Coronavirus places a renewed strain on the European Union   

David Joy – Chief Market Strategist, Ameriprise Financial
Weekly markets commentary — June 1, 2020

Stocks enjoyed another week of solid gains as the S&P 500® index climbed 3.0 percent for the second straight week. The move took the index to a new recovery closing high at 3044. It has now risen 36 percent from its March low and sits just 5.7 percent lower on the year. Volatility as measured by the VIX index continues to subside. The VIX ended last week at 27.5, its lowest weekly close since February 21. Credit spreads continued to narrow as well. 

The ICE High Yield index spread contracted 35 basis points last week to 671, the tightest weekly spread since March 6, and well down from the March 20 wide of 1,009 basis points. The ten-year Treasury note was virtually unchanged last week, ending at a yield of 0.65 percent, lower by one basis point from the prior week, and continuing the range-bound trend of 0.60-0.70 percent that extends back to mid-April. 

The European Union contemplates a coronavirus recovery fund 

The move higher in equities over the past two weeks has been even stronger in the Eurozone. The EuroStoxx 50 index rose 5.0 percent last week, after a similar move the week prior. In addition, the common currency has risen almost 3.0 percent versus the dollar, bringing the total two-week index return to 13 percent for dollar-based investors. These gains follow a proposal two weeks ago by France and Germany to create a 500-billion-euro coronavirus recovery fund intended to support less wealthy countries in the south in the form of grants, with the cost borne by the entire European Union (EU). Last week, the European Commission made its own proposal for a debt financed 750-billion-euro fund for the same purpose, two-thirds in the form of grants and one-third loans, all to be paid for by a range of new system-wide taxes. It remains to be seen if such a proposal can actually find its way into law. 

Historically, there has been strong opposition to such fiscal integration among wealthier northern member-states. But the chances of agreement this time may have been improved by the economic burden of the coronavirus that places renewed strain on the fabric of the union. Nevertheless, approval must be unanimous among the 27 member-states, making agreement difficult. The debate will coincide with budget negotiations for the next seven-year EU budget, which is to take effect at the start of next year. 

Eurozone equities trail U.S. counterparts 

Despite the sharp equity gains of the past two weeks, eurozone equities still lag their U.S. counterparts. In euro terms, the EuroStoxx 50 index has risen 29 percent from its March 18 low and remains lower on the year by 18 percent. And the euro remains fractionally lower versus the dollar year-to-date. Peripheral bond markets have responded favorably to the fiscal proposals. The yield on Italy’s ten-year bond has fallen 39 basis points to 1.47 percent in the past two weeks. Spanish bonds have seen a 19-basis point decline to 0.56 percent. In contrast, German yields have risen 12 basis points to -0.42 percent. Bond markets have also been supported by the European Central Bank’s 750 billion euro expanded bond buying program, announce back in March. The ECB meets this week amid speculation that it may announce an increase in the size of that program, which is forecast to be exhausted by October. The central bank will also update its economic projections for the Eurozone. Last week, bank president Lagarde said the currency bloc would decline by between 8-12 percent this year. 

Investors await this week’s May Employment Report 

The May jobs report headlines this week’s economic calendar. The unemployment rate is expected to rise to 20 percent, with 8 million jobs lost. Also scheduled this week are the ISM manufacturing and service sector PMIs.