The foreign exchange markets are revered for their volatility, the multitude of factors that drive prices bring opportunities (and potential losses) for traders. Though there are many contributing reasons to price action, FX is like the majority of financial assets, the price is derived from the supply and demand. Each currency is traded as a value of another, with the most liquid cross being against the greenback (USD).
The movement and exchange of currencies facilitates international trade and investment through converting currencies. Currencies are freely traded but the market is fragmented, as there isn’t a single place of exchange, price is discovered via bank dealers or exchanges such EBS (the minority of currencies are pegged or trading is restricted CNY, INR, BRL).
On Wednesday Ewald Nowotny (ECB) said that “Central banks shouldn't intervene in foreign exchange markets”
Emerging markets (EMFX)
Since investors began to second guess the tapering of the US Federal Reserve bond-buying programme, emerging market currencies have felt the wrath of traders. Currencies such as the Turkish Lira (TRY) and the Indian Rupee have hit the headlines as they have traded at all-time lows. The sell-off has been rapid with analysts split on how much further these currencies can move. Without intervention the currencies would be expected to pullback slightly as investor’s book profits. Though this dead cat bounce usually catches many retail traders unaware and the weakening can restart as the institutional traders sell.
Important to note that the market expectation is for the Federal Reserve to signal the tapering of its bond-buying programme at the Septemeber meeting.
The Indian Central bank (RBI) intervened in the market today, leading to the INR to surge 3.4% the biggest one day gain since 1986. However is this sustainable? The country’s economic growth has slowed and is struggling with inflation. The intervention will have impact the short term price action, though without the credibility or the funds, the larger trend could remain intact.
The Turkish Lira collapsed even further on Tuesday when the Central Bank governor didn’t signal a change in interest rates that had been expected. The governor Mr. Basci is reportedly under pressure to hold interest rates low, to enable growth, but this move is hurting the nation’s currency. The other factor of a political unrest and a civil war in neighbouring Syria are weighing on the currency.
Some brokers and exchanges have hiked their margins for the currencies effected by the volatility TRY,INR etc.
(Please note at current Abshire-Smith hasn’t changed any margin requirements for its products due to the recent volatility)
How can central bankers or policy makers intervene in the markets?
Over the long term monetary policy is used with varying remits depending on the country and currency. This involves interest rates, overnight lending rates, capital requirements, currency pegging, as the CB aims to meet their remit.
E.g. The Swiss National Bank (SNB) intervened in the FX markets to weaken the currency to stem the overvaluation of the CHF. This happened back in September 2011 and had be rumoured for some time, the SNB committed to buy unlimited FX to peg the EURCHF exchange rate at 1.20.
In the short term intervention could be through buying and selling in the FX markets to direct price action, it can also be verbal, though this does require credibility.