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218
MONTHLY REVIEW, SEPTEMBER 1976
Tre a su ry and Federal Reserve Foreign Exchange Operations
February-July 1976
By A lan R. H olm es
During the six-month period under review, as the
authorities of industrial countries sought to deal with the
cumulative effects of deep-rooted economic and financial
instabilities, the exchange markets experienced several
episodes of severe strain, in some cases resulting in sharply
altered rate relationships among major currencies. The
strains were particularly acute within Europe. Between
January and the end of July, against the dollar the
Italian lira depreciated by a net 20 percent, the pound
by 14 percent, and the French franc—having left the
European Community (EC) “snake” arrangement—by
8 percent. Maintenance of the EC snake itself entailed
large-scale intervention on several occasions. Although
both the German mark and the Swiss franc were often in
heavy demand, on balance they appreciated by only 2
percent and 4 percent, respectively. Elsewhere the Japa
nese yen and the Canadian dollar each rose a net 3Vi
percent against the dollar.
The dollar, through its role as vehicle currency in the
market and intervention currency for central banks, was
only occasionally caught up in the turmoil. Thus, when
the markets were particularly unsettled in February and
March, the Federal Reserve sold a total of $270.4 million
of German marks and Dutch guilders, mainly financed
by swap drawings. This debt, however, was quickly
cleared away by mid-May. Thereafter, the Federal Re
serve had no occasion to intervene in the market through
* Mr. Holmes is the Executive Vice President in charge of the
Foreign Function of the Federal Reserve Bank of New York and
Manager, System Open Market Account. Mr. Pardee is Vice Presi
dent in the Foreign Function and Deputy Manager for Foreign
Operations of the System Open Market Account. The Bank acts as
agent for both the Treasury and the Federal Reserve System in the
conduct of foreign exchange operations.
and
S cott E. P a r d e e *
the end of July, while taking advantage of opportunities
to build up modest balances.
The dollar’s greater resiliency, in contrast to other
periods of exchange market unsettlement in recent years,
largely reflected the lifting of many of the market’s previ
ous concerns over the United States economic perfor
mance. Our recovery had by early 1976 gained consider
able momentum, erasing earlier fears that the upturn
would falter. At the same time, the rate of inflation in the
United States, already one of the lowest among major
industrial countries, continued to moderate. As a sign
of our underlying competitiveness in world markets,
United States exports continued to rise in line with, if
not faster than, the recovery of economies abroad. Al
though the even greater rise in imports swung the United
States trade balance back into sizable deficit, the sources
of this surge— the rapid rebuilding of inventories early in
the year and the ballooning of fuel imports in the summer
— were generally taken as further evidence of the strength
of our expansion. In addition, United States interest rates
were fairly steady. Since they remained well above rates in
Germany and Switzerland, they helped avoid the kind of
sudden shifts of funds which had occurred in other recent
periods of exchange market stress. More broadly, with
many other political and financial uncertainties less press
ing, traders were more inclined to focus on the problems
afflicting other countries.
The pressures on individual European currencies
largely reflected market concern over the profound dis
parities in economic performance and policies among
those countries. By early 1976, only a few countries were
showing clear signs of sustained recovery and many
European governments were still being pressed at home
for further stimulus to reduce the uncomfortably high
levels of unemployment. At the same time, although
some progress had been made everywhere against the
FEDERAL RESERVE BANK OF NEW YORK
inflationary excesses of the earlier 1970’s, large differ
entials in inflation rates remained, with Switzerland and
Germany at the low end of the spectrum and Italy and
the United Kingdom at the high end. To the market, the
persistence of differential trends in production and prices
threatened to distort competitive relationships and thus
eventually to lead to further exchange rate adjustments.
Market participants, uncertain of the timing and extent of
potential adjustments, feared that a significant movement
in any European currency rate might set off a chain reac
tion in other rates as well. Consequently, each time pres
sures developed in one currency or another— whether that
currency was floating alone or linked to others in the EC
snake— the whole array of European currency relation
ships became open to question. On these occasions,
traders hastened to take speculative positions or to hedge
exposures and, in this rush to buy or sell individual cur
rencies, the markets frequently became one-sided.
These episodes presented harsh policy choices to the
authorities. For those whose currencies came into heavy
demand, to allow the exchange rate to appreciate risked
stifling exports at a time of domestic concern over un
employment, while to hold the rate through intervention
risked rekindling inflation through excessive domestic
monetary expansion. For others whose currencies came
under heavy selling pressure, to support the rate through
measures such as monetary restraints risked delaying or
aborting economic recovery, while to permit the exchange
C h a rt i
SELECTED EXCH A N G E RATES*
P e rc e n t
P e rc e n t
1975
1976
^ P e r c e n ta g e d e v ia tio n s o f w e e k ly a v e r a g e s o f N e w Y o rk n o o n o ffe r e d
fro m
th e a v e r a g e ra te fo r th e w e e k o f J u ly 7-11, 1975.
ra te s
219
rate to fall sharply risked exacerbating inflationary pres
sures through the higher cost of imports. For many, these
difficulties were compounded by political uncertainties
and by concerns over labor relations. Consequently, as
recounted in the body of this report, the national authori
ties responded with a variety of short-term measures to
deal with the immediate exchange market pressures while
seeking to establish a framework for greater stability over
the long run.
During the period under review, the United States au
thorities provided assistance, in the form of short-term
credits, to the Bank of Italy, the Bank of Mexico, and the
Bank of England. With Italy, the Federal Reserve swap
arrangement had already been reactivated in January by
a drawing of $250 million, and the Bank of Italy drew
a further $250 million in March. When market reflows
into lire developed in the early summer, these drawings
were completely repaid in July.
With Mexico, in early April the Bank of Mexico drew
the full $360 million available under its swap line with
the Federal Reserve. That drawing remained outstanding
at the end of July.
With the United Kingdom, in early June the United
States authorities agreed to provide up to $2 billion to the
Bank of England as part of a $5.3 billion total inter
national standby credit facility. As in several credits ex
tended by the United States authorities in the past, both
the Federal Reserve and the United States Treasury par
ticipated, each standing ready to provide $1 billion.
The availability from the Federal Reserve was under the
existing $3 billion swap arrangement. The Treasury’s
MONTHLY REVIEW, SEPTEMBER 1976
220
credit line, also in the form of a short-term swap facility,
was for the account of its Exchange Stabilization Fund.
By end-July, in proportion to the Bank of England’s bor
rowings from other countries participating in the facility,
the drawings on the Federal Reserve and the Treasury
each amounted to $200 million.
To summarize other Federal Reserve operations, the
System sales of German marks in February and March
amounted to $250.8 million, of which $133.9 million
was drawn under the swap arrangement with the German
Bundesbank and the remainder from balances. Purchases
of marks amounted to $265.6 million, which was used to
repay the swap drawings by mid-May and to replenish bal
ances. Sales of Netherlands guilders in February amounted
to $19.6 million, drawn under the swap line with the
Netherlands Bank. Purchases of guilders amounted to
$23.0 million, also to repay the swap drawing and to add
to balances.
With respect to obligations outstanding since August
1971, the Federal Reserve purchased $177.3 million of
Belgian francs and used most of these francs to liquidate
a further $170.5 million of the franc-denominated debt to
T able I
F E D E R A L R E S E R V E R E C IP R O C A L C U R R E N C Y A R R A N G E M E N T S
In m illion s o f dollars
Institution
A ustrian N ation al Bank .................................................................
Am ount of facility
Ju ly 31, 1976
250
N a tio n a l B ank o f B elgium .............................................................j
1,000
Bank o f Canada .................................................................................
2,000
N ation al Bank o f D enm ark .........................................................
250
Bank o f E n glan d ....................................................................................1
3,000
Bank of F r a n c e ....................................................................................
2,000
G erm an F ederal B a n k ......................................................................j
1
Bank o f Italy .......................................................................................
2,000
Bank o f Japan ......................................................................................
2,000
3,000
Bank o f M exico ....................................................................................
360
N etherlands B a n k ...............................................................................
500
Bank o f N orw ay ................................................................................
250
Bank o f Sw eden .................................................................................
300
Sw iss N a tio n a l B ank ........................................................................
1,400
Bank for International Settlem ents:
Sw iss francs-dollars ......................................................................
600
Other authorized European currencies-dollars ..............
1,250
T otal .......................................................................................................
20,160
the National Bank of Belgium and to reduce the total to
$82.4 million equivalent. The Federal Reserve in February
transferred its $600 million of Swiss-franc swap debt from
the Bank for International Settlements (BIS) to the Swiss
National Bank. During the period, the System purchased
$33.2 million equivalent of Swiss francs from correspon
dents and liquidated $20 million of its debt with the Swiss
central bank. This reduced commitments to $1,147.2 mil
lion, which remained outstanding as of end-July. The
United States Treasury’s $1,599.3 million of medium-term
Swiss franc-denominated obligations to the Swiss National
Bank was unchanged during the February-July 1976 period.
GERMAN MARK
By early 1976, the German economic recovery had
begun to catch up with the earlier turnaround in the
United States, with the initial impulse having been pro
vided by domestic consumption and exports. At the
same time, the rapid increase in German foreign orders
suggested to many market participants that export growth
would keep pace with a predicted rise in imports, thereby
enabling Germany to hold on this year to most of its
$3.8 billion 1975 current-account surplus, unlike other
countries for which deficits were expected. As for wages
and prices, Germany continued to record one of the
lowest inflation rates in the industrialized world. At
5 percent per annum, the increase in consumer prices
was just about half that of neighboring EC countries,
while pay awards in recently negotiated union contracts
in Germany remained moderate. When announcing its
monetary growth target for 1976, the Bundesbank had
stressed that the authorities would continue to attach a high
priority to keeping a tight rein on inflation. If as a result
German interest rates turned higher later in the year,
the market saw the potential for reversal of the heavy
volume of funds placed abroad by German banks in
1975.
The improving economic trends in Germany seemed
more favorable than indications of price, output, and
external payments performances suggested for other EC
countries. Thus, by late January, following a sharp de
cline in the Italian lira and a rapid buildup of specula
tive selling pressures against the French and Belgian
francs, dealers began to question whether the mark, still
relatively weak within the EC snake, should not strengthen
against other European currencies. Speculative funds were
increasingly shifted into marks. Consequently, the mark
rate moved up steadily against those European currencies
and then against the dollar as well. By January 30 the
mark had been bid up to $0.3868, IV2 percent above its
221
FEDERAL RESERVE BANK OF NEW YORK
late-1975 low, in occasionally unsettled trading.
By early February the movement of funds into the
mark gathered momentum, as rumors of a realignment
of currencies within the EC snake, possibly including a
revaluation of the mark, surfaced in the market. By Mon
day, February 9, the continued weakness of the French
franc and Italian lira, news of a devaluation of the Span
ish peseta, and press reports that an EC currency realign
ment would be discussed at the upcoming meeting between
German Chancellor Schmidt and French President Giscard
d’Estaing provoked talk of an imminent mark revalua
tion. Despite firm official denials of any intention to re
value, the already broad-based bidding for marks quickly
intensified. The mark was driven up 2V\ percent higher
from end-January levels to $0.3955 against the dollar
and, for the first time since November 1974, to the top
of the EC snake. As the advance of the mark extended the
band to its full limit of 2Va percent against the French
franc, market participants rushed to take advantage of the
emerging two-way speculative opportunity, thereby ag
gravating pressure on the franc. In response, the French
and German central banks stepped up their intervention
to defend the limits of the snake, in dollars and in each
other’s currency as well. Occasionally, the unsettled trad
ing conditions in Europe washed over into the New York
market. Thus, the Federal Reserve intervened on four
days during February 2-11 to sell a total of $137.4 million
equivalent of marks, financed by $80.9 million of drawings
under the swap arrangement with the Bundesbank and
by use of existing balances.
By February 13, the mark had begun to ease back
against the dollar and to move away from the upper limit
of the EC snake in the wake of this concerted central
bank intervention and in response to statements emerging
from the Franco-German summit reaffirming existing EC
parities. Through the month end, the mark continued to
settle back except for two occasions, February 19 and
February 27, when the market was again briefly un
settled in New York. On these two days, the Federal
Reserve sold $15.8 million equivalent of marks from
balances. Otherwise, as trading conditions continued generaly to improve, the System was able to purchase $65.2
million of marks in the market and from correspondents
through early March, using part of these acquisitions to
repay $26.4 million equivalent of the recently incurred
swap indebtedness with the Bundesbank.
On March 4, the mark was trading quietly around
$0.3880 when a sudden, sharp decline in sterling
prompted renewed concern over the viability of existing
European currency relationships. After the European
close the next day, as some of the funds moving from
C h a r t III
GERM ANY
M O V E M E N T S IN E X C H A N G E R A T E *
D o lla r s p e r m a r k
D o lla r s p e r m a r k
1975
1976
* E xch a n g e rate s sho w n in th is a n d the fo llo w in g c h a rts a re w e e k ly
a v e r a g e s o f N e w Y o rk no o n o ffe r e d
rates.
~t~Central ra te e s ta b lis h e d on Jun e 29, 1973.
sterling into dollars were in turn switched into marks, the
mark was pushed up by over V2 percent against the dollar
and again to its upper limit against the French franc in
the EC band. This polarization of the snake made trad
ing conditions hectic once more. To help settle the market
in New York, the Federal Reserve sold $40.1 million of
marks, of which $29.6 million was from balances and
$10.5 million was financed by a further drawing on the
swap line. The mark and French franc remained under
almost continuous pressure at the opposite limits of the
joint float during the following week, and both the Bundes
bank and the Bank of France continued to intervene
heavily in each other’s currency. Against the dollar the mark
held fairly steady until Friday, March 12, when, amid
unsettled pre-weekend trading prior to an EC finance
ministers’ meeting, the mark again came into heavy de
mand in New York. The Federal Reserve then sold
another $12.7 million of marks, financed by a swap
drawing.
