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Reply #77: On FX intervention and the ECB/SMP [View All]

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Roland99 Donating Member (1000+ posts) Send PM | Profile | Ignore Wed Nov-30-11 09:48 AM
Response to Reply #28
77. On FX intervention and the ECB/SMP

I sat on FX interbank desks in the 70s and 80s when the NY Fed came into the FX markets on a regular basis in an effort to stabilize and steer the dollar. The Stick (what the Fed was called) was on both the sell and buy side at different times over those years. This was low-tech time. There was a direct telephone wire to the Fed desk. It would light up and they would ask for a price on $100mm USDDM (no Euros then). Dealers are obligated to make prices. You knew you were going to get slammed as soon as they said:

Done for a 100 mil. We can carry on at that price.

All hell would break out in the FX markets when the Fed intervened. I would get little sleep for a few days. After about a dozen of these sphincter event I formed my own opinions on how intervention should be conducted. Theres plenty of academic stuff on this too. The following are considerations when evaluating the efficacy of FX intervention. Some of the lessons apply to the dilemma the ECB finds itself in today.

When confronted with unstable markets where the instability is, by itself, undermining the broader economy, the first objective is to re-establish stability. There is only one way to do that in the short-term. The financial authorities must establish Two Way Risk back into the market. Ideally, the objective is to create as much risk in being long as the risk of being short.

The ECB has failed to establish two-way risk. Virtually every (Italian, etc) bond that has been sold over the last few months has been a good sale. There has been no risk to selling, the only risk has been in buying. If the ECB wants to be successful they must create a risk situation that is equally weighted. Call that shock and awe. It has to call the dealers and make them understand sphincter power. (As the Fed did to me.) In my day, the the term Dont fight the Fed came into being because the Fed had learned (after early failures) that it had to be on the offense when it came to intervention.

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