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Currency intervention: Here's how the U.S. could move to weaken the dollar

Section: Daily Dispatches

By William Watts, New York
Wednesday, July 17, 2019

Currency traders are contemplating the "I" word.

While still seen as a longshot -- Goldman Sachs described it last week as a "low but rising risk" -- a growing number of analysts are warning that President Donald Trump's longstanding frustration with the U.S. dollar's relative strength versus major rivals could eventually lead to U.S. government to intervene in the currency market in an effort to weaken the greenback.

... Dispatch continues below ...


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Last week, Bloomberg News reported that Trump has asked aides to look for ways to weaken the dollar and asked about the currency in job interviews with the candidates he's selected for seats on the Federal Reserve's board.

Here's a guide to how intervention works and what it would mean for the market.

... What is intervention?

Intervention occurs when a central bank buys or sells its own currency in an effort to influence the exchange rate.

A government might take action to halt a precipitous slide or a sharp runup in its currency following a shock. It could also act in concert with or on behalf of other countries in an effort to stabilize a particular currency. In fact, the last time the U.S. intervened in the currency market was in March 2011, as part of a coordinated effort by the Group of Seven nations to arrest a surge in the Japanese yen following a devastating earthquake and tsunami.

Utilizing their massive reserves, central banks can get their way, at least in the short term. A credible threat -- explicit or implied -- to intervene around a certain level can often hold sway, particularly if underlying fundamentals and other factors stand in the central bank's favor.

But even central banks can be overwhelmed by the market if fundamentals are out of line with goals. The Bank of England pulled out all the stops on “Black Wednesday” in 1992 in a futile effort to keep the British pound trading within the bands set by the European exchange rate mechanism, wasting billions of pounds of reserves.

... Why is intervention so rare?

Intervention is hardly novel. In fact, as the Goldman Sachs chart below illustrates, until around the mid-1990s, it was relatively common for the U.S. and other major developed countries to wade into markets in an effort to signal a desired exchange rate.

But unilateral intervention has long been out of favor, with the U.S. and other members of the Group of 20 in June reaffirming a previous commitment to refrain from competitive devaluations and to not target exchange rates for competitive purposes.

... How is it conducted?

According to the New York Fed, the foreign currencies used to intervene by the U.S. usually come equally from Federal Reserve holdings and the Treasury's Exchange Stabilization Fund. Those holding consist of euros and Japanese yen.

The New York Fed's trading desk does the buying and selling, often dealing simultaneously with several large interbank dealers in the spot market. The New York Fed, in a 2007 note, observed that it historically hasn't engaged in the forward market or other derivative transactions.

The process is also meant to be transparent, the New York Fed says, with the U.S. Treasury secretary typically confirming the move while the Fed is conducting the operation or shortly thereafter. After all, authorities are attempting to send market participants a message, so there's little incentive for them to cover their tracks.

... Who makes the call?

While the Fed is responsible for executing any FX intervention, dollar policy is traditionally the purview of the Treasury Department. The Treasury's foreign-exchange decisions, however, have typically been taken in consultation with the Federal Reserve System.

There's much speculation around whether the Fed would go along with a unilateral intervention effort. Powell, in congressional testimony last week, repeated that the Treasury Department is responsible for exchange rate policy. Goldman Sachs strategist Michael Cahill, noting the remark, said it seems likely the Fed “would probably defer to the Treasury and go along even if it does not agree.”

If the Fed were to stick to the sidelines, it would cast the effectiveness of any intervention effort into doubt, analysts said. The Treasury's Exchange Stabilization Fund has around just $22 billion in U.S. dollar -- and another $51 billion in IMF Special Drawing Rights, or SDRs, that could be converted -- that it could tap, The Fed can use its balance sheet, giving it vastly more firepower though the Treasury and the central bank typically would go 50/50 in any intervention efforts.

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