Following consultations over the March 13-14 weekend
among the EC finance ministers, the French government
decided to withdraw the franc from the EC snake, while the
Dutch and Belgian authorities announced the suspension of
the Benelux currency arrangement. In subsequent dis
closures in the press, it was reported that Germany had
been prepared to revalue the mark as part of a broad
realignment of snake parities which, in the end, could not
be worked out. These disclosures made dealers all the more
convinced that the mark would be either unilaterally re
valued within the EC snake or allowed to float indepen
dently. Therefore, when the market reopened on the
222
MONTHLY REVIEW, SEPTEMBER 1976
morning of March 15, the mark began to rise against
the dollar, pulling the remaining EC currencies up in its
wake. In an attempt to maintain orderly markets, the
Bundesbank bought substantial amounts of dollars as
well as Belgian francs, Danish kroner, and Norwegian
kroner through March 19. This intervention contributed
to the $3.7 billion increase in Germany’s foreign exchange
reserves in February and March. The pressures on the
mark also spilled over into the New York market. Con
sequently, over March 16-17 the Federal Reserve sold
$34.9 million equivalent of marks. Of this, $29.8 mil
lion was drawn under the swap line, raising outstand
ing drawings since February to a peak of $107.5 million,
and the remainder was from balances.
The tensions within the snake began to dissipate follow
ing the March 20-21 weekend, as the German government
again expressed its commitment to maintaining the existing
mark parity within the snake. Against the dollar the mark
snapped higher before the quarter end, as German com
mercial banks bid for marks to meet reserve requirements
and traders positioned for the end of an accounting period.
After the Bundesbank purchased a small amount of
dollars at the Frankfurt fixing on March 30 and the Fed
eral Reserve sold $9.9 million equivalent of marks from
balances later that day, the market quieted. The spot rate
then leveled off to trade around $0.3945 throughout
April, some 2 percent above end-January levels. Mean
while, as funds began to flow back out of Germany, the
Federal Reserve acquired sufficient marks to repay $27.5
million of its swap debt with the Bundesbank, reducing
the total outstanding to $80 million.
During the spring, economic statistics were reinforc
ing the market’s view that the German and American
recoveries were becoming more nearly synchronized and
that the moderating trend of inflation in both countries was
continuing. Thus, day-to-day movements in the mark rate
depended largely on relative money market conditions.
As the German government drew down during April and
May balances that had been built up at the Bundesbank,
the money market became liquid and remained com
fortable even after the Bundesbank announced a two-stage
increase in required reserves effective May 1 and June 1.
By comparison, United States money market rates turned
up somewhat in late April. As a result of these divergent
tendencies, the mark slipped back gradually against the
dollar during May, declining 2 Vi percent to $0.3849 by
the beginning of June. Taking advantage of the dollar’s
buoyancy, the Federal Reserve acquired marks in the
market and from correspondents sufficient to repay the
remaining $80 million swap debt with the Bundesbank
and to restore modest working balances.
Meanwhile, some dealers also moved to unwind long
T able II
F E D E R A L R E S E R V E SY S T E M D R A W IN G S A N D R E P A Y M E N T S
U N D E R R E C IP R O C A L C U R R E N C Y A R R A N G E M E N T S
In m illions of dollars equivalent
Drawings ( + ) or repayments (— )
Transactions with
System swap
commitments,
January 1, 1976
II
J u ly
86.5
— 83.7
-4 5 .0
- 1 0 7 .5
1
N ation al Bank o f B elgiu m
........................................................................
297.6
System swap
commitments,
J u ly 31, 1976
1976
-
82.4
...............................................................................
-0 -
J + 1 3 3 .9
I - 26.4
........................................................................................
-0 -
{+
...............................................................................
567.2
J + 6 0 0 .0 *
1— 20.0
1,147.2
Bank for International Settlem ents (S w iss francs) .............................
600.0
—600.0*
-0 -
T o t a l ........................................................................................................................
1,464.8
Germ an Federal Bank
N etherlands Bank
Sw iss N ation al Bank
N ote: D iscrep an cies in totals are due to rounding.
* C onsolid ation o f Sw iss-franc sw ap debt.
-0 -
19.6
_o_
I - 19.6
1+7 5 3 .5
1 - 7 5 2 .6
- 1 9 1 .2
-4 5 .0
1,229.6
FEDERAL RESERVE BANK OF NEW YORK
standing positions in marks against other European cur
rencies. Thus, as short-term funds flowed back out of Ger
many, other central banks participating in the EC snake
bought marks to repay much of their commitments with
the Bundesbank. Nevertheless, the mark edged lower in
the snake and also dropped as much as 8 percent to a
record low against the Swiss franc by early June. To stem
the erosion of the mark rate against the Swiss franc as well
as to facilitate the further financing of the German govern
ment’s budget deficit, the German government arranged
with the Swiss authorities to place a mark-denominated
borrowing of DM 750 million with the three major Swiss
commercial banks. As dealers positioned for potential mark
purchases against sales of Swiss francs ahead of the June 15
payment date for this loan, the mark rate was temporarily
bid up to as high as $0.3908. It soon settled back to trade
between $0.3875 and $0.3890 in well-balanced trading
until late in the period.
By summer, economic indicators showed that both the
German and United States economic expansions had slowed
somewhat in the second quarter. At first, these reports were
largely offsetting in their impact on market psychology. But
toward the end of July, this news was accompanied by grad
ual declines in United States short-term interest rates that
contrasted with gently rising money market rates in Ger
many. Moreover, the market was increasingly aware of Ger
man public sector borrowing abroad. Then, sizable buy
orders for marks prompted a sharp rise in the spot rate
just before the month end. This unexpected advance after
a long period of steadiness soon attracted professional de
mand for marks and a recurrence of pressure on the EC
snake. In sometimes hectic trading, the rate jumped 134percent in two days to $0.3952 by July 30, some 2 per
cent above end-January levels.
STERLING
In contrast to most other EC currencies, sterling re
mained fairly steady in early 1976. By that time the
exchange market’s previous extreme pessimism over pros
pects for the pound had lifted somewhat. The wage re
straint program adopted in midsummer 1975 had already
showed positive results in slowing Britain’s severe wageprice spiral. The nearly 13V2 percent depreciation of
sterling over the whole year 1975 had left British exports
fairly competitive. Although the British economy was
still in deep recession, the economies of most major trad
ing partners were well into recovery and an export-led
upturn for the United Kingdom was a distinct possibility.
In the meantime, large interest rate differentials favoring
the pound stimulated sizable placements in both short-
223
and long-term sterling instruments, thereby offsetting the
continuing current-account deficit.
Consequently, even as other European currencies were
buffeted by heavy divergent pressures in January and
February, sterling traded narrowly just above $2.0250
against the dollar through early March. Over the same
period, its effective depreciation since the December 1971
Smithsonian agreement, having held steady around 30 per
cent through early February, rose to around 30.5 percent
before falling again to around 30.1 percent in early March.
The Bank of England, intervening to avoid sharp move
ments in the rate either up or down, was able to accumulate
a modest amount of dollars from market operations in
January-February which, together with public sector bor
rowings and a $1.2 billion drawing on the International
Monetary Fund (IM F) oil facility, contributed to a $1.6
billion increase in Britain’s reserves over the two months.
As this generally more favorable exchange market atmo
sphere emerged at the turn of the year, the United Kingdom
authorities allowed interest rates to ease in an attempt to
stimulate domestic investment spending and thereby to
reduce unemployment. The Bank of England’s minimum
lending rate had been gradually reduced from its peak of
12 percent in November 1975 to 9lA percent by late Feb
ruary, with scope for even further reduction on the basis
of market interest rates in early March.
Sterling’s stability nevertheless clearly rested on fragile
underpinnings. Although heartened by the results of the
wage restraint program, many traders remained skeptical
that the first year’s phase would meet its full objec
tives and that the next phase, still to be negotiated,
would be sufficient to achieve lasting improvement. More
over, the very depth and prolongation of the recession
in Britain raised concerns in the market that the govern
ment would eventually shift to a more stimulative fiscal
policy, possibly in the budget to be announced in April.
Furthermore, in the context of massive speculation over
relationships among other European currencies, the fact
that Britain continued to have one of the highest inflation
rates among industrial nations— running by then at 15 per
cent per annum— led most market participants to expect
that sooner or later the pound would undergo a further
downward adjustment.
Against this background, the market atmosphere
changed abruptly in a swiftly moving sequence of events
beginning on March 4. On that day the United Kingdom
authorities, confronted with a substantial but short-lived
bunching of commercial orders in the marketplace, inter
vened to supply sterling and absorb dollars to avoid a
potentially unsustainable appreciation of sterling above
prevailing levels. Once these demands were met, however,
224
MONTHLY REVIEW, SEPTEMBER 1976
sterling came on offer so suddenly that many market par
ticipants concluded that the authorities had acted to
depress the rate. Heavy selling pressure emerged the
next day in Europe, and sterling plunged with little
market resistance through the $2.00 level. On that day
also, the minimum lending rate was reduced by a fur
ther V4 percentage point to 9 percent. That weekend,
sterling’s breach of the $2.00 bench mark was featured
in press and television news commentary around the
world. Widespread selling of pounds resumed on Mon
day, March 8, and sterling fell nearly ten cents to below
$1.93 before edging back late in the day to trade around
$1.9425. Meanwhile, the Bank of England had inter
vened heavily to moderate the decline.
This precipitous drop of over 4 percent in three trad
ing days left the market badly shaken. With the pound
now vulnerable to further downward pressure, it was
soon caught up fully in the interplay of speculative forces
besetting other EC currencies. Commercial leads and lags
shifted abruptly against sterling as did the flow of non
resident investment funds. Various uncertainties were in
jected into the market by Prime Minister Wilson’s unex
pected resignation and the ensuing struggle within the
Labour Party from which Mr. Callaghan emerged as suc
cessor, the wide range of public pronouncements on Brit
ain’s policy choices by economic analysts and spokesmen
for different interest groups, and the continuing unrest on
the labor front. These concerns heightened the market’s
anticipation of the budget address, scheduled for April 6.
Although sterling leveled off just above $1.90 toward endMarch, a new wave of precautionary selling drove the rate
down by a further 3 percent to $1.85 in early April.
C h a rt IV
UNITED KINGDOM
M O V E M E N T S IN E X C H A N G E R A T E *
D o lla r s p e r p o u n d
D o lla r s
1975
*S e e
fo o tn o te on C h a rt III.
1976
per pound
In framing the budget message, the United Kingdom
government addressed many of the issues which troubled
the market. Among other measures, Chancellor Healey
announced a proposal to provide tax relief to the na
tion as a whole on the condition that, in the second
phase of the pay policy, the trade unions accept even
more severe restraints on wage increases than before.
As the government and the trade union leadership pressed
ahead with their negotiations, the sterling market reacted
nervously to each twist and turn in the highly publicized
bargaining process. Meanwhile, the pound’s already sharp
slide, increasingly less favorable interest rate differentials
for sterling, and reserve needs for some sterling holders
prompted many to continue to disinvest their sterling assets
or switch into other currencies. This process added to the
drag on the spot rate for sterling and to the drain on
British reserves, as the Bank of England intervened to sell
substantial amounts of dollars to cushion the pound’s de
cline. As a result, United Kingdom reserves dropped a full
$2.2 billion during March-April, even after the receipt of
$600 million of public sector borrowings.
In a sharp reversal of policy, the Bank of England
began to tighten money market rates, hiking its mini
mum lending rate IV2 percentage points to IOV2 per
cent on April 26 and following up with another 1 per
cent increase on May 24. Moreover, on May 5, the
government announced successful completion of the wage
policy negotiations with the Trades Union Congress. In
exchange for the tax cut, the government had secured
agreement from the union movement’s leadership to limit
phase-two wage increases, beginning on August 1, to 4.5
percent per annum under a formula which came close
to the terms set forth in the budget address. Also, to
bolster cash reserves, in early May the United Kingdom
authorities announced that they would take down a further
$806 million from the IMF, under a previously arranged
first-credit-tranche standby.
Nevertheless, during May the market became so thor
oughly demoralized that favorable developments were
virtually ignored, or greeted with skepticism, while traders
reacted quickly to anything which might conceivably
affect sterling adversely. News reports that particular
trade unions might possibly reject the negotiated limita
tions on wage increases and further bits of unfavorable
economic news— the unexpected increase in the April
trade deficit, the sharp rise in April retail prices, the
decline in United Kingdom industrial production in March
— sparked renewed selling of sterling. As the rate con-,
tinued to plunge, dealers expressed open concern over
the willingness or the ability of the authorities to halt
the slide. Consequently, even as the Bank of England
225
FEDERAL RESERVE BANK OF NEW YORK
T ab le III
D R A W IN G S A N D R E P A Y M E N T S B Y F O R E IG N C E N T R A L B A N K S
A N D T H E B A N K F O R I N T E R N A T IO N A L S E T T L E M E N T S
U N D E R R E C IP R O C A L C U R R E N C Y A R R A N G E M E N T S
In m illio n s o f d ollars
Drawings ( + ) or repayments ( - - )
Banks drawing on
Federal Reserve System
Drawings on
Federal Reserve
System outstanding
January 1, 1976
1
................................................................................
