent against the euro. The yen's depreciation reflected the growing speculation surrounding the pace of the country's economic recovery, as well as uncertainty about the future of Prime Minister Mori's administration. Although Prime Minister Mori won a no-confidence vote by the parliament in late November, market participants commented that Mori's low popularity ratings continued to cloud the political outlook.

The yen was also pressured by reported portfolio reallocations away from Japan by domestic and foreign investors. Japanese institutional investors Institutional Investor

A non-bank person or organization that trades securities in large enough share quantities or dollar amounts that they qualify for preferential treatment and lower commissions.
 reportedly maintained, and in some cases increased, dollar and euro investments ahead of the year-end. In addition, foreign investors were net sellers of Japanese equities for most of the fourth quarter. According to the Ministry of Finance, Japanese investors bought [yen] 1.9 trillion in foreign stocks and bonds in the fourth quarter, more than double the net amount purchased during the third quarter. Over the same period, foreign investors sold [yen]20.9 billion in Japanese stocks.

[Graph omitted]

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.

At the end of the quarter, the current values of the euro and yen reserve holdings totaled $15.7 billion for the Federal Reserve System and $15.7 billion for the Treasury's 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 have a high degree of liquidity and credit quality. To the extent practicable, the investments are split evenly between the Federal Reserve System and the Exchange Stabilization Fund.

A portion of the U.S. monetary authorities' foreign exchange reserves are presently invested in government securities held outright 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.
. Foreign currency reserves are also invested in deposits at the Bank for International Settlements and in facilities at other official institutions. As of December 29, direct holdings of foreign government securities totaled $13.9 billion, split evenly between the two authorities. Foreign government securities held under repurchase agreement totaled $2.8 billion at the end of the quarter and were also split evenly between the two authorities.

The U.S. monetary authorities' investments in marketable securities Marketable Securities

Very liquid securities that can be converted into cash quickly at a reasonable price.

Marketable securities are very liquid as they tend to have maturities less than one year, and the rate at which these securities can be bought or sold has
 have been limited to obligations of the sovereign issuer of the underlying currency; for example, the securities previously denominated in duetsche marks have been obligations of the German government. Given the introduction of the euro The introduction of the euro took place principally between 31 December 1998, when the exchange rates between the euro and legacy currencies in the Eurozone became fixed, and early 2002, when euro notes and coins were introduced and the legacy currencies withdrawn. , the U.S. monetary authorities now expect to diversify diversify

To acquire a variety of assets that do not tend to change in value at the same time. To diversify a securities portfolio is to purchase different types of securities in different companies in unrelated industries.
 their euro-denominated holdings of government securities to include the obligations of additional euro-area sovereigns. This diversification Diversification

A risk management technique that mixes a wide variety of investments within a portfolio. It is designed to minimize the impact of any one security on overall portfolio performance.

Diversification is possibly the greatest way to reduce the risk.
 will be gradual and will apply to holdings of securities on an outright basis and under repurchase agreements. The government securities eligible for investment must meet the highest standards of protection against credit, liquidity, and operational risks. In the assessment of credit quality within the euro area, the U.S. monetary authorities take into account the public credit ratings of each sovereign, as well as other institutional standards that afford a high level of safety. The assessment of liquidity and operational risks includes the analysis of secondary market factors, such as bid-ask spreads Bid-Ask Spread

The amount by which the ask price exceeds the bid.

For example, if the bid price is $20 and the ask price is $21 then the "bid-ask spread" is $1.
, average trade size, and the regularity and size of issuance.
1. Foreign currency holdings of U.S. monetary authorities based on
current exchange rates, 2000:Q4

Millions of dollars

                                                 Quarterly changes in
                                                 balances, by source

            Item                   Balance,
                                Sept. 30, 2000
                                                    Net purchases
                                                     and sales(1)


Euro                                6,872.1              0.0
Japanese yen                        8,733.7              0.0
  Total                            15,605.8              0.0

Interest receivables (net)(5)          66.8              ...
Other cash flow from
  investments(4)                        0.0              ...

