Treasury and Federal Reserve foreign exchange operations.This quarterly report describes Treasury and System foreign exchange operations for the period from July through September 1996. 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 for Foreign Operations, System Open Market Account. Christine Hall was primarily responsible for preparation of the report.(1) During the quarter the dollar appreciated 1.6 percent against the Japanese yen “Yen” redirects here. For the other use, see Yen (disambiguation). “JPY” redirects here. For the Australian singer with the same moniker, see John Paul Young. , 0.1 percent against the German mark, and 0.1 percent on a trade-weighted basis against other Group of Ten currencies. Over the quarter, the dollar was supported by expectations that the Federal Reserve would tighten monetary policy--in contrast to expectations for steady policy in Germany and Japan. In addition, sentiment for the prospect of broad participation in the European Monetary Union European Monetary Union An agreement by participating European Union member countries that includes protocols for the pooling of currency reserves and the introduction of a common currency. shifted from doubt early in the quarter to growing confidence late in the quarter, lending support to the dollar against the mark. The U.S. monetary authorities did not undertake any intervention operations in the foreign exchange market during the quarter. However, the U.S. 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. (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. ) received a $7 billion repayment from the United Mexican States related to drawings by Mexico under the medium-term swap facility with the ESF. An additional $3.5 billion remained outstanding. GENERAL STABILITY OF EXCHANGE RATES For the period as a whole, foreign exchange markets were relatively stable. The average daily trading range Trading Range The spread between the high and low prices traded during a period of time. Notes: When a stock breaks through or falls below its trading range after several days of trading in a range, it usually means there is momentum (positive or negative) building. of the dollar was substantially less than the ranges observed last year. On average the dollar traded in a daily range of 0.6 percent against both the mark and the yen. This compares with daily dollar ranges of 1.1 percent against the mark and 1.4 percent against the yen in the third quarter of 1995. Additionally, 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. on dollar-mark and dollar-yen one-month options generally maintained the low levels of the second quarter of this year. However, the period was marked by a few brief episodes of sharp dollar movements. The dollar's largest one-day move occurred early in the quarter. On July 16, the dollar traded in a 3.1 percent range against the mark, implied volatility on one-month dollar-mark options spiked higher, and prices of 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. indicated a rise in the perceived risk of a further significant dollar decline.(2) As with other sharp dollar moves over the period, the dollar's trading ranges over subsequent days fell toward the period's average, implied volatility on dollar-mark options reverted re·vert intr.v. re·vert·ed, re·vert·ing, re·verts 1. To return to a former condition, practice, subject, or belief. 2. Law To return to the former owner or to the former owner's heirs. toward record-low levels, and risk reversal prices moved closer to neutral. [TABULAR tab·u·lar adj. 1. Having a plane surface; flat. 2. Organized as a table or list. 3. Calculated by means of a table. tabular resembling a table. DATA OMITTED] RESPONSE OF THE DOLLAR TO US. INTEREST RATE EXPECTATIONS AND ASSET MARKET PERFORMANCE Expectations for a Federal Reserve tightening shifted throughout the period. Signs of strong U.S. economic growth and tightening 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 , yet benign inflation data, made the near-term interest rate outlook uncertain. Early in the quarter, the dollar reached a twenty-nine-month high against the yen of 111.19[Yen] while holding above DM 1.52 against the mark after the strong U.S. nonfarm payroll report for June, which led 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. to anticipate an imminent Federal Reserve tightening. Subsequently, U.S. stock prices declined sharply and a liquidation The collection of assets belonging to a debtor to be applied to the discharge of his or her outstanding debts. A type of proceeding pursuant to federal Bankruptcy of long dollar positions ensued. On July 16, the dollar depreciated Depreciated may refer to:
Expectations of a near-term Federal Reserve tightening were scaled back after Chairman Greenspan's Humphrey-Hawkins testimony in July. Market participants appeared to focus on his comments about the potential for an economic slowdown in the second half of the year. Subsequent reports of benign inflation further diminished expectations for a tightening, and the August meeting of the Federal Open Market Committee ended with no announced change in policy. In September, expectations began to build anew a·new adv. 1. Once more; again. 2. In a new and different way, form, or manner. [Middle English : a, of (from Old English of; see of) + new for a Federal Reserve tightening at the September 24 FOMC See Federal Open Market Committee. FOMC See Federal Open Market Committee (FOMC). meeting. The August nonfarm payroll data continued to show robust employment growth. The dollar steadily recovered all of its losses against the mark and yen, supported by expectations of higher U.S. short-term interest rates Short-term interest rates Interest rates on loan contracts-or debt instruments such as Treasury bills, bank certificates of deposit or commerical paper-having maturities of less than one year. Often called money market rates. as well as by ongoing strength in the U.S. stock market in September. The FOMC's decision at the September 24 meeting to keep policy unchanged surprised many market participants. Although the dollar declined sharply on the day of the announcement, it more than recovered its losses the following day. Despite the FOMC's decision to leave policy unchanged, some market expectation for a tightening by year-end remained. 2. Net profits or losses (-) on 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 Federal Reserve foreign exchange operations, based on historical cost-of-acquisition exchange rates, 1996:Q3
Millions of dollars
U.S. Treasury
Period and item Federal Exchange
Reserve Stabilization
Fund
Valuation profits and losses on
outstanding assets and liabilities,
June 30, 1996
Deutsche marks 2,118.7 663.5
Japanesse yen 1,337.5 1,968.3
Total 3,456.1 2,631.7
Realized profits and losses
from foreign currency sales,
June 30, 1996-Sept. 30, 1996
Deutsche marks .0 .0
Japanese yen .0 .0
Total .0 .0
Valuation profits an losses on
outstanding assets and liabilities,
Sept. 30, 1991(1)
Deutsche marks 2,065.5 636.6
Japanese yen 1,211.2 1,783.0
Total 3,276.8 2,419.6
NOTE: Figures may not sum to totals because of rouding.
