U.S. Third Quarter Foreign Exchange Operations (Text)

Following is the text of the U.S. foreign exchange operations report.


July-September 2013

During the third quarter, the U.S. dollar’s nominal trade-weighted exchange value decreased 3.0 percent as measured by the Federal Reserve Board’s major currencies index. The dollar depreciated against most major currencies, on net, as relative softness in U.S. economic data and the continuation of asset purchases by the Federal Reserve prompted investors to pare back dollar exposures established in the second quarter. The dollar depreciated 3.8 percent and 0.9 percent against the euro and Japanese yen, respectively, though its performance against emerging market and cyclically sensitive currencies varied widely. The U.S. monetary authorities did not intervene in the foreign exchange markets during the quarter.


During the third quarter, the trade-weighted U.S. dollar depreciated 3.0 percent, on net, after reaching its highest level since July 2010 early in the quarter. The dollar’s depreciation over most of the quarter occurred amid some signs of softening in U.S. economic data relative to the second quarter and the trajectory of data in other major economies, as well as the reevaluation of the outlook for U.S. monetary policy. Most notably, the July and August U.S. employment reports were interpreted as disappointing, as headline nonfarm payrolls printed below expectations, while the drop in the unemployment rate remained driven in part by declining labor force participation. Housing data were also mixed over the quarter, as mortgage rates increased and housing starts were weaker than expected, while homebuilder sentiment and house prices increased. These mixed U.S. data contrasted with generally improving euro area and U.K. growth indicators and prompted some investors to pare back long U.S. dollar positions established during the second quarter.

The U.S. dollar depreciated between 1 and 2 percent against major currencies immediately following the decision by the Federal Open Market Committee (FOMC) at its September meeting to maintain the stance of monetary policy given the recent tightening in financial conditions, the need for sustained labor market improvement, and fiscal headwinds. Specifically, the outcome of the FOMC meeting was interpreted as more accommodative than expected given growing market expectations that the pace of the Federal Reserve’s asset purchases would be pared back. This expectation also contributed to the rise in Treasury and agency mortgage-backed-security yields, both of which reached their highest levels since mid-2011. In addition, the Committee members’ projections for the path of the federal funds rate were released for the first time for yearend 2016, and were below the level expected by market participants. These factors prompted investors to reevaluate the U.S. economic outlook and the path of monetary policy, and contributed to a further paring back of long U.S. dollar positions.


The U.S. dollar was mixed against emerging market currencies during the second quarter as shifting U.S. monetary policy expectations and the outlook for higher developed market interest rates remained a key driver. As expectations for a reduction in the pace of policy accommodation from the Federal Reserve solidified through much of July and August, the U.S. dollar appreciated notably against several emerging market currencies, in many cases reaching its highest level since 2009. Early in the quarter, rising U.S. and other developed country interest rates reduced the relative attractiveness of many emerging market assets, contributing to the trend of continuing capital outflows by foreign investors that began in the second quarter. However, emerging market currencies mostly stabilized later in the quarter, particularly as U.S. yields declined following the disappointing August employment report and the aforementioned September FOMC decision to maintain the pace of asset purchases.

Country-specific factors also affected emerging market currency performance, as investors generally continued to reduce exposures to countries with above-target inflation, relatively large current account and fiscal deficits, and softening growth outlooks. During July and August, the U.S. dollar appreciated between 5 and 11 percent against the Turkish lira, Brazilian real, Indian rupee, and Indonesian rupiah, while depreciating between 1 and 3 percent against the Korean won and several Eastern European currencies. Implied volatility on several emerging market currency pairs also rose notably during this time, in contrast with more subdued implied volatility in major currency pairs.

Amid this volatility, monetary authorities in some emerging market countries implemented policy measures intended in part to address currency depreciation, elevated volatility, and broader domestic economic issues. Most notably, India and Indonesia unexpectedly increased their target policy rates and either established or expanded bilateral swap arrangements with other Asian central banks, among other measures. Monetary authorities in both countries reportedly sold reserves throughout the third quarter, as official reserve levels declined by $7.9 billion and $2.4 billion, respectively. Elsewhere, the Central Bank of Brazil formalized its official currency operations by introducing daily forward liquidity swaps and weekly spot dollar repurchase operations, which contributed to a stabilization of the Brazilian real in late August.


