Markets are currently optimistic and driving higher, despite the fact that economic recovery is expected to be slow and fragmented. In the US, the S&P 500 rose a further 4.5% in May, bringing total gains since the market bottomed out in late March to more than 36%. The expectation is that, despite the economic damage brought about by COVID-19, the monetary and fiscal policy stimulus will be sufficient in magnitude to ensure that the recovery will be quick, robust and sustainable.
This optimism also spilled over into broader assets, with oil prices staging a remarkable recovery over the month. West Texas Intermediate Cushing oil spot prices rose more than 88% in May, after the futures prices - for the first time on record - briefly dipped into negative territory in April. In addition, further supply cuts by OPEC+ were announced. This helped the commodity’s supply-demand outlook to improve significantly.
For the first time since the height of the coronavirus crisis, cracks appeared in the US dollar trajectory, as it lost some steam in late May. The US Dollar Index lost 2% during the latter part of the month. Part of this greenback weakness relates to the establishment of a €750 billion eurozone recovery fund.
The significance of this move should not be underestimated. Apart from providing much-needed stimulus, it also heralds the first time that the eurozone will be able to raise debt under a collective European Union (EU) banner. Previously, debt was raised at a sovereign level, which then contributed to the collective EU. Now, subject to ratification, this announcement opens the way for greater EU cooperation and fiscal integration.
The euro rebounded strongly on the news, while previous concerns around the EU’s ability to stimulate the region’s economies disappeared rapidly. However, it does still remain to be seen whether this arrangement will be politically viable, given the pressing nature of the needed stimulus.
After having strengthened in April, the Japanese yen also gave up some ground against a stronger euro. The currency lost more than 4.5% from its highest level in early May.
Emerging markets, while benefitting from capital flows on the back of a risk-on sentiment, remain in a vulnerable space. Latin America is only now beginning to see the full effects of an upwards trajectory in COVID-19 infections. Fragmented policy responses and fragile healthcare systems are at the heart of most emerging markets’ COVID-related problems, a situation which is expected to worsen. Emerging market currencies and bond yields recovered from their worst levels during May, but if their healthcare systems become overloaded over the course of the next few months then currency weaknesses may return.
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