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 January through March 1998. It was presented by Peter R. Fisher, Executive Vice President, Federal Reserve Bank of New York, and Manager, System Open Market Account. Daniel Osborne was primarily responsible for preparation of the report.

During the first quarter of 1998, the dollar appreciated 2.8 percent against the German mark and 2.2 percent against the Japanese yen. On a trade-weighted basis against Group of Ten (G-10) currencies, the dollar appreciated 1.9 percent.(1) Against the mark, the dollar traded in a relatively narrow range through most of the period. This range reflected market expectations of stable monetary policy in both the United States and Germany as well as reduced volatility in European currencies, as expectations for a smooth progression toward the European Economic and Monetary Union (EMU) solidified. Against the yen, the dollar retreated from five-year highs reached early in the period, as it was pressured lower by the possibility of official intervention to support the yen and by comments from Japanese politicians calling for measures to stimulate Japan's economy. The dollar later rebounded as expectations for additional Japanese stimulus waned and as market participants refocused on the diverging economic outlooks for the United States and Japan. Although the dollar was little changed on net over the period, other asset prices experienced significant appreciation. Global bond and equity markets reached record highs, and many Asian markets rebounded from earlier weakness. The U.S. monetary authorities did not intervene In the foreign exchange markets during the quarter.


Expectations of steady U.S. monetary policy solidified over the period as market participants focused on the countervailing effects of a drag from the slowdown of Asian economies and the continued signs of strong domestic demand in the United States. Comments by Chairman Greenspan and Governor Meyer In early January were interpreted as suggesting concern over the potential deflationary effect of an Asian economic slowdown on the U.S. economy. As a result, there was some speculation that the next move by the Federal Open Market Committee (FOMC) could be an ease. The yield implied by the April 1998 contract on federal funds futures declined to levels below the 5.50 percent funds target--reaching a low of 5.31 percent on January 9--and the benchmark thirty-year Treasury bond yield fell to an all-time low of 5.69 percent on January 12.

Expectations for FOMC policy shifted to a more balanced view after Chairman Greenspan's Humphrey-Hawkins testimony on February 24. Market participants interpreted the testimony as emphasizing a domestic environment of tight labor markets and strong domestic demand, while depicting less concern over the potential effect of the Asian slowdown. After the testimony, the implied yield on the contract on April federal funds futures rebounded to levels higher than 5.50 percent, while the benchmark bond yield reached a high for the quarter of 6.07 percent on March 3. Expectations for steady policy solidified despite subsequent evidence of tight labor markets and strong domestic demand, and the thirty-year benchmark yield fell 13 basis points from its peak, to end the period at 5.94 percent. Low inflation and anticipation of diminished issuance of Treasury securities supported this decline.

In Germany, expectations for steady monetary policy also solidified amid a benign inflationary outlook, concern over high unemployment levels, and the ongoing belief that official European interest rates would converge to German levels ahead of the EMU. Also contributing to the steady policy outlook was continued concern over the potential deflationary effect of an Asian economic slowdown on German growth. The yield implied by three-month German mark forward rate agreements three months hence fell 10 basis points, to 3. …

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