(1.) Valuation profits or losses are not affected by peso holdings,
which are canceled by forward contracts.
SUPPORT OF THE DOLLAR AGAINST THE MARK FROM EXPECTATIONS FOR STEADY OR LOWER GERMAN RATES May data for German industrial production and orders, which were released early in the quarter, indicated a third consecutive month-to-month rise in each series. These data contributed to market perceptions that German economic recovery would preclude further Bundesbank interest rate cuts and that market rates would rise by year-end. The perception that German rates had bottomed contributed to the decline in the dollar against the mark in mid-July when declines in U.S. equity prices also weighed on the dollar. Subsequently, however, market expectations of Bundesbank policy gradually shifted as the mark appreciated against the dollar, growth in the Bundesbank's M3 monetary aggregate decelerated, and German business sentiment deteriorated. Also, Bundesbank officials made periodic comments that held open the possibility of further reductions in the Bundesbank's key repurchase rate. Long-term interest rate differentials between 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 widened further in favor of the dollar and contributed to the stabilization Stabilization The action undertakes a country when it buys and sells its own currency to protect its exchange value. Actions registered competitive traders undertake by on the NYSE to meet the exchange requirement that 75% of their traded be stabilizing, meaning that sell orders of the dollar after its sharp decline in mid-July. On July 25, at its last meeting before the summer recess, the Bundesbank disappointed market expectations, leaving its repo rate repo rate The rate of interest (annualized) on a repurchase agreement. unchanged at 3.3 percent, and the German mark rose sharply. The dollar fell from an opening price of DM 1.4905 to a low of DM 1.4723 on the announcement. However, in a largely unanticipated move, at its August 22 meeting the Bundesbank cut its repo rate 30 basis points to 3 percent. The dollar appreciated after the Bundesbank's decision as interest rate differentials between the United States and Germany widened further in favor of the dollar. After the reduction market participants generally came to expect that monetary policy in Germany would remain stable through the early part of 1997. Reflecting that sentiment, implied yields on three-month Euromark futures contracts 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. through March 1997 declined to levels only slightly above cash rates. The Bundesbank's cut in the repo rate fostered an impression among many market participants that the Bundesbank was motivated, at least in part, to ease pressures on other European Union European Union (EU), name given since the ratification (Nov., 1993) of the Treaty of European Union, or Maastricht Treaty, to the European Community members to meet the economic convergence criteria This is an article about European politics, Convergence criteria is also a mathematical term regarding series. Convergence criteria (also known as the Maastricht criteria) are the criteria for European Union member states to enter the third stage of European Economic and of the Maastricht Treaty Maastricht Treaty officially Treaty on European Union Agreement that established the European Union (EU) as successor to the European Community. It bestowed EU citizenship on every national of its member states, provided for the introduction of a central . In addition, the anticipated pressures on European currencies during the release of government budgets across Europe did not materialize. This led to sales of German marks against higher-yielding European currencies. In September, the dollar steadily climbed back above DM 1.52.
3. Currency arrangements, September 30, 1996
Million of dollars
Institution Amount of Outstanding.
