The “risk off” trade received an almighty boost yesterday evening from a wholly unexpected quarter, when the German authorities caught the market completely on the hop, when it announced its intention to ban naked short-selling in the CDS market.

It has introduced a temporary ban on naked short selling and naked credit-default swaps of euro-area government bonds starting at midnight last night.

The ban will also apply to naked short selling in shares of 10 banks and insurers that will last until March 31, 2011.

It mimics the same mechanism that was used by UK and US authorities’ to little effect, to try and prop up the equity markets in 2008 in the wake of the Lehman crisis.

If anything, the bans in 2008 exacerbated market declines and volatility, as investors took fright and bailed out of the whole sector and the Germans run the risk of causing the same mayhem.

The ban is even more curious with respect to the shares of the financial institutions involved, given that their share prices have been relatively orderly over the past few days and weeks. It creates a lot of uncertainty as to the reasons why they have decided to act now, and why these particular shares?

In taking this action the German authorities could end up causing the very market crisis of confidence they are seeking to prevent, by what could be construed, as somewhat hasty and ill-conceived actions.

As it is the Euro made fresh 4 year lows on this move, and yesterday’s news that the US Senate blocked by 94 votes to zero the use of US taxpayer’s money to fund the IMF portion of the European bail-out plan, will not have helped the credibility of the EU bail-out package agreed over a week ago either.

Also see Euro-Dollar Spreads .

On the sterling front yesterday’s worse than expected inflation figures should throw an interesting light on the release of last weeks Bank of England minutes today and the committee’s take on the decision to leave rates unchanged.

The release of the FOMC meeting minutes later on in the day, should also shed light on any further dissent within the Fed with respect to the tone of the statement, and the “extended period” phrase. Will additional members of the committee join Kansas Fed President Thomas Hoenig in the dissenters’ corner? If they do the Euro could fall even further.

EURUSD – last nights decision by the German authorities cut the legs from underneath the single currency, as it looks set to hit its long term target of $1.2135, which is the 50% retracement of $0.8230/$1.6040 up move.

Yesterday’s rally stopped short of the resistance around $1.2450/60, and while below this level further downside pressure will likely continue to build up and send the Euro towards $1.1700 on a break and close below $1.2130/35. A break above $1.2450/60 could well target $1.2750.

GBPUSD – the pound has been caught in the backwash of the short selling ban as investors pile into safe haven dollar buying.

Having been unable to break above the £1.4500/20 area yesterday on the high inflation numbers the pound slipped back. A break of the 13 months lows around £1.4240/50 would open up the next support around £1.4110 which is the 30th March 2009 lows on the way to a test of £1.4000.

£1.4000 remains a key support on a monthly close.

EURGBP – currently trading in a broad triangular range between £0.8500 and £0.8600, a break of £0.8500 should target the lows around £0.8400, and then a break lower towards £0.8250.

USDJPY – continued risk aversion has continued to favour the yen and we have seen the currency drop towards the ¥91.60 lows of 19th April. Any rallies should find resistance around ¥92.70 and ¥93.50/60, while a break of ¥91.60 targets the 91.20 area.

FX commentary from Michael Hewson, Analyst, CMC Markets.

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