Treasury and Federal Reserve foreign exchange operations

Federal Reserve Bulletin, March, 1995 by Carol Osler

This quarterly report describes Treasury and System foreign exchange operations for the period from October through December 1994. It was prepared by Peter R. Fisher, Executive Vice President, Federal Reserve Bank of New York, and Manager for Foreign Operations, System Open Market Account. Carol Osler was primarily responsible for preparation of the report.(1)

During the fourth quarter of 1994, the dollar fell 0.1 percent against the German mark but rose 0.5 percent against the Japanese yen and 1.0 percent on a trade-weighted basis.(2) On November 2, the U.S. monetary authorities purchased $800 million against the German mark and an equal amount against the Japanese yen, and Treasury Secretary Lloyd Bentsen issued a statement affirming the Administration's support for a stronger dollar. On November 3, the U.S. monetary authorities intervened again, this time purchasing $500 million against the German mark and an equal amount against the Japanese yen. In other operations, the US. and Mexican monetary authorities activated their $6 billion swap facility after Mexico announced, before the market opened on December 22, that the peso would be allowed to float.

THE DOLLAR DECLINES DURING OCTOBER

Having closed the previous period at DM1.5510, the dollar traded fairly steadily against the German mark. Against the Japanese yen, the dollar rose briefly from 99.10[yen], its close at the end of the previous quarter after a partial trade agreement between the United States and Japan was announced on October 1. Soon thereafter, however, the dollar started to decline against both currencies.

Early in the period, continued signs of robust growth in the U.S. economy led market participants to question the Federal Reserve's decision not to raise rates at its September 27 meeting, and concern that the stance of monetary policy was inadequate to contain price pressures began to grow. At the same time, market participants perceived short-term and long-term US. rates as too low relative to comparable foreign rates and found in these differentials an explanation for the dollar's weakness during the year and a reason for further dollar weakness.

Against the mark, the dollar started to decline sharply on October 13. This decline occurred as expectations rose that the coalition government of Chancellor Helmut Kohl would be returned to office in Germany's October 16 federal elections and as German bond and stock markets rallied. The dollar's downward movement accelerated as it breached a number of important technical points. From its closing level of DM1.5405 on October 12, the dollar fell to DM1.4937 on October 17. After this abrupt decline, market discomfort with the level of U.S. interest rates grew more pronounced and market participants began to express the view that the U.S. Administration was becoming less concerned about the dollar. At the same time, the dollar also began to decline against the yen, particularly as a result of heavy dollar sales by Japanese exporters.

By October 25, the dollar had declined to 96.40[yen and a period low of DM1.4860. The release on October 28 of gross domestic product data containing encouraging news about the U.S. price deflator provided a brief respite, but as November began, pressure on the dollar intensified once again.

U S. MONETARY AUTHORITIES ENTER THE MARKET TO BUY DOLLARS AGAINST THE MARK AND THE YEN

On the morning of Wednesday, November 2, the dollar fell to a new postwar low of 96.11[yen] and was trading at DM1.4910. Shortly after 11:00 a.m., the Federal Reserve Bank of New York's Foreign Exchange Desk entered the market, purchasing dollars for the U.S. monetary authorities. During the course of the day, the Desk purchased $800 million against the mark and $800 million against the yen.

As the intervention began, Treasury Secretary Bentsen issued the following statement:

I believe that recent movements in the dollar are inconsistent with the fundamentals of a strong investment-led recovery in the United States and the greatly enhanced ability of U.S. firms to compete around the world. This Administration is committed to sound economic policies that expand the economy's capacity and sustain recovery with low inflation. Continuation of recent foreign exchange trends would be counterproductive for the United States and the world economy. A stronger dollar will reduce inflation pressures, improve American living standards, and promote investment. We will continue to monitor developments closely in cooperation with our G-7 (Group of Seven) partners.

Later that day Bundesbank President Hans Tietmeyer expressed support for the U.S. operation, saying "I welcome the fact that the American monetary authorities have clearly expressed their interest in a stronger dollar and want to back this with an appropriate policy. This statement (by Secretary Bentsen) is likely to contribute to bringing the value of the dollar on markets more into line with the fundamental data." After reaching intra-day highs of DM1.5220 and 98.00[yen], the dollar closed at DM1.5149 and 97.60[yen].