The excitement of Facebook's IPO this morning overshadowed the market's ongoing concerns about Europe. The euro recovered all of its losses against the U.S. dollar overnight and is now higher against the greenback in anticipation of a positive open for US stocks. Most of the major currencies have enjoyed a nice intraday reversal even as their downtrends remain firmly intact. With Facebook setting up to be the largest US public offering, there is so much enthusiasm in the market that investors have completely overlooked Moody's decision to downgrade the ratings of 16 Spanish banks. The downgrades come at a terrible time for Europe and the euro and if not for Facebook's IPO, the EUR/USD would have probably broken below its 2012 low today. But instead any reason for optimism has brought relief to investors even as they realize that risk appetite could reverse if the G8 disappoints. With Spanish and Italian 10 year bond yields back above 6 percent, Europe desperately needs to take steps to stem the contagion but in our opinion, it would be wishful thinking to expect anything concrete from this weekend's G8 meeting. The U.S. and other non European members will seek reassurance from Eurozone nations that they will do more to stimulate growth but the best that we expect is a more conciliatory tone about introducing growth focused measures from German Chancellor Merkel. Facebook's IPO is cold comfort in an environment where Europe's political troubles continue to cripple the market and without additional support from the EU or ECB (which is unlikely), the euro and other high beta currencies could be in for more losses.
There are no U.S. economic reports on the calendar today but the sharp contraction in Philadelphia's manufacturing activity reinvigorated QE3 speculation. Up North, hotter inflation in Canada helped to lift the Canadian dollar. Consumer prices grew 0.4 percent in the month of April with core prices rising by the same amount. This brought the annualized pace of growth to 2.1 from 1.9 percent. With inflation back above their 2 percent target, we can understand why the Bank of Canada felt the need to prepare the market for possible tightening.
Solid job growth last month will only put more upside pressure on inflation and unfortunately the Canadian dollar has not provided any help. While the BoC is the only major central bank talking about monetary tightening, like many other high beta currencies, the Canadian dollar succumbed to risk aversion in recent weeks. The sell-off of the currency adds to inflation and increases pressure on the Bank of Canada to tighten.