Is Intervention a Signal of Future Monetary Policy? Evidence from the Federal Funds Futures Market
Sterilized foreign exchange market intervention may affect the exchange rate if it signals future monetary policy actions. Signalling will be effective if the central bank backs up intervention with predictable changes in the stance of monetary policy and, in turn, affects current expectations. We investigate whether intervention operations in the United States are related to changes in expectations over the stance of future monetary policy. Expected changes in policy are inferred from changes in second- and third-nearby Federal funds futures rates. We also test the signalling hypothesis using survey-based measures of expected short-term interest rate changes. Estimates obtained from a GARCH time-series model over the 1989-93 period do not support the signalling hypothesis: dollar-support intervention is not related to a rise in expected future short-term interest rates (monetary tightening). However, intervention significantly increases the conditional variance of Federal funds futures rates, suggesting that it adds considerable noise to the market.
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