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. Signaling 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, where expectations are proxied by federal funds futures rates. This relatively new futures market instrument has proved to be an efficient and unbiased predictor of the future spot federal funds rate. Estimates obtained from a GARCH time-series model over the 1989-93 period using daily data do not support the signaling hypothesis: dollar-support intervention is not related to a rise in expected future short-term interest rates (monetary tightening). However, intervention appears to significantly increase the conditional variance of federal funds futures rates, suggesting that it adds considerable noise to the marker and possibly increasing the degree of uncertainty over the future course of monetary policy.