facility Sept. 30, 1996
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(1) 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
European currencies 1,250 0
Total 32,400 0
U.S. Treasury
Exchange Stabilization Fund
Currency Arrangements
Deutsche Bundesbank 1,000 0
Bank of Mexico(1)
Regular swaps 3,000 0
United Mexican States(1)
Medium-term swaps ... 3,500
Total(1) ... 3,500
(1) Facilities available to Mexico comprise short-term swaps
between the bank of Mexico and both the Federal Reserve and the
ESF, as well as medium-term swaps and government guarantees
between the government of Mexico and the ESF. The total amount
available from both medium-term swaps and government guarantees
is $20 billion, less any outstanding drawings on the short-term
facilities
SUPPORT FOR THE DOLLAR AGAINST THE YEN FROM RECEDING EXPECTATIONS FOR A TIGHTENING BY THE BANK OF JAPAN Early in the quarter, most market participants believed that a hike in Japanese interest rates would soon follow any tightening by the Federal Reserve. This assumption came into question, however, as official commentary and the Bank of Japan's quarterly outlook, released in late July, suggested that the economy had not achieved a "self-sustaining" recovery. A sharp decline in Japanese stock prices in late August further contributed to the belief that the Bank of Japan would not raise rates in the near term. Additional evidence accumulated to suggest that Japan's economic recovery remained fragile. On August 28, a weak August Tankan report showed an unexpected deterioration de·te·ri·o·ra·tion n. The process or condition of becoming worse. in business confidence. In mid-September, the second-quarter report on gross domestic product showed an annualized annualized Of or relating to a variable that has been mathematically converted to a yearly rate. Inflation and interest rates are generally annualized since it is on this basis that these two variables are ordinarily stated and compared. quarter-on-quarter decline of 2.9 percent. On the last day of the quarter, the dollar reached a two-and-a-half year high of 111.68 [Yen] against the yen, boosted by expectations that Japanese investors would increase their investments in higher-yielding foreign assets in the second half of the Japanese fiscal year. The market's reaction to trade data released during the third quarter was mixed. Early in the period, declines in Japan's trade surplus, the U.S. trade deficit, and the U.S.-Japanese bilateral deficit, albeit all of which occurred at a slower pace than the rate of decline in previous quarters, supported the dollar. At the end of the quarter, U.S. trade data for July indicating a widening overall U.S. deficit as well as a larger bilateral deficit with Japan, prompted a sharp but temporary decline in the dollar. CONTINUATION OF THE DOWNWARD TREND OF INTEREST RATES IN CANADA Low inflation, a firming Canadian dollar Noun 1. Canadian dollar - the basic unit of money in Canada; "the Canadian dollar has the image of loon on one side of the coin" loonie dollar - the basic monetary unit in many countries; equal to 100 cents , and steady U.S. monetary policy allowed interest rates to continue their downward trend in Canada. Over the period, 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. reduced its overnight call money range 75 basis points. The midpoint mid·point n. 1. Mathematics The point of a line segment or curvilinear arc that divides it into two parts of the same length. 2. A position midway between two extremes. of the target range ended the quarter at 4 percent, about 125 basis points below the 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. . By the end of the period, positive yield spreads between Canadian government bonds and comparable U.S. Treasuries existed only beyond the five-year maturity sector. The spread between the benchmark ten-year Canadian government bond and the ten-year U.S. Treasury note narrowed from 99 to 43 basis points over the period. 4. Drawings/rollovers and repayments (-) by Mexicans monetary authorities, 1996:Q3
Milliions of dollars
Currency arrangements Out- Out-
with the U.S. Treasury standing, July Sept. standing,
Exchange Stabilization Fund June 30, Sept. 30,
1996 1996
Bank of Mexico
Regular 0 0 0 0
Medium-term 10,500 0 -7,000 3,500
NOTE: Data are on a value-date basis.
INVESTOR OPTIMISM IN MEXICO The peso strengthened over the quarter despite periodic concerns about a near-term interest rate hike in the United States. Market participants became optimistic op·ti·mist n. 1. One who usually expects a favorable outcome. 2. A believer in philosophical optimism. op about the strength of Mexico's economic recovery, after a 7.2 percent rise in its second-quarter GDP GDP (guanosine diphosphate): see guanine. . Domestic interest rates fell, while Mexican Brady debt spreads over U.S. Treasuries fell from 669 to 510 basis points. Mexico successfully raised funds in the international capital markets in four issues in the third quarter. In July, Mexico issued $6 billion in five-year, floating-rate notes Floating-rate note (FRN) Note whose interest payment varies with short-term interest rates. floating-rate note An unsecured debt issue with an interest rate that is reset at specified intervals (usually every six months) according to a at a spread of 200 basis points over London interbank offered rates London Interbank Offered Rate A short-term interest rate often quoted as a 1,3,6-month rate for U.S.dollars. , and in September, it placed a $1 billion twenty-year Eurobond issue at narrower-than-expected spreads over U.S. Treasuries. On August 5, Mexico repaid in advance $7 billion of the $10.5 billion outstanding under the U.S. Treasury's ESF medium-term swap facility. Of this amount, $5 billion was used to repay the two swaps that had been drawn in April and May of 1995, and $2 billion was used to pay down 80 percent of the July 1995 drawing. The repayments reduced the amount outstanding from these swaps to $3.5 billion. 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 foreign currency reserve holdings of the Federal Reserve System and the ESF were valued at $19.4 billion and $15.9 billion, respectively and consisted of German marks and Japanese yen. The U.S. monetary authorities invest all 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 that are held either 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 $6.4 billion and included investments in Japanese treasury bills and German government securities. 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 agreements by the U.S. monetary authorities totaled $11.0 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.) The charts for the report are available on request from Publications Services, Mail Stop 127, Board of Governors of the Federal Reserve System Board of Governors of the Federal Reserve System The managing body of the Federal Reserve System, which sets policies on bank practices and the money supply. , Washington, DC 20551. (2.) A risk reversal is an option position consisting of a written put and a purchased call that mature on the same date and are equally out-of-the-money. The price of a risk reversal indicates whether the dollar call or the dollar put is more valuable. If the dollar call is at a premium, the market is willing to pay more to insure against the risk that the dollar will rise sharply. If the dollar put is at a premium, the market is willing to pay more to insure against the risk that the dollar will fall sharply. |
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