The U.S. dollar depreciated by 3.8 percent and 6.0 percent against the euro and British pound, respectively, as euro area and U.K. economic data continued to show signs of improvement. Euro area surveys of manufacturing and service sector activity for the third quarter were better than expected, while second-quarter GDP data were positive on a quarter-over-quarter basis for the first time in two years. In the United Kingdom, second-quarter GDP growth accelerated modestly, and manufacturing and labor market data were better than expected. The appreciation of the euro and the pound was consistent with the 7 and 11 basis point widening in the German bund and U.K. gilt five-year interest rate differentials with five-year Treasury yields, reflecting the better euro area and U.K. economic data relative to U.S. data.

The European Central Bank (ECB) and the Bank of England (BoE) provided forward guidance on policy rates over the quarter. At its July policy meeting, the ECB’s Governing Council said that “key interest rates” would “remain at present or lower levels for an extended period of time,” a departure from its previous statement that it does not precommit, though this elicited minimal currency response. At the same time, the BoE signaled that it would study the merits of using forward guidance, prompting a 2.5 percent depreciation of the pound following the announcement. However, the actual BoE policy announcement in August was seen as less accommodative than expected, as market participants viewed the employment and inflation thresholds as potentially limiting the duration for which the policy would be in effect.


The U.S. dollar was relatively stable against the Japanese yen during the quarter, as there were few new developments in Japan that significantly influenced currency moves. The dollar-yen currency pair traded within the narrow ¥97 to ¥100 per-dollar range for the better part of the quarter. This stability followed a roughly 26 percent appreciation of the dollar against the yen in the previous three quarters as Japanese authorities announced and implemented significant expansionary monetary and fiscal policies. Several data releases pointed to a continuation of the trend of economic improvement since the April announcement by the Bank of Japan (BoJ) of its Qualitative and Quantitative Easing program, including strong second-quarter GDP growth of 3.8 percent. Toward the end of the quarter, the yen began to modestly appreciate against most major currencies as near-term U.S. fiscal uncertainties resulted in modest safe-haven flows.

TREASURY AND FEDERAL RESERVE FOREIGN EXCHANGE HOLDINGS The U.S. monetary authorities did not undertake any intervention operations during the quarter. As of September 30, the value of the U.S. Treasury’s Exchange Stabilization Fund foreign-currency-denominated assets totaled $23.45 billion, comprising euro and yen holdings. The Federal Reserve System Open Market Account holdings of foreign-currency-denominated assets totaled $23.47 billion, also comprising euro and yen holdings.

Liquidity Swap Arrangements with Foreign Central Banks

On December 13, 2012, the Federal Reserve, in coordination with the Bank of Canada (BoC), the BoE, the BoJ, the ECB, and the Swiss National Bank (SNB), agreed to extend the authorization of the U.S. dollar and foreign currency liquidity swap arrangements through February 1, 2014. The rate on the dollar liquidity swap arrangements was unchanged at the U.S. dollar overnight indexed swap rate plus 50 basis points. As of September 30, the ECB had $511 million outstanding under the U.S. dollar liquidity swaps, of which $186 million was in three-month tenors and $325 million was in a one-week tenor transaction. The BoC, BoE, BoJ, and SNB had no outstanding swaps at the end of the quarter.

Foreign Exchange Reserve Holdings

The U.S. monetary authorities invest their foreign currency reserves in a variety of instruments that yield market rates of return and have a high degree of liquidity and credit quality. To the greatest extent practicable, the investments are split evenly between the System Open Market Account and the Exchange Stabilization Fund. A significant portion of the U.S. monetary authorities’ foreign exchange reserves is invested on an outright basis in German, French, and Japanese government securities. The amount of euro-denominated reserves held on deposit at official institutions remained elevated in the third quarter, given extremely low rates in euro-denominated money markets, although the amount of yen-denominated deposits has remained fairly steady over recent quarters. A smaller portion of the reserves is currently invested in euro-denominated repurchase agreements, under which the U.S. monetary authorities may accept sovereign debt backed by the full faith and credit of the following governments: Belgium, France, Germany, Italy, the Netherlands, and Spain. Foreign currency reserves are also invested at the Bank for International Settlements and in facilities at other official institutions. As of September 30, direct holdings of foreign government securities totaled $22.24 billion and foreign government securities held under repurchase agreements totaled $4.47 billion.

This report, presented by Simon Potter, Executive Vice President, Federal Reserve Bank of New York, and Manager of the 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 July through September 2013. Evan Kereiakes was primarily responsible for preparation of the report.

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