German Action Backfires

Just as it appeared that a semblance of calm was returning to markets over the last day or so, markets went into a tailspin in reaction to the announcement that the German regulators will temporarily ban naked short-selling of shares in 10 financial institutions, EUR government bonds and credit-default swaps based on these bonds. “Exceptional volatility”, “massive” short-selling and excessive price movements were cited as reasons for the ban. The action was reminiscent of a similar move by the US SEC in September 2008.

The action appears to have backfired, fuelling uncertainty over its impact, potential replication by other European countries, how and to whom it would apply as well as how it will be enforced. Once again a single eurozone country has enforced a unilateral measure in an uncoordinated fashion. It is unclear whether other eurozone countries will follow Germany’s actions but it is clear that the measure has led to a further bailout from European asset markets.

Aside from a reversal in equity markets, risk currencies will remain under pressure, with EUR/USD dropping to a low of 1.2163 following a tentative rally earlier. Options barriers on the way down could prevent a more rapid sell-off, with 1.2033 seen as the next support level. Pressure is likely to continue today and will likely spread through Asian markets and currencies. Clearly confidence is extremely low and unfortunately such measures are doing very little to change the growing negative sentiment towards Europe.

Even at current levels the risk of intervention on EUR/USD remains low. The pace of the move in EUR/USD and its volatility may be more important than even the level of the currency. In any case, at current levels EUR/USD is trading around “fair value” and a weaker EUR will be a boon to the European economy. Implied EUR/USD volatility is also not at a particularly high level, suggesting little concern by European officials about the level of the EUR.

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