-0 -
.....................................................................................................
-0 -
Bank o f E ngland
B ank o f Italy
+ 2 0 0 .0
+ 5 0 0 .0
+ 3 6 0 .0
B ank for Intern ation al Settlem ents (against G erm an m arks) ......
-0 -
f + 14.0
1 - 14.0
To ta l
-0 -
+ 5 0 0 .0
200.0
- 5 0 0 .0
-0 -
provided further support— official reserves declined by
$250 million in May net of the IMF drawing—the
pound dropped through $1.80 to $1.75 by end-May
and plummeted to as low as $1.7020 in the first week of
June. This represented a drop from early March of 1534percent against the dollar and 11.8 percentage points to
41.9 percent on an effective trade-weighted basis since
the December 1975 Smithsonian agreement.
Meanwhile, Chancellor of the Exchequer Healey and
other government spokesmen expressed the firm view that
the various measures taken so far would achieve the
greater price stability and improved productivity neces
sary to strengthen sterling over the long run. Indeed, the
wage restraint program negotiated with the Trades Union
Congress was by that time gaining acceptance in votes
among individual unions. To deal with the immediate
concerns of the exchange market, however, the United
Kingdom authorities began in early June to discuss short
term credit availability with foreign central banks and gov
ernments.
From those discussions, largely conducted over the
weekend of June 5-6, emerged a $5.3 billion package of
standby credits to the United Kingdom from the Group of
Ten countries plus Switzerland and the BIS. As part of
the package, the Federal Reserve stood ready to make
available up to $ 1 billion under the swap arrangement with
the Bank of England and the United States Treasury up
J u ly
II
..........................................................................................
Bank o f M exico
Drawings on
Federal Reserve
System outstanding
J u ly 31, 1976
1976
f+ 5 7 4 .0
14.0
1 -
-0 360.0
f + 37.0
37.0
-0 -
J + 37.0
1 -5 3 7 .0
560.0
I -
to $1 billion through the Exchange Stabilization Fund.
In announcing the United States participation, the United
States Treasury and the Federal Reserve said: “These ar
rangements have been made in the light of the recent fall
in the value of the pound sterling under exchange market
pressures which have led to disorderly market conditions,
and in the common interest in the stability and efficient
functioning of the international monetary system.”
Announcement of the standby credit was carried by
the news services shortly after 10:30 a.m. New York time,
at which point the Bank of England and the Federal Re
serve Bank of New York, as its agent, simultaneously en
tered their respective markets, bidding openly for sterling
at the current rate of exchange. The combined force of the
news and the central bank presence in the market had an
electrifying effect. Within a matter of minutes and with
only a nominal purchase of sterling by the authorities
before they withdrew to the sidelines, the spot rate shot
upward in a rise which carried it to $1.80 by the time the
London market reopened the following morning. How
ever, the market quickly sought to test the determination
of the British authorities to support the rate at prevailing
levels. As sterling dropped back to around $1.77, the
Bank of England countered with substantial dollar sales,
both in London and through this Bank in New York,
while reinforcing a liquidity squeeze by operating in the
market for short-dated swaps. These operations helped
226
MONTHLY REVIEW, SEPTEMBER 1976
stabilize the pound somewhat, and over subsequent days
fairly good two-way business was again moving through
the market.
Nevertheless, dealers continued to look for new do
mestic policy initiatives to cut public expenditures and to
restrict monetary growth, as well as evidence of an under
lying improvement in British economic performance. Con
sequently, sterling remained vulnerable to an occasional
burst of selling pressure and on individual days official
support for the pound was quite heavy. By end-June,
the spot rate was around $1.77 and intervention had
diminished considerably. To offset outflows from reserves
resulting from recent intervention operations, the Bank of
England drew in late June on the standby facility. In this
connection, it took down $200 million on the swap line
with the Federal Reserve and $200 million from the
Exchange Stabilization Fund.
During July, the sterling market gradually became
less fragile and rate movements progressively narrowed.
Evidence of a more firmly based economic recovery
oegan to appear. Moreover, the British government an
nounced details of a reduction in public sector expendi
ture for the 1977-78 fiscal year to free more resources
for exports and industrial investment. Although the mar
ket initially reacted with some disappointment mat these
measures were not stronger, trading conditions soon im
proved. By end-July the pound had settled around $1.78,
some AVi percent above the early-June low. Meanwhile,
the effective trade-weighted depreciation had improved to
38.8 percent.
SWISS FRANC
Coming into 1976, the market’s attitude toward the
Swiss franc was even more bullish than before. Switzer
land’s inflation rate had declined to below 3Vi percent per
annum, a striking improvement from the 10 percent rate
that had prevailed just twelve months before and well
below rates elsewhere. The current-account balance was
in exceptionally strong surplus and, with domestic de
mand still stagnant and showing few signs of an early
recovery, was expected to remain favorable well into the
new year. Although Swiss interest rates had been kept low
and the outflow of capital was swollen with greatly in
creased nonresident borrowings in Swiss francs, the market
was concerned over the potential demand for francs
that could arise whenever borrowers covered themselves.
Indeed, a number of market participants with recent and
long-standing debts in Swiss francs moved to cover their
franc exposures in early January. The franc, therefore,
came into strong demand, rising through the month end
by some 5V2 percent from its September 1975 low to
$0.3844 against the dollar while reaching par against the
German mark.
In the meantime, the Swiss authorities, concerned about
the eventual adverse effects of a strengthening exchange
rate on Swiss exports, took steps to limit the franc’s rise.
The official discount and Lombard rates were reduced fur
ther to 2 Vi percent and 3 Vz percent, respectively, in early
January. In addition, the National Bank stepped up its
official purchases of dollars in Zurich and, to a modest
extent, in New York through this Bank as agent. To avoid
jeopardizing the authorities’ monetary target for the year,
these operations were offset in part by the ongoing pro
gram requiring foreign borrowers of Swiss francs to con
vert the proceeds of their borrowings at the central bank
and in part by increased government borrowings.
"although by early February the particular demands for
Swiss francs had largely been met, the franc soon was
caught up in the tensions afflicting other currencies in midFebruary and early March. Marked up against the dollar in
sympathy with the rise of the German mark, the rate in
creased to $0.3970 on March 17, even as the National
Bank continued to intervene. After pressures within the
EC snake began to subside late in March, the Swiss franc
remained in demand in response to the usual quarter-end
needs for francs. The National Bank provided liquidity
assistance, mostly through swaps over the month end but
cuso through further outright spot dollar purchases, with
the result that the spot rate held steady against the dollar
and around par with the German mark.
Br.rly in April, however, the Swiss franc once again
emerged as a focus of market attention, rising strongly
not only against the dollar but also against the German
mark. Recent economic indicators confirmed the further
moderation of price increases in Switzerland as well as the
continued strength of the current-account surplus. Swit
zerland once again provided a haven for those funds seek
ing an escape from the continued uncertainties elsewhere,
and the franc was bid up strongly as funds were shifted
out of Italian lire and sterling. Renewed hedging of long
term Swiss-franc commitments by United States and other
corporations, periodic inflows from the Organization of
Petroleum Exporting Countries (OPEC), eastern Europe,
and third world countries, and outright speculative posi
tioning further reinforced demand for Swiss francs.
In view of these continuing sources of strength, the
market became fearful that the authorities would again
seek to contain the franc’s rise by imposing yet more con
trols against the inflow of foreign funds. The announce
ment early in April of new regulations restricting the im
portation of foreign bank notes seemed to confirm the
FEDERAL RESERVE BANK OF NEW YORK
C h a rt V
SWITZERLAND
M O V E M E N T S IN E X C H A N G E R A T E *
D o lla r s p e r fr a n c
D o lla r s p e r fr a n c
.4 2
.4 2
.41
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.4 0
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1975
*S e e
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-
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;
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F
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.4 0
A
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.3 6
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1976
fo o tn o te on C h a rt III.
market’s concern, and the franc again became strongly
bid. The Swiss National Bank continued to purchase dol
lars in the market to contain the franc’s rise. At the same
time, however, National Bank President Leutwiler con
ceded that neither the balance-of-payments nor cost-price
relationships warranted a restoration of earlier rates for
the franc. Thus, the franc was subjected to successive
waves of demand that swept the spot rate up by June 2
to a peak of $0.4197, 9 percent above late-January levels
and its highest point since early 1975. In the meantime,
the franc gained some 8 percent to a record high against
the German mark.
The protracted rise of the Swiss franc threatened to ag
gravate the pressures on Swiss exporters at a time when
the domestic economy still had not joined in the economic
recovery developing elsewhere. In response, the Swiss
authorities prepared to stiffen their resistance to the
franc’s advance. They agreed that a DM 750 million loan
for the German government be placed with the three
major Swiss commercial banks and that the marks be pur
chased in the market. On June 8 the Swiss National Bank
announced an extensive package of exchange controls
and other measures to curb the “excessive speculation
that led to the Swiss franc’s clear overvaluation”. In addi
tion, the authorities pledged to “intervene massively, if
necessary, to correct disorderly exchange rate move
ments”, blocking the Swiss franc countervalue of their
dollar purchases if needed to avoid undermining Swiss
monetary targets. Moreover, the Swiss central bank again
cut both its discount and Lombard rates to 2 percent and
227
3 percent, respectively, the lowest levels since 1963.
Following these actions, the Swiss authorities immedi
ately stepped up the scale of their intervention in both
dollars and German marks. As the market assessed the
impact of this heavier intervention and the German gov
ernment borrowing on the franc-mark relationship, dealers
moved to cut back some of their large Swiss franc posi
tions. The franc therefore fell back 5Vi percent against
the dollar to $0.3960 on June 9, while dropping a similar
amount against the German mark. As the Swiss franc
weakened, some of the banks and multinational cor
porations with exposures in francs took advantage of
these rates to begin again to cover themselves. Moreover,
sales of Swiss francs to finance participations in the Ger
man government loan soon tapered off. As a result,
demand for francs reemerged and remained periodically
heavy over subsequent days, with the National Bank pro
viding resistance to a further sharp rise in the rate.
By the end of June, the Swiss National Bank had pur
chased a total of $4.4 billion since the beginning of the
year. During the first quarter, the bulk of the spot inter
vention had been offset, largely under the capital export
conversion program, and the National Bank had provided
temporary liquidity partly by conducting short-term swaps
with the Swiss banks. During the second quarter, how
ever, a smaller portion of the reserves injected through
the Swiss National Bank’s intervention was absorbed and
the Swiss money market became increasingly liquid. To
help keep monetary expansion in line with the National
Bank’s target, reserve requirements on foreign deposits
were raised, effective July 26, and government borrowings
were stepped up. But even so, Swiss interest rates remained
extremely low in sharp contrast to the somewhat firmer ten
dencies that developed from time to time in other centers.
Consequently, the Swiss franc leveled off to trade more
narrowly around $0.4038 during most of July. Just before
the month end, however, it was pulled up somewhat by
the German mark’s advance. As a result, by July 30, the
franc was on balance somewhat more than 4 percent above
end-January levels but still 33A percent below its peak
of early June. Against the German mark, it had gained
2 V2 percent on balance over the period, though the gap
between the two currencies had narrowed some 5Vi per
cent from its widest point two months before.
During the period, the Federal Reserve transferred its
$600 million of Swiss franc swap debt from the BIS to the
Swiss National Bank. The System purchased $33.2 million
equivalent of Swiss francs from correspondents and liqui
dated $20 million of its debt with the Swiss central bank.
Swiss franc commitments outstanding at end-July totaled
$1,147.2 million.
MONTHLY REVIEW, SEPTEMBER 1976
228
FRENCH FRANC
During much of 1975, the French franc was bolstered
by a strong improvement in France’s external position. A
severe recession at home and reduced energy requirements
helped to swing France’s trade account into surplus. Rela
tively high interest rates in France had stimulated sizable
inflows of foreign funds, while French companies had
been encouraged to borrow abroad. Thus, the French
franc remained relatively firm within the EC snake after
its reentry at the former parity in July 1975. The Bank
of France intervened frequently to keep the franc off the
top of the EC band, with the official purchases reflected
in the increase in French reserves recorded for the second
half of 1975.
By the turn of the year, however, the balance of market
forces began to turn against the French franc. The fiscal
stimulus provided early last fall, when the recovery in
France— as in other European countries—was still lagging
behind that in the United States, had by then generated a
quick rebound in the domestic economy. This drew
imports in from abroad sufficient to turn France’s trade
position back into deficit by late 1975. It also raised
market concern over whether the inflation rate, which had
eased just below 10 percent, would continue to decline
toward levels more nearly in line with those in Germany
and the United States. In the meantime, domestic interest
rates eased back somewhat, thereby narrowing the inter
est differentials favoring France. As credit conditions
improved, French companies repaid some of their previous
foreign borrowings while new borrowings abroad declined.
With the outlook for France’s balance of payments
more uncertain, the French franc was left exposed to the
successive waves of selling which developed in early 1976.
Following the January 21 suspension of official sup
port for the Italian lira and its subsequent sharp drop,
the market increasingly came to question the competi
tive relationships within Europe and the viability of
existing EC parities. As a result, the French franc had
already come on offer late in January when dealers
unloaded long French franc positions and leads and lags
shifted against the franc. As the franc weakened, it
dropped below the midpoint of the EC snake. The Bank
of France intervened to cushion its decline by selling
dollars heavily in Paris and limited amounts in New York
with the Federal Reserve Bank of New York acting as its
agent.
