Treasury and Federal Reserve Foreign Exchange Operations - Statistical Data Included

Federal Reserve Bulletin, Sept, 2000 by Peter R. Fisher, Laura Sarlo

This report, presented by Peter R. Fisher, Executive Vice President, Federal Reserve Bank of New York, 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 April 2000 through June 2000. Laura Sarlo was primarily responsible for preparing the report.

The dollar ended the second quarter little changed against the euro and 3.1 percent stronger against the yen. The dollar initially appreciated as much as 5.9 percent and 6.2 percent against the euro and yen, respectively, but slipped midquarter as expectations for the U.S. economy moderated. On a trade-weighted basis, the dollar ended the period modestly stronger, having risen 1.3 percent against the currencies of the major U.S. trading partners. The U.S. monetary authorities did not intervene in the foreign exchange markets during the quarter.

At the beginning of the quarter, weakness in technology shares led declines in U.S. equity markets as the Nasdaq tell 27.4 percent during the first two weeks of April. The equity markets' decline reportedly fostered some flows into U.S. Treasury securities, and two-year yields fell 24 basis points during the same period. However, economic data released in April were widely interpreted as reflecting a pattern of strong growth along with some inflationary pressure, as retail sales and producer and consumer price indexes for March had exceeded expectations. Market participants anticipated further rate increases, raising consensus expectations for a May 16 tightening to 25 and then to 50 basis points. After its May 16 meeting, the Federal Open Market Committee (FOMC) announced a 50-basis-point increase in the federal funds target rate, raising it to 6.50 percent. Immediately after the meeting, the dollar appreciated 1.1 percent against the euro but was little changed against most other major currencies. Later in the quarter, economic data were widely interpreted as suggesting signs of moderation in the U.S. economy, and they contributed to a gradual depreciation of the dollar from its earlier highs.

WEAKENING OF THE EURO AND YEN AGAINST THE DOLLAR DURING THE FIRST HALF OF THE QUARTER

During the first half of the quarter, the dollar appreciated against most major currencies as market participants reaffirmed expectations that U.S. economic growth would continue to outpace that of other major economies, including the euro area, and as U.S. asset markets continued to be perceived as generally attractive investment opportunities.

Data released during this time indicated that the U.S. economy grew 5.4 percent year-on-year during the first quarter, while euro-area fourth-quarter gross domestic product rose 3.1 percent; and a June 9 release indicated that first-quarter euro-area economic growth was 3.2 percent year-on-year. In addition, surveys reflected global investors' preference for maintaining lower levels of exposure to euro-area assets or to further reduce euro holdings. Traders also suggested that euro sales related to merger and acquisition activity may have increased demand for other currencies. Additionally, euro-area political developments, including the resignation of Italian Prime Minister Massimo D'Alema and further tension between Austria and its European Union partners, may have dampened sentiment toward the euro.

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After starting the period at $0.9555, the euro fell to $0.8845 intraday on May 4, the lowest level since its January 1999 launch. The euro then rebounded as markets responded to numerous comments by euro-area senior officials regarding the prospects for intervention. Implied volatility in one-month euro-dollar options rose to a high of 15.1 percent on May 5.

The yen weakened 1.9 percent against the dollar during the first two weeks of the quarter. After Foreign Prime Minister Keizo Obuchi became incapacitated on the first day of the period and the March Tankan report indicated an improvement in business sentiment and a smaller-than-expected decline in planned capital expenditures, Japanese monetary authorities reportedly sold yen against other currencies. The yen weakened intraday from [yen] 102.82 to [yen] 105.65 against the dollar. For the remainder of the second quarter, the yen weakened a further 1.2 percent against the dollar although it appeared little affected by the change in the cabinet and the June 25 legislative election. Declines in the Nikkei and net portfolio investment outflows during the quarter may have also contributed to the yen's depreciation.

MODEST DEPRECIATION OF THE DOLLAR DURING THE SECOND HALF OF THE QUARTER

Beginning in late May, many market participants perceived a moderating trend in U.S. economic growth, as reflected in several economic data releases. Among these data releases were the weaker-than-expected National Association of Purchasing Managers and Chicago Purchasing Managers Index surveys, the employment report and the consumer price index for May, and retail sales data. This shift in growth expectations prompted many to revise downward their forecasts for further monetary tightening. The implied yield on the July federal funds futures contract declined 19 basis points from mid-May to the end of the quarter. During this period, market participants reassessed the probability of an FOMC rate increase at the June 28 meeting and began to debate the degree of additional tightening expected before the year-end. The revision in policy expectations, as well as a series of strong first-quarter earnings reports, boosted U.S. equities, with the Nasdaq gaining 12.4 percent between May 15 and the end of the quarter.