With no major U.S. economic data on the calendar today, currency traders are licking their wounds. All of the major currencies that have fallen steeply in recent days are trading higher, led by the gains in the AUD/USD and NZD/USD. The EUR/USD, which has enjoyed a nice rally since May, is also trading lower despite the rise in Eurozone Industrial production. Although today’s retracement is modest in relation to the broader swings experienced by these currencies over the past month, there’s more to these moves than a technical recovery.

While G10 central banks are sitting on the sidelines watching the volatility in the currency, equity and bond markets, central banks in emerging market economies have sprung into action. Indonesia raised interest rates by 25bp to boost the rupiah, which dropped almost 5% in the past 12 months. Poland decided to intervene directly in the currency market to drive the Zloty lower against the EUR for the first time in 2 years and the Turkish central bank introduced a series of liquidity tightening measures to calm the volatility. They held five $50 million forex-selling auctions and threated to intervene directly in the foreign exchange market. These central banks finally realized that they can’t just sit around and wait for the larger players to take action – they have to take their fate into their own hands and control volatility in their local markets.

For the time being, these defensive policy measures have halted the deleveraging in the FX and equity markets but more aggressive action or comments from G10 central banks are needed for these currencies to bottom. This means that for the EUR/USD, today’s move could prove to be a temporary pullback and for USD/JPY and the AUD/USD, a short lived recovery.

NZD in Play

The best performing currency this morning is the New Zealand dollar, which is up 1.4%. The Reserve of New Zealand meets tonight and what they say about currency intervention should determine whether the NZD gives up these gains or extends its recovery. While the NZD/USD has been in a relentless downtrend, the central bank’s focus is on their currency’s value against the AUD – and they have haven’t been happy with the move. According to data released in late May, the Reserve Bank conducted its largest intervention to weaken the NZD in April since May 2008. Central Bank Governor Wheeler even took the unusual step of confirming the intervention. Unfortunately there’s been very relief in the exchange rate since we last heard from the central bank and if they harden their warning on currency intervention, the NZD could resume its slide. If they don’t mention intervention in this afternoon’s, the currency could find itself trading firmly above 80 cents.

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