Nevertheless, speculative pressures within the EC mon
etary agreement continued to mount as repeated rumors
of a possible realignment of snake currencies—involving
some combination of a franc devaluation and a German
mark revaluation— swept through the markets. Conse
quently, the franc and the mark were pushed toward
the opposite extremes of the joint float by the second
week of February. The February 9 devaluation of the
Spanish peseta and the approach of a scheduled FrancoGerman summit meeting on February 12-13, reportedly
to discuss among other things an EC currency realign
ment, further intensified the two-way speculation within
the snake. In response, the Bank of France stepped up
the scale of its operations, selling large amounts of dol
lars as well as a substantial sum of German marks be
tween February 9 and February 12. At the same time,
in Frankfurt, the Bundesbank followed up on its dollar
purchases with some French franc acquisitions to help
keep the franc above the floor of the snake.
T able IV
U N I T E D S T A T E S T R E A S U R Y S E C U R IT IE S
F O R E IG N C U R R E N C Y S E R IE S
In millions of dollars equivalent
Issues ( + ) or redemptions (— )
Issued to
Am ount
outstanding
January 1, 1976
1
Swiss N ational Bank
1,599.3
T otal
1,599.3
Am ount
outstanding
J u ly 31, 1976
1976
II
J u ly
1,599.3
-0 -
-0 -
-0 -
1,599.3
229
FEDERAL RESERVE BANK OF NEW YORK
In the wake of this officially acknowledged intervention,
the markets began to settle down by February 13. More
over, reports from that weekend’s summit meeting
reaffirming prevailing EC parities, together with a tighten
ing of French interest rates, prompted some covering of
short franc positions. As a result, the franc regained a por
tion of the ground it had lost against the mark and later
eased back less than other Continental currencies as the
dollar generally firmed. By the month end, it had declined
against the dollar some V2 percent from early-February
levels to $0.2234. Against other European currencies,
however, it had firmed to a level % percent above the
floor of the EC snake, and the Bank of France began to
recoup some of its reserve losses.
Nevertheless, most market participants remained con
vinced that an early realignment of EC parities was
inevitable. Thus, when sterling’s sharp decline in early
March and the continuing plunge of the Italian lira again
brought into question competitive relationships within
Europe, a new and more virulent round of speculation
against the franc was quickly ignited. In the wake of these
precipitous declines in exchange rates for two of France’s
major trading partners, the French franc came under
massive pressure, as commercial and professional market
participants offered huge amounts of francs in the ex
changes at the same time that the German mark was
strongly bid. Leads and lags shifted even more heavily
against the franc, and the large-scale speculative positions
established during January and February were lengthened
even further. The Bank of France met these pressures
with further forceful intervention that resulted in a con
siderable loss of French reserves for the several days that
preceded the March 13-14 meeting of EC finance ministers.
Over the weekend, when no realignment within the EC
snake was achieved at the summit meeting, the French
government decided to withdraw the franc from the EC
snake and allow it to float independently. When trading
resumed on Monday, March 15, the franc at first plum
meted over 5 percent in a nervous and uncertain market.
But, as the cost of overnight borrowings in the Euro-franc
market abroad soared to as much as 800 percent per
annum, dealers responded by covering their extremely
expensive short franc positions. The spot rate soon re
covered to around $0.2150 against the dollar, or about
2 V2 percent below its old support limit against the German
mark within the EC snake.
Over subsequent weeks, dealers remained cautious
toward the French franc and there were no significant
reversals of the speculative outflows of January-March.
The franc market was roughly in balance, however, as
a modest unwinding of adverse leads and lags and con
C h a rt V I
FRANCE
M O V E M E N T S IN E X C H A N G E R A T E *
D o lla r s p e r fr a n c
D o lla r s p e r fr a n c
.2 5
.2 5
V
.2 4
.2 3
- V
.2 2
—
a
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-
.2 4
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.2 3
—
.2 2
-
.21
-
.2 0
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\
.21
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.2 0 -
1 1 1 I 1
.19
J
A
S
O
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1975
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.19
A
1976
* S e e fo o tn o te on C h a rt III.
i ” C e n tra l ra te e s ta b lis h e d on Febi ru a ry 12, 1973.
versions of new French corporate borrowings abroad
tended to offset continuing commercial demand for for
eign currencies by French residents. The spot rate drifted
down gradually to $0.2108 by early June, as the dollar
gained generally in response to a renewed rise in United
States short-term interest rates. Against other EC cur
rencies, the French franc held fairly steady. The Bank of
France was therefore able to take advantage of occasional
bidding for francs to purchase currencies in the market.
Even so, the decline in France’s reserves for the first five
months of the year came to about $3 billion.
During the summer, the market became even more
hesitant toward the franc. Although the pace of inflation
had moderated, many market participants feared that
a continued expansion of domestic demand would re
verse this trend and widen the gap between inflation rates
in France and those abroad. Then, the market’s attention
shifted to the impact on France of the severe European
drought. More serious in France than in most other
countries, the drought was expected by many forecasters
to push up food prices, cut into agricultural exports, and
increase oil imports to compensate for the loss of hydro
electric power.
Under these circumstances, the selling of French francs
again built up early in July. The Bank of France initially
resisted with heavy dollar sales. But the pressures con
tinued, fueled by open debate in the press over the gov
ernment’s resolve to stem a further decline in the rate and
to contain continuing wage and price pressures. The
authorities then moved to resist a further decline in the
230
MONTHLY REVIEW, SEPTEMBER 1976
franc rate by raising domestic interest rates, including a
IV2 percentage point increase to 9V2 percent in the Bank
of France’s discount rate, effective July 22. The market
at first interpreted this move as indicating a considerably
more flexible intervention policy, and the rate briefly
eased further. By the end of July the spot rate had fallen
to about 10 percent below its former lower intervention
point against the German mark. Trading at $0.2035, the
franc was some 9 percent below early-February levels
against the dollar.
ITA LIAN LIRA
Pressure against the Italian lira had been building up
during the fall of 1975 in response to deepening economic
and political uncertainties in Italy. Industrial activity
showed only tentative signs of recovery, as sectoral bottle
necks blunted the impact of the fiscal and monetary
stimulus provided earlier in the year. At the same time, the
strengthening of the dollar against the lira prompted
large repayments of foreign borrowings by Italian banks
and a drop in domestic interest rates facilitated the fi
nancing of a sharp rise in raw materials imports as firms
began to restock depleted inventories. Thus, the outflow of
capital accelerated and the trade balance deteriorated suf
ficiently to erode much of the improvement evident earlier
in 1975. Meanwhile, the fall in real income in Italy and
renewed upturn of the inflation rate had generated in
creasing political and social unrest, with important labor
negotiations approaching a critical stage. After a pro
longed cabinet crisis, Italy’s minority coalition government
resigned in January 1976 and, as efforts went forward
to strike a new political compromise on which a viable
cabinet could be formed, the lira came heavily on offer in
the exchanges.
At first, the Bank of Italy countered these pressures
with forceful intervention to keep the lira rate roughly in
line with other European currencies. From January 2 to
January 20, it sold more than $500 million, raising the
entire reserve loss since mid-1975 to $2.4 billion. As a
result, the Bank of Italy was left with only $594 million in
convertible currency reserves and, to add to its cash bal
ances, it drew $250 million under the swap line with the
Federal Reserve. But, in the absence of a new government
and with the adequacy of Italy’s reserves a matter of open
discussion in the press and the market, prospects of a
further flight of capital from the country became over
whelming. Thus, on January 21 the Italian authorities
announced that the Bank of Italy would suspend official
dealings in the exchange market to conserve reserves.
This decision left the lira effectively floating freely
and, with selling continuing into February, the spot rate
dropped fairly sharply from time to time in a thin market.
There were occasional pauses in the decline, as traders re
sponded to events which gave rise to hopes of an end to
Italy’s governmental crisis or a resumption of official
dealing. Nevertheless, the market was so thoroughly de
moralized that two hikes in the Bank of Italy’s discount
rate from 6 percent to 8 percent during February and
increased bank reserve requirements evoked little market
response. Moreover, the eventual announcement that a
new minority government would be formed under Premier
Aldo Moro gave but a momentary boost to market psy
chology. Instead, in increasingly one-sided trading, the lira
fell to $0.001245 (Lit 803) by February 24, 15V4 per
cent below levels prevailing before the cabinet resignation.
Meanwhile, the Italian authorities grew more concerned
about the deterioration of market conditions and the
drop in the rate that threatened to set off a new bout of
inflation at home. Consequently, the Bank of Italy moved
ahead with plans to resume official intervention to restore
more orderly trading once again. Even as the new gov
ernment was being formed, the Italian authorities initiated
discussions for a new IMF standby and concluded
arrangements with other EC governments to borrow $1
billion in the international markets through the EC oil
facility. As these negotiations to secure medium-term
credit went forward, the Federal Reserve agreed to make
available to the Bank of Italy, in addition to the $250
million already drawn, a further $500 million under the
swap arrangement to backstop the Bank of Italy’s cash
resources.
Late in February, when the new government presented
its economic program to parliament, the authorities also
announced that they would reopen official exchange mar
ket dealings on March 1, with some $2 billion of credit
available including the funds extended for this purpose
by the Federal Reserve. The market responded favorably
and, while potential purchasers of foreign currencies held
off satisfying their needs until March 1, the lira was
marked up over 4 Vi percent to $0.001302 (Lit 768)
temporarily at the end of February.
In early March, when the backlog of commercial
orders for dollars particularly by Italian oil companies
reached the market, the lira immediately came under
selling pressure. Then, just as the market was settling
down, the lira was caught up in the resurgence of
generalized speculation over European currency relation
ships. Hit by renewed selling, the spot rate was driven
down by 9 percent to $0.001188 (Lit 842) by March 16,
even as the Bank of Italy provided large-scale support.
The Italian authorities responded to these pressures by
FEDERAL RESERVE BANK OF NEW YORK
tightening regulations on capital outflows and by re
stricting the capacity of commercial banks to cover their
customers’ forward lira sales through requiring a 10 per
cent reduction in commercial bank “spot against forward”
transactions by the month end. More importantly, they
imposed severe fiscal and monetary deflationary measures,
raising the Bank of Italy’s discount rate an unprecedented
4 percentage points to 12 percent and proposing emer
gency tax and gasoline price increases estimated to absorb
some $1.8 billion equivalent. The announcement of these
measures, at a time when there were still only tentative
indications of a recovery in the domestic economy, im
pressed the market and touched off a sharp rebound in the
spot rate. In the forward market, however, the discount on
three-month lire more than doubled to over 17 percent per
annum on March 31, as liquidity in Italy tightened and the
new exchange control restrictions began to take effect.
Meanwhile, the Bank of Italy took down another $250
million on its swap line with the Federal Reserve, raising
the total of actual drawings to $500 million. The EC oilfacility borrowing was also completed, bringing a further
$1 billion into Italian reserves.
The tentative improvement in market conditions fol
lowing the March measures was dealt a stunning blow in
early April, when a serious disagreement over noneco
nomic issues erupted in parliament. As it became clear
that new elections were inevitable, market fears of a strong
showing by the Communist Party led to renewed capital
outflows which pushed the spot rate down by May 5 to
a record low of $0.001090 (Lit 917), fully 26 percent
below early-January levels. Also in early May the forward
C h a r t V II
ITALY
M O V E M E N T S IN E X C H A N G E R A T E *
D o lla r s p e r lir a
D o lla r s p e r lir a
1975
*S e e
fo o tn o te on C h a rt III.
1976
231
discount soared to 42 percent per annum.
After the close of trading that day, the Italian caretaker
government began to announce a set of tough foreign
exchange restrictions designed to curb import growth, to
encourage reversals of adverse leads and lags, and to stabi
lize the lira spot rate until a new government could be
elected. As of May 6, all foreign currency purchasers,
except grain importers, were required to deposit 50 percent
of the countervalue of their acquisitions in noninterestbearing accounts for three months. This measure, aimed
at discouraging speculative outflows via the over-invoicing
of imports, was also expected to mop up about $4 bil
lion equivalent of liquidity over three months. On May 7,
Italian exporters were told to convert foreign currency
earnings within seven days of receipt to shorten the lag
between export transactions and foreign currency conver
sions. On May 10, exporters granting foreign currency
trade credits of up to 120 days were required to convert
30 percent of the value of those credits into lire within
seven days of the transactions. Moreover, technical
changes in existing exchange restrictions were announced
to raise both the cost and risk of maintaining short lira
positions.
The imposition of these sweeping exchange restraints
provoked an immediate scramble for lira balances. The
spot rate shot up to as high as $0.001235 (Lit 810) in
early European trading on May 10, before settling around
$0.001193 (Lit 838) later in May, 9V2 percent above the
low early in the month. Thereafter, as the exchange con
trol measures continued to contribute to a squeeze on
domestic liquidity, the lira traded more quietly around
this level until the June 20-21 general elections.
The election outcome, with a narrow but clear-cut
plurality for the Christian Democratic party, swept aside
a major source of market uncertainty, and a reflux of
speculative funds developed as soon as the first results
were known on June 21. Thereafter, news of a reduced
balance-of-payments deficit for May and a slowing in
the rate of inflation lifted some of the gloom surround
ing the Italian economic outlook. With Italy’s tourist
earnings becoming seasonally strong and the various
exchange controls continuing to induce a reversal of ad
verse leads and lags, the lira came into demand. In
view of the earlier heavy reserve losses, the Bank of Italy
took advantage of the lira’s buoyancy at prevailing rates
to absorb large amounts of dollars in the market. Con
sequently, while the substantial inflows of funds continued,
the lira rate held steady through end-July. The Bank of
Italy was thus able to post reserve gains of $1.7 billion
for June and July, even after repaying in late July the full
$500 million of swap drawings on the Federal Reserve.
