Academic journal article Federal Reserve Bulletin

Treasury and Federal Reserve Foreign Exchange Operations

Academic journal article Federal Reserve Bulletin

Treasury and Federal Reserve Foreign Exchange Operations

Article excerpt

This quarterly report describes U.S. Treasury and System foreign exchange operations for the period from October through December 1997. It was presented by Peter R. Fisher, Executive Vice President, Federal Reserve Bank of New York, and Manager, System Open Market Account. Andrew Jewell was primarily responsible for preparation of the report.

In a period marked by dramatic developments in Asia, the dollar appreciated 8.3 percent against the Japanese yen and 2.2 percent against the German mark. On a trade-weighted basis against Group of Ten (G-10) currencies, the dollar appreciated 2.7 percent.(1) Against the yen, the dollar rose to its highest levels since 1992 as market participants reacted to an increasingly pessimistic economic outlook in Japan, concern over the health of the Japanese financial sector, and spreading volatility in Asian financial markets. Against the mark, the dollar initially weakened, pressured by the effect of Asian volatility on markets in North and South America. However, the dollar later recovered amid a growing perception that European economies were more exposed to events in Asia than previously thought and as market participants scaled back expectations of further monetary tightening in Germany. The U.S. monetary authorities did not intervene in the foreign exchange markets during the quarter.

A FALL OF THE DOLLAR'S AVERAGE INTRADAY TRADING RANGE FROM THIRD-QUARTER LEVELS AND A RISE IN IMPLIED VOLATILITY

The dollar's average intraday trading range against the yen fell in the fourth quarter of 1997 to 1.0 percent from 1. 1 percent in the third quarter but was higher than the 0.7 percent range in the fourth quarter of 1996. The dollar's average intraday trading range against the mark fell to 0.9 percent in the fourth quarter from 1.1 percent in the previous quarter, but was higher than the 0.7 percent range in the fourth quarter of 1996. The combined average intraday trading range against both the yen and the mark fell to 0.9 percent from 1.1 percent in the previous quarter, marking the first decline since the third quarter of 1996.

Implied volatility moved higher, reflecting expectations for potentially large dollar moves. One-month dollar-yen implied volatility peaked at more than 14 percent in December, approaching highs for the year, as the dollar appreciated to its strongest levels in more than five years against the yen. One-month dollar-mark implied volatility rose more than 12 percent in late October after sharp losses in the dollar's value against the mark but later returned to levels of less than 10 percent as the dollar recovered.

DEVELOPMENTS IN ASIA

Movements in the U.S. dollar were influenced throughout the period by disruptions in Asian markets. Currency market turmoil in Southeast Asia continued, with the Thai baht, the Indonesian rupiah, the Philippine peso, the Malaysian ringgit, and the Singapore dollar reaching historic lows against the U.S. dollar. In late October, focus shifted northward to the sustainability of the Hong Kong dollar peg after the decision by monetary authorities in Taiwan to allow the new Taiwan dollar to depreciate. In response to mounting pressure on the Hong Kong dollar, the Hong Kong Monetary Authority pushed interest rates higher. With overnight rates trading as high as 150 percent and the one-month Hong Kong interbank offered rate rising to 47.5 percent on October 23, the Hong Kong dollar strengthened from HKD 7.75 to HKD 7.71 against the U.S. dollar, then stabilized in later weeks around the HKD 7.73 level. Higher interest rates, however, pressured stock prices and property values lower. On October 23, the benchmark Hang Seng index fell 10.4 percent, followed by a 13.7 percent decline on October 28.

Sharp losses in Hong Kong's stock market triggered abrupt reversals in equity markets across Asia, Europe, and the Americas. Benchmark stock indexes in Japan, Germany, Mexico, and the United States fell 9. …

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