3 August 2001, 09:02 Fed confirms it did not intervene in FX in second quarter
--Fed: Dollar appreciated 3.33% against the euro in Q2
--Fed: Dollar depreciated 1.2% against the yen in Q2 2001
--Fed: Perceptions of US economic rebound supported dlr vs euro
--Fed: Euro, yen FX reserves at $14.4 bln in Q2
--Fed: Treasury euro, yen FX reserves at $14.4 bln in Q2
By Cornelius Luca
New York, Aug. 2 (BridgeNews) - The Federal Reserve of New York
confirmed Thursday that the U.S. monetary authorities did not intervene in
the foreign exchange markets during the April-June quarter of 2001.
Perceptions that the U.S. economy would emerge from the downturn sooner
than the euro zone underpinned the dollar versus the euro, the Fed said.
During the second quarter, the Federal Open Market Committee (FOMC)
lowered its target federal funds rate a total of 125 basis points from
5.0% to 3.75%. Market participants debated the extent of the U.S. economic
slowing and considered the scope for any future easing in monetary policy,
the Fed report noted.
Market discussion on the outlook for inflation contributed to Treasury
curve steepening. Over the quarter, the two-year Treasury yield rose 6
basis points while the yield on the 10-year note rose 43 basis points,
widening the spread between the two- and 10-year yields by 40 basis points
to 117 basis points, the Fed said.
The release of stronger-than-expected data for GDP growth in the first
quarter and several first-quarter earnings announcements contributed to a
temporary revival in investor sentiment. However, other U.S. economic data
releases, such as the March and April employment reports, suggested
continued softening in some sectors of the economy, heightening
expectations for further easing of monetary policy by the FOMC.
Directional trends in major currency pairs were largely muted and the
dollar closed the quarter nearly unchanged on a trade-weighted basis, the
Fed said. A notable decline in option implied volatility across maturities
in G-3 currencies suggested lower investor demand for protection against
sharp exchange rate movements and a greater level of comfort with recent
trading ranges and directional trends. The dollar traded in a range of
$0.87 to $0.91 against the euro, and moved between 120 yen to 125 yen for
most of the quarter.
One-year dollar-yen and euro-dollar implied volatilities reached their
lowest levels in over a year and ended the quarter 2.5% and 2.3% lower at
10.65% and 10.9%, respectively.
The euro depreciated 3.2% against the dollar and 4.4% against the yen,
the quarterly report noted. After trading in a relatively narrow range
against the dollar during the first half of the quarter, the single
currency weakened to a new low for the year. Economic data indicating
slowing euro-area growth and rising inflation, and debate among market
participants regarding the objectives of the European Central Bank weighed
on sentiment toward the single currency. Net cross-border investment
outflows and a shift in investor positioning further pressured the euro.
According to the ECB, the net outflow of direct and portfolio
investment from the euro area totaled 20.8 billion euros in April,
following an 86 billion euro outflow in the first quarter of 2001. The
data seemed to corroborate anecdotal market reports that highlighted
Japanese disinvestment from the euro area as the currency-adjusted value
of these investments deteriorated.
Additionally, following the yen's appreciation in May, International
Monetary Market positioning data showed net euro positions by speculative
investors turned short for the first time in nine months.
Early in the quarter, euro-area economic data indicated that growth
was slowing and price pressures were rising, the Fed said. M3 growth and
headline inflation-the ECB's stated monetary policy pillars-remained above
their respective reference values. On May 10, the ECB surprised market
participants by lowering official interest rates by 25 basis points,
bringing the two-week marginal refinancing rate to 4.50%.
Later in the second quarter, however, euro-area economic data
continued to show signs of rising inflation, shifting expectations for
another interest rate reduction to a later date. The yield implied by the
September 2001 three-month euribor futures contract rose 20 basis points
to 4.25%, while the yield implied by the March 2002 contract rose only 11
basis points. Meanwhile, euro-area data releases showed continued
deceleration in economic activity, most notably in Germany.
Although the FOMC eased policy more than the ECB, long-dated interest
rate differentials remained in favor of the dollar in the second quarter,
the Fed noted. Following the ECB's May 10 move to ease rates, the spread
between the 10-year dollar and euro swap rates reached its widest level
for the year at 91 basis points. The euro depreciated 4.6% against the
dollar in May after the policy change.
The yen appreciated as much as 6.0% and 10.0% against the dollar and
the euro, before depreciating to end the quarter 1.2% and 4.6% stronger
against the dollar and the euro, respectively, according to the quarterly
report. Investor sentiment toward Japan improved after Japan's ruling
party selected a new Prime Minister in April, and investor position
adjustments contributed to yen strength in the first half of the quarter.
However, signs of further economic deterioration, delays in implementing
anticipated reforms, and market perceptions of official U.S. and Japanese
tolerance for yen depreciation reintroduced a negative bias toward
Japanese assets and contributed to the yen's subsequent decline against
the dollar and the euro.
In mid-May, the euro's weakness and resulting Japanese investor losses
reportedly led to a retrenchment of European investments by Japanese
investors.
The yen's initial appreciation sparked a spate of short yen position
covering, further accelerating the exchange rate movement. Against this
backdrop of position adjustment and capital flows, the yen appreciated
sharply in late May, breaking below the 120 and 101 yen levels against the
dollar and the euro, respectively, the Fed noted.
In June, this price action was largely reversed: the yen weakened 4.5%
against the euro and 4.9% against the dollar, as post-election enthusiasm
and initial hopes for specific structural reform plans began to ebb. In
addition, market participants interpreted a Japanese newspaper report as
suggesting that U.S. policymakers would tolerate a weaker yen exchange
rate if it resulted from a restructuring of Japan's economy. Japanese
economic data and downward revisions of growth forecasts reduced investor
expectations for an economic recovery. Japan's trade surplus for May
declined markedly, largely attributed to economic deceleration in Japan's
major trading partners, according to the Fed.
At the end of the second quarter, the values of euro and Japanese yen
reserve holdings based on exchange rates as of March 31, 2001, totaled
$14.389 billion for the Federal Reserve System and $14.386 billion for the
U.S. Treasury's Exchange Stabilization Fund.
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