232
MONTHLY REVIEW, SEPTEMBER 1976
NETH ER LAND S GUILDER
Coming into 1976, the Netherlands guilder was bol
stered by expectations of a continuation of that country’s
strong payments position. A sharp rise in natural gas
exports, together with a recession-induced fallback in
imports, had already widened the current-account surplus
to $1.6 billion in 1975. With economic recovery well
under way in several of the Netherlands’ major foreign
markets, the outlook for Dutch exports promised to be
even brighter for 1976. Sizable capital outflows were
expected to continue, reflecting the relatively low interest
rates in Amsterdam compared with other financial centers,
but not in sufficient volume to offset fully the currentaccount surplus. Moreover, although unemployment was
still rising and the inflation rate was still about 10 percent,
the domestic economy was beginning to show signs of an
upturn. Consequently, exchange market sentiment was
extremely favorable, and the guilder traded firmly at the
top of the EC snake as well as at the upper limit against
the Belgian franc in the W 2 percent Benelux band.
When tensions developed in many European currency
markets in late January, a press report that the Benelux
band might be abandoned— although immediately denied
by the Netherlands and Belgian governments— triggered
large-scale speculative demand for guilders and offerings
of Belgian francs. To counter these pressures, the Nether
lands Bank intervened in coordination with the National
Bank of Belgium and bought substantial amounts of Bel
gian francs as well as dollars. The Dutch central bank
announced a Vi percentage point cut in its discount rate
to 4 percent and 1 percentage point reductions in other
official lending rates. In Belgium, the authorities also took
several measures to support the franc, including the boost
ing of short-term interest rates. This forceful response,
coupled with an easing of liquidity conditions in Amster
dam and a corresponding tightening of liquidity in Brus
sels, reassured the market, and by early February the
immediate strains had subsided somewhat.
By that time, however, the markets were alive with
rumors of a possible general realignment of EC currencies.
In view of the strong ties between the Netherlands and
German economies and the fact that each enjoyed a sub
stantial current-account surplus, market participants
tended to tag the guilder as a prime candidate for revalua
tion along with the German mark. Consequently, as
the mark came into heavy demand, the guilder also
strengthened, joining the mark at the upper limit of the
EC snake and stretching the Benelux band once again.
The dollar market became unsettled, too, and the guilder
rose by 3A percent to a peak of $0.3781. In this atmo
sphere, when a flurry of demand for guilders developed
on February 11 in the New York market, the Federal
Reserve supplemented its offers of German marks with
offers of guilders, selling $19.6 million equivalent fi
nanced by a drawing on the swap line with the Nether
lands Bank. Subsequently, as the immediate exchange
market turbulence abated and the guilder eased back
somewhat, the Federal Reserve purchased sufficient
guilders to liquidate the swap debt by early March.
Following sterling’s drop below the $2.00 level, expec
tations of a broader EC exchange rate realignment reap
peared, generating renewed demand for guilders. By the
second week of March, the guilder was hard against its
upper margin for the Belgian franc. Even though there
was sizable intervention to defend the Benelux limits,
bringing total support since early February to over $350
million equivalent, the guilder was pushed to the top of
the EC band along with the mark.
The results of the March 13-14 EC finance ministers’
meeting in Brussels had a jarring effect on market expec
tations for the guilder. The Benelux joint float arrange
ment was abruptly suspended, relieving an immediate
source of speculative demand. At the same time, the
press reported that, in the showdown which developed at
Brussels, Dutch officials had rejected proposals to revalue
the guilder. By that time, also, technical factors were
weighing on the market, as the guilder liquidity created
by central bank intervention, together with usual seasonal
factors, had so eased money market conditions in the
Netherlands that short-term interest rates there were well
below those in Germany and Belgium. Consequently, the
guilder came on offer, easing slightly against the dollar but
falling sharply against the mark and other currencies
within the EC snake. The Netherlands Bank began to sell
moderate amounts of dollars to cushion the decline, but by
April 6 the guilder had slipped to the bottom position of
the joint float.
During the spring, several developments prompted
increasingly bearish sentiment toward the guilder. Eco
nomic indicators during the first months of 1976 showed
that Dutch exports had leveled off and that the incipient
economic recovery at home had stalled. The inflation rate
remained stubbornly high, well above those in Germany,
Switzerland, and the United States. Moreover, serious
union opposition had emerged to a proposed extension of
the government’s social contract for limiting wage in
creases. In addition, higher government borrowing require
ments associated with continued growth of public sector
spending were a source of concern to the market. At the
same time, widespread press reports of disputes within the
government coalition over a number of social and eco-
233
FEDERAL RESERVE BANK OF NEW YORK
oped, pushing up market interest rates sharply and prompt
ing some covering of short guilder positions in the exchange
market. The guilder thus turned firmer against the dollar
and came off the floor of the EC snake.
Thereafter, the guilder market was in better balance
until late in July, when the snake came under renewed
strains as the movement into German marks became more
generalized. At that time, the Netherlands Bank again
intervened in support of the guilder within the EC band
and announced a further Vi percentage point increase in
its discount rate to 5l/i percent, effective August 2. By
end-July the guilder rate had recovered to $0.3708, some
2X
A percent above its June low.
BELGIAN FRANC
nomic issues added further to the uncertainties.
Through early May the spot guilder therefore stayed
in the lower range of the EC band. Against the dollar it
held steady at around $0.3725, as the National Bank of
Belgium completed guilder purchases to repay commit
ments incurred prior to suspension of the Benelux band.
Thereafter, the guilder was left more exposed to selling
pressure that intensified after mid-May. The rate began
to soften and reached a low of $0.3628 on June 1, some
4 percent below the February high, before the immediate
selling pressure subsided. To keep the guilder away from
its lower intervention limit against the mark in the EC
band, the Netherlands Bank intervened in substantial
volume, with the result that reserves declined by nearly
$1.2 billion between mid-March and mid-June. Moreover,
the Netherlands Bank, following market developments,
raised its discount rate in two Vi percentage point steps
to 5 percent by June 18. During that time, the Federal
Reserve took the opportunity to purchase a modest
amount of guilders ($3.6 million equivalent) for working
balances.
By mid-June the Dutch money market had gradually
tightened, partly as a result of the heavy exchange market
intervention by the authorities. Moreover, recent economic
indicators were more favorable, with tentative signs of
improvement in industrial production and better price
figures. At the time of end-June positioning in the Nether
lands, therefore, a scramble for guilder balances devel
Late in 1975, Belgium’s balance of payments had
shifted into deficit as a result of a slowdown in exports
and an increased outflow of long-term capital. Domesti
cally, the economy was slow to join in the recoveries al
ready getting under way in other countries. In addition,
Belgium’s inflation rate, while declining to below 10 per
cent, was still high enough to generate market concern
that it could thwart a sustained recovery. There was
further uneasiness that the government had not reached
agreement with the trade unions for modifying Belgium’s
wage indexation system, a mechanism many observers
felt was helping to weaken the competitiveness of Belgian
exports.
Against this background, the commercial Belgian franc,
trading around $0.025520 vis-a-vis the dollar in early
January 1976, had fallen to near the bottom of the EC
snake and had also settled at the lower limit of the
separate IV2 percent Benelux band with the Dutch guilder.
There was no particular pressure against the franc, how
ever, until late in January when, amidst generalized
speculation over European currency relationships, news
paper reports suggesting that the Benelux currency arrange
ment might be disbanded set off heavy selling of Belgian
francs. The selling reflected adverse shifts in commer
cial leads and lags and was therefore concentrated in the
market for commercial francs. The financial franc, which
floats freely, moved in parallel to the commercial rate but
was not under unusual strain. Although the press reports
were officially denied, the pressure continued and interven
tion mounted by both the Belgian and Netherlands central
banks, largely in Benelux currencies. As a result, liquidity
tightened in Brussels and simultaneously eased in Amster
dam, raising the cost of holding positions short of francs
and long of guilders and thereby relieving the strain on the
franc by mid-February.
234
MONTHLY REVIEW, SEPTEMBER 1976
Bolstered by the continuing tautness in Belgium’s local
money market, the franc was not immediately caught up
in the market turmoil surrounding other European cur
rency markets early in March. But by March 11, as traders
came once again to expect an adjustment of EC parity
relationships, speculative selling of Belgian francs reemerged. The spot rate was driven back to its lower
limit against the guilder, where it again required heavy
support.
The announcements following the EC finance ministers’
meeting over the March 13-14 weekend only intensified
the selling of Belgian francs. News that the French franc
had been withdrawn from the EC snake and the Belgian
and Netherlands governments had suspended the Benelux
currency arrangement generated expectations that the
Belgian franc would be either devalued or cut loose from
the joint float. Dealers therefore drove the franc almost
immediately to the bottom of the snake, which was then
being pulled up against the dollar by the rise of the
German mark.
The Belgian government, however, quickly signaled its
determination to keep the Belgian franc in the snake at
its existing parity to prevent a falling exchange rate from
aggravating domestic inflation. As the Belgian franc came
heavily on offer against the mark at the lower limit of
the snake, the National Bank of Belgium intervened
heavily between March 15 and March 19, selling large
amounts of marks while the Bundesbank purchased a
large volume of Belgian francs in Frankfurt. Moreover,
to convince the market of its resolve to support the franc,
the Belgian authorities took further steps to raise the cost
of holding speculative positions against the franc. The
National Bank announced a 1 percentage point hike in its
discount rate to 7 percent, effective March 18, and re
stricted access to its short-term lending facilities. In ad
dition, it required commercial banks to deposit a fixed
percentage of their funds in government securities. These
measures were followed up with public affirmations on
the part of a number of Belgian officials of their determi
nation to guarantee the existing Belgian franc parity.
By March 22, the combined impact of these various
liquidity-tightening measures had taken hold. Overnight
rates in the Euro-Belgian franc market were bid as high
as 200 percent per annum, and the cost of rolling over
short franc positions became more than most specu
lators were willing to bear. Thus, in a sharp two-day turn
around, the franc jumped over 2 percent against the dol
lar and traversed the entire width of the EC snake before
easing back to trade around $0.025600, fairly comfort
ably within the joint float.
By early April, industrial production in Belgium was
rising more strongly than anticipated at the beginning of
the year, but the pace of domestic price increases remained
worrisomely high. The Belgian cabinet agreed on budget
cuts on April 5 to reduce domestic inflation further and
to provide support for the exchange rate. In addition,
the authorities followed up their mid-March measures
by strengthening the controls on resident foreign exchange
transactions. The cumulative effect of these various actions
was to trigger a gradual reversal of previously adverse
leads and lags. As these reflows persisted throughout
April and May, the Belgian authorities were able gradu
ally to ease their mid-March monetary restrictions, reduc
ing some interest rates to pre-crisis levels and, in early
June, lifting the special regulations requiring commercial
banks to maintain specific levels of investments in gov
ernment securities. In addition, the National Bank com
pleted its repayment of Dutch guilder commitments
incurred prior to suspension of the Benelux band and
purchased sufficient German marks to liquidate its com
mitments in that currency as well. Even so, the com
mercial franc continued to hold in the middle of the EC
snake, while falling off with the other European currencies
against the dollar.
Thereafter, dealing in francs was generally quiet and
well balanced through early July. Only on two successive
Fridays in late May-early June was trading temporarily
unsettled by a spillover of pressure directed at the Dutch
guilder. In each case, the National Bank of Belgium
quickly countered with small sales of dollars. In mid-July,
however, as the market began once again to reassess exist
ing European currency relationships, pressures on the
Belgian franc were renewed and the franc fell to its lower
limit against the German mark. The National Bank re-
FEDERAL RESERVE BANK OF NEW YORK
235
panies rushed to cut back their dollar positions, Japanese
corporations converted their foreign borrowings, and
nonresidents responded to an increased premium on the
forward yen by moving more funds into Japanese securi
ties. The spot rate jumped in hectic trading to a peak
on April 8 of $0.003365 (¥297.2), some 3 percent above
its mid-December low. Throughout this period the Bank
of Japan met the sporadically heavy demand for yen with
occasionally large purchases of dollars in Tokyo to mod
erate the rise and to maintain orderly markets. These
purchases, especially in February and April, accounted
for the bulk of Japan’s $2.1 billion increase in reserves in
the first four months of this year, reversing the $1.8 bil
lion loss in the second half of 1975.
