Fed Makes Its Biggest-Ever Single-Day FX Intervention

The Federal Reserve Bank has disclosed details of its largest single-day intervention yet in the foreign exchange markets -- purchases of $1.56 billion on June 24 through the sale of Deutsche marks and yen on its own behalf and that of the U.S. Treasury. In a similar exercise, the Fed also bought $1.25 billion by selling marks and yen on May 4, says senior vice president and manager for the Fed's foreign operations Peter Fisher.

Of the May 4 total, $750 million was against the mark and $500 million against the yen, while the comparable split for the bigger operation was $950 million and $610 million against the mark and yen, respectively. For the period, dollar volume for intervention operations totalled $2.81 billion and are described by Fisher as "not particularly large." Since operations conducted on the last business day of April settled in May, however, intervention operations settling during the period totalled $3.51 billion. During May-June the dollar declined four per cent against the mark, three per cent against the yen, and 2.7 per cent on a trade-weighted basis, according to Fed reports.

The disclosures at the press briefing are unusual because they cover the U.S. Federal Reserve Bank's and Treasury Department's foreign exchange business over two months. The briefing was organised so that the Fed could facilitate its change over to a quarterly calendar-year disclosure cycle. Its next such meeting is on October 1, covering the previous three months.

Fisher says it is useful to segment market activity in two: one period from early May to early June was characterised by range trading and a gradual rise in the dollar against the mark and yen --driven by expected shifts in U.S. and German interest-rate policies; a second extending to June 30 was marked by a rapidly declining dollar, which Fisher attributes to the faltering U.S.-Japanese trade talks and an anticipated end to Japan's flexible monetary policy.

Fisher says he studies the structure of currency options prices for an indication of currency market sentiment. By examining the premiums of equally out-of-the-money near-term dollar puts and calls, effectively a "clearing price for currency protection," he says, he and others gauge forex market sentiment. In late June, Fisher says, the difference between these option pairs reached an unprecedented level, with dollar puts trading "at an extraordinarily high premium over equally out-of-the-money dollar calls." Fisher says this "boded ill for the dollar," prompting a number of calls to him from market participants he had never heard from before.

Fisher describes the May 4 intervention as "fairly successful in developing better market sentiment for the dollar and dissipating market perceptions that the administration was holding to its policy of talking the dollar down." He adds that the June 24 intervention was "somewhat disappointing," but also believes that outside perception of the operation as a failure was "too quick and too negative." Fisher claims the large and coordinated intervention did "in fact help to stabilise the dollar below 100 yen, and establish better market conditions and sentiment."

In communicating its policies, Fisher says, the Fed seeks to address two distinct audiences: short - term traders at commercial and investment banks and trading desk managers and related executives at financial service institutions, currency portfolio managers, analysts and the media.

Fisher cites the Fed's relatively small August 19, 1993 intervention, which resulted in a five-to-six per cent appreciation of the yen, "which in it itself became an effective communicator" as a successful intervention (FX Week, December 13).

The May 4 intervention failed to provoke a strong initial reaction, but in the following days, Fisher says, the "intentions of the U.S. monetary authorities was perceived and acknowledged, [the intervention] got through to the broader audience as well as moving short-term positions."

Turning to the June 24 intervention, Fisher says: "We didn't have effective communication with short-term traders, but there was a subsequent stabilisation in the market." He believes the selling was part of "a systematic unwinding of long dollar positions accumulated as a result of a potential strengthening of the dollar."