Total                              15,672.6              0.0


Euro                                6,869.5              0.0
Japanese yen                        8,733.8              0.0
  Total                            15,603.3              0.0

Interest receivables(5)                57.6              ...
Other cash flow from
  investments(4)                        0.0              ...

Total                              15,660.9              0.0

                               Quarterly changes in balances, by source

                                Effect of   Investment      valuation
                                sales(2)      income     adjustments(3)


Euro                               0.0         69.5           434.3
Japanese yen                       0.0          3.7          -492.8
  Total                            0.0         73.2           -58.5

Interest receivables (net)(5)      ...          ...             ...
Other cash flow from
  investments(4)                   ...          ...             ...

Total                              0.0         73.2           -58.5


Euro                               0.0         69.6           434.0
Japanese yen                       0.0          3.7          -492.8
  Total                            0.0         73.3           -58.8

Interest receivables(5)            ...          ...             ...
Other cash flow from
  investments(4)                   ...          ...             ...

Total                              0.0         73.3           -58.8

                                Quarterly changes in
                                balances, by source

            Item                                         Balance,
                                      Interest         Dec. 31, 2000
                                    and other(4)


Euro                                    ...                7,375.9
Japanese yen                            ...                8,244.6
  Total                                 ...               15,620.5

Interest receivables (net)(5)           9.7                   76.5
Other cash flow from
  investments(4)                        0.0                    0.0

Total                                   9.7               15,697.0


Euro                                    ...                7,373.1
Japanese yen                            ...                8,244.7
  Total                                 ...               15,617.8

Interest receivables(5)                 3.6                   61.2
Other cash flow from
  investments(4)                        ...                    0.0

Total                                  -3.6               15,679.0

NOTE. Figures may not sum to totals because of rounding.

(1.) Purchases and sales for the purpose of this table include foreign
currency sales and purchases related to official activity, swap
drawings and repayments, and warehousing.

(2.) This figure is calculated using marked-to-market exchange rates;
it represents the difference between the sale exchange rate and the
most recent revaluation exchange rate. Realized profits and losses on
sales of foreign currencies, computed as the difference between the
historical cost-of-acquisition exchange rate and the sale exchange
rate, are reflected in table 2.

(3.) Foreign currency balances are marked to market monthly at
month-end exchange rates.

(4.) Values are cash flow differences from payments and collection of
funds between quarters.

(5.) Interest receivables for the ESF 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.

... Not applicable.
2. Net profits or losses (-) on U.S. Treasury
and Federal Reserve foreign exchange operations,
based on historical cost-of acquisition exchange rates,

Millions of dollars

                                         Federal       U.S. Treasury
                                         Reserve         Exchange
          Period and item              System Open     Stabilization
                                      Market Account       Fund

Valuation profits and losses on
outstanding assets and liabilities,
Sept. 30, 2000
Euro                                     -1,370.9        -1,587.3
Japanese yen                              1,687.5         1,899.7

Total                                       316.6           312.4

Realized profits and losses
from foreign currency sales,
Sept. 30, 2000-Dec. 31, 2000
Euro                                          0.0             0.0
Japanese yen                                  0.0             0.0

Total                                         0.0             0.0

Valuation profits and losses on
outstanding assets and liabilities,
Dec. 31, 2000
Euro                                       -936.6        -1,153.3
Japanese yen                              1,194.7         1,406.9

Total                                       258.1           253.6
3. Reciprocal currency arrangements, December 31, 2000

Millions of dollars

                     Amount of    Outstanding,
 Institution         facility     Dec. 31, 2000

                         Reciprocal currency

Bank of Canada         2,000           0.0
Bank of Mexico         3,000           0.0

Total                  5,000           0.0

                  Federal Reserve and U.S. Treasury
                     Exchange Stabilization Fund
                        currency arrangements

Bank of Mexico         3,000           0.0
Total                  3,000           0.0
COPYRIGHT 2001 Board of Governors of the Federal Reserve System
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2001, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Author:Faulkner, Ryan
Publication:Federal Reserve Bulletin
Article Type:Statistical Data Included
Geographic Code:1USA
Date:Mar 1, 2001
Previous Article:Industrial Production and Capacity Utilization: The 2000 Annual Revision.
Next Article:Industrial Production and Capacity Utilization for January 2001.

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