Although Japan’s export performance in the first quar
JAPANESE YEN
ter had far outstripped even the most optimistic forecasts,
Early in 1976 the balance of market sentiment had by mid-April many market participants had begun to
swung back in favor of the Japanese yen, as an un question whether this improvement could be sustained.
expectedly rapid improvement in the balance of payments The current sharp upsurge in exports was concentrated
outweighed lingering concern over the sluggishness of in only a few of Japan’s export industries. A slowdown
Japan’s economic recovery. The current account had re in consumer spending, together with increased talk of
turned to surplus, as export shipments of automobiles import restrictions in many of Japan’s foreign markets,
and a few other items expanded sharply in response to the threatened to forestall any spilling-over of demand to
inventory buildup in the United States and elsewhere other export sectors and to blunt sales of those exports
while Japan’s import growth remained stagnant. More currently in strongest demand. Moreover, figures for the
over, Japan enjoyed sizable inflows of capital as short first quarter pointed to a renewed strong advance in out
term interest rates, though down from their mid-1975 put in Japan and a decline in inventories of imported ma
highs, were still well above comparable interest rates in terials, suggesting that Japan’s imports would soon expand
the United States. The resulting interest rate differentials as well.
favoring Japan stimulated large foreign purchases of Japa
This more skeptical outlook helped bring the market
nese government securities, not only on an uncovered for the Japanese yen into better balance after mid-April.
basis but also on a covered basis, since the forward yen Shortly thereafter, interest rates in the United States began
was frequently at a premium. Moreover, taking advantage to firm while rates in Japan eased. As the previously
of favorable market conditions, Japanese corporations favorable interest rate differentials narrowed and eroded
were active in borrowing in the European and New York incentives for foreigners to maintain their short-term
bond markets as well as through foreign-currency- investments in Japan, some of the earlier inflows were
denominated loans from Japanese branches of foreign reversed. During subsequent weeks, the Bank of Japan
banks. Conversions of these foreign borrowings gave an intervened nominally, and then only to counter a brief
additional lift to the yen in the exchanges.
flurry of demand for yen in early May. Otherwise, the rate
Coming into February 1976, therefore, the yen had eased back on its own, slipping 1 percent to around
advanced 1 percent from its December 1975 lows and it $0.003330 (¥300.3) by June 4. Later that month the
rose another 1 percent to $0.003333 (¥300) by mid Japanese authorities took the opportunity to announce an
month. In March the yen was again well bid, largely easing of some foreign exchange controls— covering travel
in response to uncertainties in the European currency allowances and outward payments—that had previously
markets. Meanwhile, a number of reports suggested that been tightened in response to the oil crisis, but this an
several overseas monetary authorities had increased their nouncement generated no immediate reaction in the
yen holdings. With these reports, market uncertainty over market.
the durability of existing exchange relationships in gen
In late June, press reports out of the Puerto Rico eco
eral stimulated demand for yen by both residents and non nomic summit suggested that officials of other countries
residents to cover future needs. By early April a scramble had raised questions concerning Japanese foreign ex
for yen developed, as Japanese banks and trading com change policy. Subsequently, following release of further
sumed its intervention and also announced a discount rate
increase of 1 percentage point to 8 percent, effective July
26. Subsequently, the Belgian franc was dragged up by the
rise of the German mark to trade by the month end at
$0.025527, close to its early-February level against the
dollar.
During the six months under review, the Federal Re
serve continued to make small frequent purchases of Bel
gian francs against swap commitments incurred prior to
August 1971. These acquisitions, totaling $177.3 million
equivalent, were used to repay a total of $170.5 million
equivalent of such commitments, reducing the outstanding
swap debt to $82.4 million, and to add to balances.
MONTHLY REVIEW, SEPTEMBER 1976
236
strong trade figures for May, the Japanese press carried
reports from a government source indicating a readiness
to accept a further appreciation of the yen. In this atmo
sphere, the yen was bid upward once again, reaching as
high as $0.003420 (¥292.4) toward mid-July, before
renewed intervention by the Bank of Japan and a prompt
denial of the press reports quieted the market. Thereafter,
in more subdued trading, the yen settled back somewhat
to $0.003412 (¥293.1) by the month end. At this level
the yen was, on balance, about 3 Vi percent higher than
early-February levels.
CANADIAN DOLLAR
In 1974-75, with Canada’s economic slowdown de
cidedly shallower than the recessions in other major indus
trial countries, domestic demand remained relatively
buoyant, serious inflationary pressures persisted, and the
current-account balance moved into deeper deficit. Dur
ing the second half of 1975, this deficit was more than
offset by an increasingly heavy volume of long-term for
eign borrowings, which totaled $3.2 billion. As economic
activity in Canada gained more momentum from the
pickup of activity in the United States, the Canadian
authorities moved to check cost-push pressures by intro
ducing a three-year anti-inflation program, which included
wage and price controls, and announced targets to
contain the growth in monetary aggregates. But the de
mand for credit remained strong, and Canadian inter
est rates did not follow the declines in other industrial
countries late in the year. In response to the lower
cost and greater availability of funds abroad, provincial
authorities, public utilities, and private enterprises in
creasingly tapped foreign markets early in 1976, raising
inflows to $3 billion for the first quarter alone.
Thus, while the market remained hesitant about the
longer term implications of the more rapid wage inflation
in Canada than in the United States, dealers expected
that inflows of long-term capital would cover by far tne
current-account deficit and provide a strong underpin
ning for the exchange rate in 1976. Consequently, the
Canadian dollar continued the steady advance that had
begun in August 1975. Buoyed by conversions of several
large new borrowings as well as occasionally heavy com
mercial demand for grain purchases, it was bid up to
$1.01 Vi by the end of February. The Bank of Canada,
which continued to intervene to moderate day-to-day
exchange rate movements, was on balance a buyer of
dollars, and official reserves increased during the first two
months by $551 million.
From early March through late May, by contrast, the
market for Canadian dollars was more nearly balanced.
Day-to-day movements in the spot rate were at times
quite large, as the market adjusted to the flow of con
tinuing conversions, announcements of yet more new
issues, or rumors of OPEC shifts into Canadian dollardenominated assets. In addition, dealers were sensitive to
signs of possible changes in interest rate differentials
between Canada and the United States that might alter
incentives to borrow abroad. In early March, in reaction
to a slight firming in United States money market rates,
the Canadian dollar eased before snapping back just a
couple of days later after the Bank of Canada raised its
discount rate from 9 percent to 9Vi percent. But, on
balance, by late May the Canadian dollar had gained only
fractionally to the $1.02 level, as part of the demand
arising from continued conversions of foreign borrowings
was increasingly taken out of dealers’ own positions.
In early June, however, market sentiment became de
cidedly more bullish toward the Canadian dollar. The
C h a rt X I
CAN AD A
M O V E M E N T S IN
EXCHANGE R A T E *
D o lla r s p e r C a n . d o l l a r
D o lla r s p e r C a n . d o l l a r
1 .0 4
1 .0 4
1 .02
1 .0 0
-
/
.9 8
.9 6
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i.
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i
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1975
fo o tn o te on C h a rt III.
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M
1976
l
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A
FEDERAL RESERVE BANK OF NEW YORK
domestic recovery seemed to be well under way and the
rate of price advance had abated to 6 percent under the
anti-inflation program. The Montreal Olympics was
expected to generate substantial tourist earnings. The
leveling-off of United States short-term interest rates was
seen as a positive factor for the Canadian dollar. And
then a renewed burst of reported foreign issues by Ca
nadian interests caught many dealers by surprise. Con
sequently, market participants began to bid progressively
more heavily for Canadian dollars, in part to cover the
new large-scale conversions expected during the sum
mer. By June 24 the spot Canadian dollar rate had been
propelled to a two-year high of $1.0388, with the Bank
of Canada on balance buying substantial amounts of dol
lars to moderate the rise.
By this time, the rise of the Canadian dollar had
attracted the attention of many more market participants
abroad. Professional position taking increased, exchange
rate movements for the Canadian dollar became more
volatile, and each swing in the rate triggered a larger
flurry of activity. In the face of these unsettled market
conditions, the Bank of Canada operated increasingly
forcibly on both sides of the market to maintain orderly
trading conditions until market activity slackened by early
July.
Subsequently, many market participants came to feel
that the Canadian dollar had risen to unrealistically high
levels. In addition, most of the conversions for the large
borrowings placed in July had already been covered, and
237
C h a rt X II
INTEREST RATES IN THE UNITED STATES, CAN ADA,
AND THE EURO-DOLLAR MARKET
T H R E E -M O N T H M A T U R I T IE S *
P e rc e n t
P e rc e n t
12
12
C a n a d ia n
10
f in a n c e p a p e r
_ __ M
— 10
—
8
_
A
8
E u r o - d o ll a r s
— ''
6
L o n d o n m a rk e t
C e r t if ic a t e s o f d e p o s i t o f
6
v,».
N e w Y o rk b a n k s
S e c o n d a ry m a rk e t
4
J
A
S
O
|
N
f
D
1975
J
I
F
M
I
A
I
M
I
J
I
4
J
A
1976
* W e e k ly a v e ra g e s o f d a ily rate s.
the calendar of upcoming issues indicated a reduced vol
ume of scheduled placements. Moreover, the eventual
turnaround in tourist receipts, following the end of the
Olympics, weighed on the market. Consequently, the Ca
nadian dollar drifted back in a tendency that began to
accelerate late in July as dealers started to cut back their
own positions. By the month end, the spot rate had de
clined to $1.02Vi, still some 3V2 percent above early1976 levels. Although the Bank of Canada was a net
seller of dollars in July, its net market operations contrib
uted to a $467 million increase in Canadian official re
serves since the beginning of the year.
238
MONTHLY REVIEW, SEPTEMBER 1976
Th e Business Situation
The growth of economic activity remained modest dur
ing the first months of the summer. In July, industrial
production registered only a small gain while both hous
ing starts and retail sales declined. Employment gains
were small in August, and the rate of joblessness increased
for the third successive month. At the same time, however,
evidence suggesting that the pause in activity would be
temporary continued to mount. Personal income posted a
large advance in July, which should help to stimulate
consumer spending, and the Department of Commerce
index of leading indicators advanced for the seventeenth
consecutive month. Residential building permits rose and
prospects for increased outlays for business fixed invest
ment improved, as new orders for nondefense capital
goods jumped sharply.
Although month-to-month price changes are volatile
and difficult to interpret at times, the overall performance
of most key indicators suggests that inflationary pressures
are gradually diminishing. Wage settlements remain high
but are generally decelerating and, when advances in
productivity are considered, cost pressures appear to have
moderated. In the consumer sector, favorable movements
in food prices have helped hold overall price increases to
about a 4 X
A percent annual rate over the first seven
months of this year. On the wholesale front, overall price
gains have been moderating. While price increases for in
dustrial commodities accelerated over the three-month
period ended in August, steel producers appear to have
dropped plans for further price hikes this fall. Prospects
of improved foreign production and record-size domestic
crops have been reflected in reduced spot food prices, and
wholesale food prices have continued downward.
July 1976 covering the first sixteen months of the eco
nomic recovery, industrial output climbed a healthy 12.6
percent at an annual rate. In more recent months, how
ever, the growth of production has slowed noticeably,
largely reflecting the ebbing in consumer demand and, to
a lesser extent, the rubber and coal strikes. The slowdown
appears to be broadly based among sectors. Output of
consumer goods, after rising at a 14.9 percent annual rate
from March 1975 to May 1976, remained unchanged
over the three-month period ended in July. This produc
tion adjustment coincided with the midsummer lull in con
sumer buying and with efforts by businessmen to keep
inventories lean. Production of business equipment has
increased only modestly in recent months, and the output
of intermediate products and materials has followed a
basically similar pattern. In July, strike activity retarded
coal mining and the production of motor vehicles and parts
was significantly reduced. The outlook for auto produc
tion, however, is good. In the second half of the year,
domestic auto manufacturers have programmed produc
tion at 4.2 million units, close to the record 1973 rate.
New orders received by durable goods manufacturers
fell in July, but the decline can be attributed to an excep
tionally large drop in defense-related capital goods orders.
Other sectors generally showed strength. The sharp drop
in defense orders appears to be related to the delayed
beginning of the 1977 fiscal year for the Federal Govern
ment. In previous years, the Department of Defense
placed a large number of orders at the end of the fiscal
year, which were registered in the July data. As a con
sequence, seasonally adjusted orders for July typically lie
well below unadjusted figures because seasonal adjustment
procedures are designed to eliminate the impact of reg
ular periodic movements. This July is unique, however,
PRODUCTION, ORDERS, INVENTORIES,
because
of the change in the Federal Government’s fiscal
AND LEADING INDICATORS
year. As part of the fiscal changeover, a transition quarter
Industrial production inched ahead a scant 0.2 percent has been instituted, effectively delaying the end of fiscal
in July, the smallest increase recorded since October 1976 until October. This has reduced the reliability of
1975. Over the period from March 1975 through the seasonal adjustment factors, especially in July, and
239
FEDERAL RESERVE BANK OF NEW YORK
increased the likelihood of a sharp spurt in seasonally
adjusted new orders for defense equipment occurring in
the fall.
The book value of manufacturing and trade inven
tories increased sharply in June, rising by $3.5 billion. To
at least some extent, it appears that the inventory buildup
was unintentional and reflected the impact of recent
slackening in the growth of consumer demand. Inventory
building continued in the manufacturing sector during
July, with nondurables accounting for most of the ac
cumulation. Nondurables shipments advanced in line with
inventories, however, and the inventory-shipments ratio
was little changed in that sector. The pattern differed in
durables manufacturing, where a marked drop in ship
ments combined with a modest $223 million increase in
inventories to cause a jump in the inventory-sales ratio.
Overall, the book value of manufacturing inventories in
creased nearly $870 million in July and shipments ad
vanced only slightly, resulting in a third consecutive
monthly increase in stocks relative to sales.
The Commerce Department index of leading indi
cators continued to signal underlying strength in July as
it advanced 0.5 percent, its seventeenth consecutive
monthly gain. Six of the eleven components of the index
available thus far showed improvement, including resi
dential building permits and contracts and orders for
new plant and equipment. Reflecting the weakness in con
sumer spending, manufacturers’ new orders for con
sumer products and materials appeared among the five
components of the index of leading indicators that moved
adversely. Though recent gains have been moderate, the
direction of movement in the indicators remains unmis
takable and serves to underscore the continuing momen
tum of the recovery.
