European stocks are trading higher this morning and EUR/USD is trading comfortably, albeit choppily, above yesterday's lows but anxiety levels in the market remain elevated. The VIX is at its highest levels for a week, Libor is maintaining its uptrend and oil is holding around its lowest levels of the year.

The squeeze higher in the EUR/USD yesterday was significant insofar as a key technical level held. A move to EUR/USD1.2135 would mark a 50% retracement of the whole rally from 2000 and 2008. That said, the better tone of the EUR can likely be explained by short-covering. Some fear of intervention was in the market yesterday afternoon though it still unlikely that the ECB will follow through with action. ECB studies have in the past concluded that intervention can actually raise the degree of volatility in the market and ECB practice to date suggests that intervention is not a favoured policy tool. When German exporters were struggling last year under a strongly overvalued EUR, there was no attempt by the ECB to intervene in the market.

Overnight the EC's Juncker commented that there was no need for such action. That said ECB officials will be worried that market activity may become disorderly. Clearly the uncertainty injected by Germany's surprise decision yesterday to ban naked short selling may increase the degree to which speculators express positions in the fx markets. Not only that but insofar as it is now clear that Germany acted in complete isolation of its EU partners it is becoming more obvious that Chancellor Merkel is under intense pressure to win back the support of her electorate. Tomorrow, Germany's parliament will vote on whether to allow EUR123 bln of German taxpayers money to form the mainstay of the new EUR750 bln European Stability Fund. While Germany will have to pay in order to maintain the coherence of EMU, the reluctance of Germany to keep paying combined with the over-ambitious fiscal targets of the Greek government suggests that Greece still faces a managed default in the future. EMU is clearly still facing considerable uncertainties suggesting the selling pressure is likely to resume. A break of USD1.2135 would increase the likelihood that EUR/USD will move down towards its long-term average of USD1.18 and potentially below.

Raised anxiety levels in the market are consistent with broad based USD strength. Cable, like many USD crosses will struggle in this environment. The pound, however, has also weakened vs the EUR today, though some support was garnered from better UK retail sales data. Technically, the move back above the 21 day sma ends the downtrend which has evident since March. The move can be linked with fears that the new government may be forced to admit that the terrible fiscal position of the UK economy is even worse than expected. The degree to which the government tackles the fiscal deficit and the manner in which the population accepts austerity will be a crucial determinant of the value pound going forward. On the assumption that the government can make progress on fiscal repair, EUR/GBP is likely to move back to its 2009 lows at GBP0.8400, a move below this level could trigger a stronger recovery in the pound. That said expect sterling to remain nervous ahead of the June 22 budget.

Better than expected news on US oil inventories usually has the capacity to support the oil price. Yesterday, however, oil failed to find encouragement on the release of US inventory data. The fact remains that the oil market is amply supplied and fear that fiscal repairs will slow the global recovery is inevitably pressuring prices lower. OPEC currently favour oil prices in a $70 to $80 /b range, though a move towards $60 /b is likely in the months ahead given the high levels of supply. The pressure on commodities suggests that the AUD, CAD and the NZD will struggle vs the USD. USD/AUD is looking oversold and has managed to find support above the 0.8250 this morning, looking forward another leg lower in EUR/USD could prove a squeeze higher in AUD/EUR.

Worse than expected Japanese GDP data did nothing to lift the spirits of Asian equity markets overnight. The data did prompt Japan's Finance Minister to call on the BoJ to stop deflation. Another indication from the BoJ's policy meeting tomorrow that it may stimulate further should offset some of the safe haven demand for JPY. The USD/JPY 91.00 area continues to hold yen gains despite current market anxieties. US initial claims, Philly Fed and leading indicators are due. Canadian leading indicators will also be released.

Jane Foley Research Director FOREX.com jfoley@forex.com +44 207 398 5024