C A P ITA L SPENDING AND CORPORATE
PROFITS
Prospects for a pickup in business spending on fixed
capital appear, on balance, to be brightening. To be sure,
in most industries, capacity constraints are not a concern
at this point but, because of the long delay between plan
ning and the eventual arrival of capital projects on stream,
businessmen appear to be looking ahead to production
requirements in 1977 and 1978. New orders for nonde
fense capital goods jumped by a record amount in July,
marking the seventh consecutive monthly gain (see Chart
I). Propelled by the large July increase, these orders have
risen 32 percent since the end of 1975. Because of the
lag between orders and shipments, this advance should
strengthen spending on producers’ durable equipment into
1977.
C h a rt I
NEW ORDERS FOR NONDEFENSE CAPITAL G O O D S
B illio n s o f d o lla r s
B illio n s o f d o lla r s
M ONTHLY GROW TH
!
RATE
■ ■ ■ I . . !
j.
.i.
J____ i
i
1.
i
i
_ L ......i
_ i ____
1975
Source:
i
i
1
i
I
!
1976
U n ite d S tate s D e p a rtm e n t o f C om m erce.
The most recent Commerce Department survey of
planned plant and equipment spending indicates a 7.4
percent increase in such outlays over 1976 as a whole.
While this represents little change in plans from the previ
ous survey conducted in the spring, second-quarter spend
ing fell short of expectations. Planned expenditures in
the second half of the year have been marked up, especially
in the fourth quarter. In a separate survey conducted by
The Conference Board, the nation’s 1,000 largest manu
facturers increased new appropriations for plant and
equipment 13.2 percent in the second quarter. Since ap
propriations are the first step in the investment process,
the advance recorded by the latest Conference Board
survey provides the basis for increased outlays over coming
quarters. Moreover, the gain would have been substantially
larger had it not been for a drop in appropriations by
petroleum companies. Oil companies have been reluctant
to expand capital outlays both because of concern over
slim profits and because of price controls on domestic
production.
Prospects for increased capital spending are also sup
ported by the turnabout of retained earnings available to
finance additional outlays that has occurred during the
recovery. Revised data indicate that nonfinancial cor
porate cash flow— the sum of capital consumption allow
240
MONTHLY REVIEW, SEPTEMBER 1976
ances and aftertax profits— rebounded 61 percent
since its cyclical low in the third quarter of 1974, while
business fixed investment gained only 4.6 percent over
the same period (see Chart II). The improved cash flow
situation, caused mainly by a strong surge in profits, both
increases the attractiveness of investment in new plant and
equipment and reduces firms’ dependence on outside
sources of finance. The impact of this turnabout on invest
ment spending was blunted in 1975 by the presence of
extensive spare capacity. Moreover, firms tended to adopt
the attractive alternative of debt retirement, thereby cre
ating improved balance-sheet positions. But now, with
debt burdens somewhat reduced and firms looking to
capacity requirements in 1977 and beyond, the availability
of ample internal funding will greatly facilitate needed
expansion.
Underlying in part the expected growth in fixed invest
ment outlays for the rest of 1976 are mandated expendi
tures for pollution abatement. These growing expen
ditures, amounting to more than 5 percent of total
business fixed investment, have served to shore up invest
ment spending during the recession and should contribute
some momentum on into 1977. Of course, this additional
expenditure normally does not increase productive ca
pacity.
PERSONAL INCOME AND CONSUMER DEMAND
Personal income posted a strong 1 percent increase in
July, the largest rise since October 1975. A major part
of the jump was due to higher social security payments
which resulted from a midyear cost-of-living increase of
6.4 percent. At the same time, wage and salary disburse
ments to workers in the private economy rose sharply.
This advance reflected gains in employment and higher
average hourly earnings. On the near horizon, Federal
Government employees’ wages and salaries may receive
a boost this fall from a proposed pay hike of nearly 5
percent.
The advance report of retail sales suggested an ebbing
in consumer demand through July. Retail sales declined
in that month and have been essentially flat since April.
After adjustment for the impact of higher prices, it ap
pears that consumers have actually retrenched in recent
months. Nevertheless, the latest surveys suggest that con
sumer confidence continues to improve, and the recent
rapid growth of personal income should provide some
impetus to consumer spending in the period ahead.
The overall outlook for residential construction re
mains clouded. While ample mortgage money is avail
able, borrowing costs have held at high levels. The
multifamily sector in particular is still substantially de
pressed. True, the prospects for multifamily building
appear to have improved, as rental vacancy rates remain
much below 1975 levels and the absorption rate of newly
completed apartments has risen, but profit margins con
tinue to be squeezed by higher maintenance, repair, and
construction costs. As a consequence, the incentive to
build is generally not strong. In contrast to the lack
luster multifamily sector, the recovery in single-family
housing starts has pushed to more than 1.1 million units
in recent months, considerably above levels that pre
vailed a year earlier. Single-family starts, however, have
leveled off at this plateau. This leveling may be due, in
part, to builder concern over relatively high stocks of
unsold homes. Merchant builders’ sales of new onefamily homes have moved erratically in recent months.
At the same time, inventories of unsold homes have been
edging up so that, at current sales rates, inventory stocks
represent about nine months of sales.
PRICES, WAGES, AND TH E LABOR M ARKET
The recent pattern of changes in consumer and whole
sale prices has been roughly in line with the experience
of the preceding two or three months. Consumer prices,
for example, advanced at a 5.6 percent annual rate in
FEDERAL RESERVE BANK OF NEW YORK
July, just a little below the 6 percent rise posted over the
three-month interval ended in June. Prices for food
climbed at only a 1.3 percent rate in July. On the other
hand, the prices charged for consumer fuel and power
jumped substantially. Leaving the volatile food and en
ergy components aside, consumer prices rose in July at a
6 percent rate.
Wholesale prices, seasonally adjusted, rose at a 2.6
percent annual pace over the three months ended in Au
gust. This relatively moderate increase was heavily influ
enced by large outright declines in the prices of farm
products and processed foods and feeds. Wholesale prices
of industrial commodities, normally less volatile than farmprices, climbed at a rate of 7.6 percent over the same
period, spurred by increases in metals prices and in
energy-related items. Though wholesale prices of crude
materials excluding foods and feeds jumped substantially
during June and July, in August this spurt cooled. Over
all, the evidence suggests that future price increases may
be close to recent experience. The National Association
of Purchasing Management reports that most purchasing
executives anticipate only moderate to slight increases in
the prices they pay. Given the promising agricultural out
look, it is likely that food prices will behave favorably
while energy prices may well move adversely.
Throughout the first half of 1976, the rise in private
nonfarm business-sector unit labor costs has been well
below the underlying trend rate of increase in consumer
prices and has thus exerted a moderating influence on the
overall rate of price increase. Unit labor costs rose at an
annual rate of 3.3 percent in the second quarter, close
241
to the 3.5 percent first-quarter pace. Though increases
in unit labor costs have been quite moderate, compensa
tion per hour worked advanced at a 9.1 percent annual
rate in the second quarter, down a bit from 9.5 percent
first-quarter gains. These substantial pay increases were
offset by brisk productivity gains, as output per hour
worked in the private nonfarm business sector advanced
at a 5.8 percent rate in the first quarter and this pace fell
off only slightly to 5.6 percent in the second three months
of the year.
The labor market situation was little changed in Au
gust. Reflecting the slowdown in the growth of real output,
total employment edged ahead at an annual pace of only
1 percent. Although labor force growth slowed after its
oversize July spurt, a sufficient number of new workers
entered the labor market to push the unemployment rate up
from 7.8 to 7.9 percent. Increased unemployment was
not evenly spread across labor market groups. Among
persons less than twenty-five years of age, there was a
substantial increase in the rate of unemployment, with
teenage unemployment— a volatile component— record
ing its largest rise since January 1975. On the other hand,
there was an encouraging August reduction in the rate
of joblessness among those aged twenty-five and over.
Still, even among these groups, there has been some slip
page, on balance, over the previous few months. More
over, the percentage of persons claiming extended unem
ployment of over fifteen weeks duration, which had fallen
from 3.2 percent of the labor force last winter to 2.1
percent this spring, has risen for three months and now
stands at 2.5 percent.
242
MONTHLY REVIEW, SEPTEMBER 1976
Th e Money and Bond Markets in August
Bond yields declined in August, extending the trend
begun in early June, while rates on money market instru
ments generally edged down following larger declines in
July. By the month end, interest rates on most bonds were
near and in some cases slightly below previous lows
for the year recorded in April. Contributing to the de
cline in bond yields were reduced concern over the re
kindling of very rapid inflation and expectations of con
tinued slackening in the pace of debt financing in the
Government and corporate markets. Treasury borrowing
needs for the near term were scaled down after the earlyAugust refunding raised more new cash than planned. In
addition, the corporate calendar was fairly light during the
month and announcements of forthcoming offerings were
very modest in comparison with the recent past. Most new
issues having somewhat lower yields than in recent months
were well received. Underwriting syndicates broke through
1976 lows with a few new corporate and municipal bond
issues, some of which encountered initial investor resis
tance.
Preliminary estimates of the narrowly defined money
stock (M x) and the more broadly defined money stock
(M2) indicate continued expansion at moderate rates.
With the absence of any strong turnaround in business
loan demand, banks continued to allow the volume of
large negotiable certificates of deposit (CDs) outstanding
to run off over the month. Consequently, the bank credit
proxy declined in August.
TH E MONEY M ARKET AND TH E
M O NETARY AGGREGATES
Interest rates on some money market instruments edged
downward in August, while rates on others remained es
sentially unchanged. At the July 20 meeting of the Federal
Open Market Committee (FOM C), it was agreed that the
Federal funds rate would be permitted to vary within a 4%
to 5% percent range until the next meeting on August
17. In fact, the effective rate on Federal funds remained
in a fairly narrow trading range in the intermeeting period
(see Chart I). For August the Federal funds rate aver
aged 5.29 percent, 2 basis points below the average of
the previous month. The rate on 90- to 119-day com
mercial paper held near the level recorded late in the
previous month and closed the period at 5.38 percent.
Rates on 90-day bankers’ acceptances fell about 7 basis
points over the month. Reflecting the shrinking supply of
CDs outstanding, rates on 90-day certificates in the sec
ondary market declined further during most of the month
and stood at 5.33 percent by the end of August. Subse
quent to a Va percentage point reduction effective at the
beginning of the month, the quoted rate commercial banks
charge prime business borrowers remained at 7 percent.
During August, Federal Reserve open market operations
continued to be shaped, in part, by fluctuations in Treasury
balances at the Federal Reserve Banks. The rise that usually
begins around the middle of the month was enlarged sub
stantially when the Treasury received the funds raised in
its quarterly financing. Buyers were required to pay for
the securities no later than August 16. As the amount of
funds raised was larger than originally planned and not
needed for expenditures until later, the Treasury kept
these deposits at the Federal Reserve Banks. To offset the
associated drain on commercial bank reserves, the Fed
eral Reserve engaged in large acquisitions of Treasury
securities in the final two weeks (see Table I).
Recovery in the demand for business loans has yet
to materialize. Commercial and industrial loans at all
weekly reporting banks, including loan sales to affiliates,
fell by $884 million over the four statement weeks
ended August 25. While business loans at weekly re
porting banks have dropped about $8.7 billion from their
level of fifty-two weeks earlier, most other major cate
gories of loans have increased over the same period. For
example, consumer instalment loans at weekly reporting
banks have risen 7.9 percent, or $2.7 billion over this
period, and real estate loans have gone up 4.3 percent,
or $2.6 billion.
243
FEDERAL RESERVE BANK OF NEW YORK
C h a rt I
SELECTED INTEREST RATES
J u n e -A u g u s t 19 76
BOND
2
9
16
23
30
June
N o te -.
7
14
21
28
J u ly
4
11
18
M ARKET
Y IE L D S
25
August
J u ly
A ugust
D a t a a r e s h o w n f o r b u s in e s s d a y s o n ly .
M O N E Y M A R K E T RATES Q U O T E D :
o f fe r in g
s ta n d a r d A a a - r a te d b o n d o f a t le a s t tw e n ty y e a r s ’ m a tu rity ; d a ily a v e r a g e s o f
P r im e c o m m e r c ia l lo a n r a te a t m o s t m a jo r b a n k s ;
r a t e s ( q u o te d in te rm s o f r a t e o f d is c o u n t ) o n 9 0 - to 1 1 9 - d a y p r im e c o m m e r c ia l
y ie ld s o n s e a s o n e d A a a - r a t e d c o r p o r a te b o n d s ; d a ily a v e r a g e s o f y ie ld s on
p a p e r q u o t e d b y t h r e e o f th e fiv e d e a le r s t h a t r e p o r t t h e i r r a te s , o r th e m id p o i n t o f
l o n g - te r m G o v e r n m e n t s e c u r it ie s ( b o n d s d u e o r c a l l a b l e in te n y e a r s o r m o re )
th e r a n g e q u o t e d i f n o c o n s e n s u s is a v a i l a b le ; th e e f f e c t iv e r a t e o n F e d e r a l fu n d s
a n d o n G o v e r n m e n t s e c u r it ie s d u e in th r e e to f i v e y e a r s , c o m p u te d o n th e b a s is
(th e r a te m o s t r e p r e s e n t a t iv e o f th e t r a n s a c t io n s e x e c u t e d ) ; c lo s in g b id r a te s ( q u o te d
in te r m s o f r a t e o f d is c o u n t) o n n e w e s t o u t s t a n d i n g t h r e e - m o n t h T r e a s u r y b ills .
o f c lo s in g b i d p r ic e s ; T h u r s d a y a v e r a g e s o f y i e l d s o n t w e n t y s e a s o n e d t w e n t y -
B O N D M A R K E T YIE LD S Q U O T E D :
Y ie ld s o n n e w A a a - r a t e d
p u b lic u t ilit y b o n d s a re b a s e d
o n p r ic e s a s k e d b y u n d e r w r i t i n g s y n d ic a te s , a d ju s t e d to m a k e th e m e q u i v a l e n t to a
Preliminary data indicate that in August
grew at
about the same moderate rate as in the previous month,
while expansion in M2 slowed a bit from that of July.
Over the four weeks ended August 25,
— private
demand deposits adjusted plus currency outside com
mercial banks— averaged 7.3 percent at a seasonally ad
justed annual rate above its average level in the four
statement weeks ended eight weeks earlier. At the July
meeting, the FOMC established a tolerance range of 4
to 8 percent for growth of
over the two months ended
with August. Tolerance ranges are short-run operating
guides for the intermeeting period. They are set at each
FOMC meeting and applied to the two-month period
ending the following month. During the four statement
y e a r t a x - e x e m p t b o n d s ( c a r r y in g M o o d y ’ s r a t in g s o f A a a , A a , A , a n d B a a ) .
S o u rc e s :
F e d e r a l R e s e rv e B a n k o f N e w Y o r k , B o a r d o f G o v e r n o r s o f th e F e d e r a l
R e s e rv e S y s te m , M o o d y ’ s In v e s to r s S e r v ic e , In c ., a n d T h e B o n d B u y e r .
weeks ended August 25, M2— M1 plus commercial bank
time and savings deposits other than large negotiable
CDs— averaged 11.1 percent at an annual rate above its
average during the four statement weeks ended eight
weeks earlier. The FOMC M2 tolerance range for the two
months ended August was IV2 percent to HV 2 percent.
Taking a longer perspective, over the 52-week period
ended with the four-week averages through August 25,
Mi expanded 4.5 percent while M2 rose 9.6 percent (see
Chart II).
Following a modest increase in the previous month,
the adjusted bank credit proxy— total member bank de
posits subject to reserve requirements plus certain non
deposit sources of funds— declined in August. The drop
MONTHLY REVIEW, SEPTEMBER 1976
244
in the proxy reflected a sharp fall in the volume of
CDs outstanding. Since their peak in January 1975, CDs
have declined in most months and, by the end of August,
were almost $28 billion below their peak level of around
$93 billion.
T ab le I
FA C T O R S T E N D I N G TO IN C R E A S E O R D E C R E A S E
M E M B E R B A N K R E S E R V E S , A U G U S T 1976
In m illions of dollars; ( + ) denotes increase
and ( —) decrease in excess reserves
Changes in daily averages—
week ended
Net
changes
Factors
August
4
August
11
August
IS
August
25
“ M a rk e t” factors
G2 +
660 — 461
Member bank required reserves . ..
-
Operating transactions (subtotal) .
-1,467
+2,301
Treasury operations* ......................
-1,402
+2,271
Gold and foreign account ............
38
+
Federal Reserve float ....................
+
50
+
358
—1,105 —4,474
+
260
— 637 —4,065
64 — 128
+
112
— 43(5 — 50!)
+
and capital ....................................
+
— 175
Total “ m arket” factors ...............
+2,961
Currency outside banks ................
33
Other Federal Reserve liabilities
351
—1,566
D ire c t F ed era l Reserve c re d it
tra n sa c tio n s
4-2,001
Open market operations (subtotal)
+2,665
+4,211
+
+1,286
Outright holdings:
Treasury securities ......................
—
Bankers’ acceptances ..................
_
407
550
10
15
—
886
16
Federal agency obligations ........
—
17
—
4
Repurchase agreements:
Treasury securities ......................
+2,107
—2,634
+1,576
+2,596
Bankers' acceptances ..................
-f
— 345
+
17*
+
252
Federal agency obligations ........
+ 44
—
75 +
46
+
98
—
34
—
18
Member bank borrowings
............
—
Seasonal borrowings! ..................
Other Federal Reserve assets?
—
Total ................................................
Excess reservest§
327
5 +
87
+ 1.H71
^
+ 2in
-3,442
+ 1,97,
+
..............................
+3,992
409
124
D a ily average levels
M em ber b a n k :
Total reserves, including vault cashf§ .
34.706
33,565
34,435
33,953
Required reserves ......................................
34,262
33,602
34,063
33,705
Excess reserves § ........................................
444
372
24S
Total borrowings ......................................
156
122
Seasonal borrowings-)- ..........................
22
34,55<>
Nonborrowed reserves ..............................
Net carry-over, excess or deficit (—
....
—
4
—
37
85
67
26
30
30
33,443
34,350
33,886
191 —
23
Note: Because of rounding, figures do not necessarily add to totals.
* Includes changes in Treasury currency and cash,
t Included in total member bank borrowings.
t Includes assets denominated in foreign currencies.
§ Adjusted to include waivers or penalties for reserve deficiencies in
accordance with the Regulation D change effective November 19, 1975.
|| Average for four weeks ended August 25, 1976.
HNot included in data above.
152
T H E G O VER N M EN T SECURITIES M A R K ET
Yields on Federal Government securities extended pre
vious declines during the course of August. The Trea
sury raised over $6 billion of new cash early in the month,
+ 495
when it replaced $4.5 billion of maturing issues with
—4,745
$2 billion of three-year notes auctioned August 3 at an
— 72
average yield of 6.91 percent, about $8 billion of 8 per
—3,833
cent ten-year notes sold August 4, and $1 billion of 25+ 10
year
bonds auctioned August 6 at an average yield of
— 987
8.01 percent. Available on a subscription basis in mini
mum denominations of $1,000, the ten-year notes were
substantially oversubscribed and the orders accepted by
-4,250
the Treasury exceeded its original plan to issue between
$4 billion and $6 billion of the notes. As a result, projec
tions of future Treasury borrowings were lowered
+5,309
accordingly. Financing needs of the Federal Government
remained
substantial, however, and an additional $3 bil
+1,206
lion was raised through note auctions during the month.
— 58
On August 19, $2.5 billion of two-year notes was sold
—
4
at an average return of 6.67 percent, 28 basis points
+3,645
below that of a similar offering the month before. These
+ 407
replaced $1.4 billion of maturing securities. An auction
+ 113
of four-year notes on August 31 raised $2 billion. The
— 92
average yield was 6.93 percent, down 78 basis points
+ 3 from a similar sale in early June.
— 721
With these operations accomplished smoothly and with
+4,496
the inflation outlook improving, rates on outstanding
+ 246
intermediate- and long-term issues continued the declines
begun in early June. By the end of the month, they were
M onthly
averages!!
only somewhat above the lows for the year recorded in
April. Treasury bill rates generally edged down during
the month. At the last regular weekly auction in August,
average issuing rates on the new three- and six-month
34,165
33,908
bills were 5.09 percent and 5.35 percent, respectively (see
257
Table II). These levels represented declines of 10 and 15
108
basis points from rates established at the final auction in
27
July. The yield on the 52-week bill auctioned on August
34,057
18 was about 25 basis points below that attained four
79
weeks earlier. Rates on most bills ended the month from
5 to 25 basis points below levels at the end of July.
Prices also continued to rise in the Federal agency mar
ket. Early in the month, the Federal Home Loan Banks
refinanced maturing securities through issuing $700 mil
lion of four-year bonds with a yield of 7.30 percent and
FEDERAL RESERVE BANK OF NEW YORK
$500 million of eight-year bonds with a yield of 7.85
percent. At the same time, $200 million of 8% percent
Federal Home Loan Mortgage Corporation-guaranteed
certificates with a thirty-year maturity was priced to yield
8.52 percent. These issues were well received. On August
18, $28 million of new cash was raised through sales of
$436.1 million of 5.65 percent six-month Banks for Co
operatives bonds and $770 million of 5.85 percent ninemonth Federal Intermediate Credit Bank bonds. The rates
on these two issues were down 15 and 25 basis points,
respectively, from similar issues sold a month earlier and
were the lowest since April. Also, at midmonth the Depart
ment of Housing and Urban Development placed $287.3
million of tax-exempt notes to finance urban renewal proj
ects at an average interest rate of 2.958 percent, down
almost 28 basis points from a similar sale in the previous
month. On August 25, the Federal National Mortgage
Association issued $800 million of 54-month debentures
at 7.35 percent and $400 million of ten-year debentures at
7.90 percent, raising $200 million of additional cash.
245
T ab le II
A V E R A G E IS S U I N G R A T E S
A T R E G U L A R T R E A S U R Y B IL L A U C T IO N S *
In percent
W eekly auction dates— August 1976
M aturity
August
2
August
9
Three-month ........................................
5.151
5.181
Six-month
5.473
5.422
............................................
August
23
August
30
5.143
5.138
5.091
5.390
5.380
5.351
August
16
M onthly auction dates— June-August 1976
Fifty-two weeks ..................................
June
23
Ju ly
21
August
IS
6.081
5.8S7
5.633
* Interest rates on bills are quoted in terms of a 360-day year, with the discounts
from par as the return on the face amount of the bills payable at maturity. Bond
yield equivalents, related to the amount actually invested, would be slightly higher.
OTHER SECURITIES M ARKETS
C h a r t II
GROW TH OF SELECTED MONEY STOCK MEASURES
S e a s o n a lly a d j u s t e d
N o te :
a n n u a l r a te s
G r o w th ra te s a r e c o m p u te d on th e b a s is o f fo u r -w e e k a v e r a g e s o f d a ily
fig u re s fo r p e r io d s e n d e d in th e s ta te m e n t w e e k p lo tte d , 13 w e e k s e a r lie r a n d
5 2 w e e k s e a r lie r. The la te s t s ta te m e n t w e e k p lo tte d is A u g u s t 25 , 1976.
M l = C u rre n c y p lu s a d ju s te d d e m a n d d e p o s its h e ld b y th e p u b lic .
M 2 = M l plu s c o m m e rc ia l b a n k tim e a n d s a v in g s d e p o s its h e ld b y th e p u b lic , less
n e g o tia b le c e rtific a te s o f d e p o s it is s u e d in d e n o m in a tio n s o f $1 0 0 ,0 0 0 o r m ore.
S o u rc e :
B o a rd o f G o v e rn o rs o f th e F e d e ra l R e s e rv e System .
Yields in the corporate bond market reacted to stable
money market rates, a light calendar of new financing,
and reports of slower economic expansion by extending
the decline begun in June. By the month end, returns on
outstanding issues were near lows for the year recorded
in April. Municipal bonds also benefited from the improved
tone of the debt markets generally.
New issue activity in the corporate sector was high
lighted during the month by a key offering of Aaa-rated
telephone debentures. The $175 million underwriting was
offered to investors at a yield of 8.25 percent for forty
years. This return was 43 basis points lower than a com
parably rated telephone issue offered two months earlier
and was the lowest on such an issue in two and one-half
years. The terms were widely regarded as a test of the
market’s ability to pass through the April trough in inter
est rates. Initially, investors evidenced little interest in
these terms and sales proceeded slowly, although the issue
was reported sold by the end of the month. Providing fur
ther evidence of market improvement over the month,
$70 million of an electric utility’s A-rated thirty-year first
mortgage bonds was successfully distributed at an 8.95
percent return, the lowest on a utility issue with this rating
since April. The decline in yields on corporate debt also
was exemplified in the $100 million sale of Baa-rated sevenyear notes by the finance subsidiary of an industrial cor
poration. The return on these notes was 9.55 percent, while
the same borrower had provided a 10 percent yield on
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MONTHLY REVIEW, SEPTEMBER 1976
five-year notes only two months earlier.
In the tax-exempt sector, a good reception was ac
corded Pennsylvania’s $130 million offering of A -l/A A rated (Moody’s/Standard & Poor’s) bonds priced to yield
between 3 percent in 1977 and 6.7 percent in 1995-96.
A similar issue by Pennsylvania sold in March at yields
ranging from 3.25 percent in 1976 to 7.05 percent in
1995. However, investors considered yields from 4.1 per
cent in 1981 to 5.4 percent in 1994 on a $150 million
Oregon issue unattractive. In some maturities, these A aa/
AA-rated bonds were down 20 basis points from a similar
offering by Oregon in April, when municipal yields reached
their previous lows for the year. The State of California’s
Aaa-rated bonds also sold slowly at prices scaled to yield
3 percent in 1977 to 5.5 percent in 1996, somewhat below
the rates on an earlier California financing in March. Late
in the month, however, underwriters easily distributed $ 111
million of Tennessee bonds rated A aa/A A and yielding
from 3 percent in 1977 to 5.7 percent in 1996. Reflecting
the rate declines over the month as a whole, The Bond
Buyer index of twenty bond yields on twenty-year taxexempt bonds stood at 6.52 percent on September 2, down
21 basis points from the end of July and the lowest level
for 1976. The Blue List of dealers’ advertised inventories
rose by $67.7 million to close the month at $824 million
on September 1.
A novel development in the capital markets during
August was a $367.2 million bond offering by the Na
tional Power Corporation, the government-owned public
utility of the Philippines. A relatively large issue for a
foreign governmental borrower in the United States,
it consisted of $160 million of serial bonds yielding from
8.05 percent in 1987 to 8.2 percent in 1989 and $207.2
million of 8*A percent sinking-fund bonds due in 1991.
The bonds, which were unrated, were the first public
offering in the United States to be guaranteed by the
United States Government through the Export-Import
Bank, which usually makes direct private loans. The
bonds were sold at rates somewhat above United States
Government agency securities of similar maturities.
@FedFRASER