Geopolitical Noise and Market Resilience

May concluded with a more constructive market backdrop than geopolitical noise would suggest at first glance. In the United States, the S&P 500 rose 5.15% over the month and the Nasdaq gained 8.36%, both supported by a combination of robust corporate earnings, persistent enthusiasm surrounding artificial intelligence, and some anticipation of relief on the trade and geopolitical fronts. In Europe, the STOXX 600 fully recovered the losses accumulated since the onset of the Middle East conflict and approached its all-time high—a sign that investors remain willing to look past immediate shocks as long as nominal growth and earnings remain reasonably resilient. Nevertheless, the month was far from linear: rising yields, oil volatility, and conflicting headlines regarding a potential understanding with Iran reminded investors that the market remains highly sensitive to shifts in the inflation-growth trade-off.

In the US, the macroeconomic backdrop remains mixed but falls short of pointing toward an abrupt deterioration. The labor market revealed greater-than-expected robustness in its latest release: 172,000 non-farm payrolls were added in May, while April’s figure was revised upward to 179,000, and the unemployment rate held steady at 4.3% for the third consecutive month. This framework points to a deceleration from past peaks, rather than a breakdown in employment. Concurrently, manufacturing activity surprised to the upside, with the ISM Manufacturing index rising to 54.0 in May—its highest level in four years—strongly propelled by front-loaded orders, inventory rebuilding, and demand linked to technology capital expenditures.

On the inflation front, May data confirmed a distinct acceleration in headline inflation, though the core component presented a less alarming reading than the aggregate figure suggested. Headline CPI rose 0.5% MoM and accelerated to 4.2% YoY, up from 3.8% in April, driven primarily by energy: the energy index advanced 3.9% over the month and 23.5% against the previous year, with gasoline surging 7.0% in May and 40.5% YoY. Conversely, CPI excluding food and energy increased by just 0.2% MoM and 2.9% YoY, indicating that, for now, the energy shock has not translated into a generalized acceleration of underlying prices. In parallel, the goods trade deficit narrowed in April, supported by stronger exports. The pivotal element for the Federal Reserve remains the fact that headline inflation has once again drifted away from its target, even if the core component offers some relative comfort—thereby reducing the scope for near-term monetary easing.

In the Eurozone, the framework is more fragile in terms of growth, accompanied by a relatively more subdued market performance. Headline inflation stood at 3.0% YoY in April, up from 2.6% in March, primarily reflecting the energy shock. In May, consumer confidence improved but remained in contractionary territory, and activity indicators continue to point to an economy with a narrow margin of safety: the Eurozone Manufacturing PMI slipped to 51.6, still in expansion but characterized by weak new orders and intense cost pressures. The European Commission revised down its growth outlook for 2026, now projecting just 0.9% growth and 3.0% inflation, precisely because soaring energy costs have once again weighed on real income, margins, and demand.

Against this backdrop, the ECB faced a challenging dilemma in June: inflation has reaccelerated, but growth remains too anemic to support an aggressive monetary tightening cycle. The June meeting confirmed the 25-basis-point hike already discounted by the market, bringing the deposit facility rate to 2.25%. The ECB maintained a vigilant, data-dependent stance regarding subsequent steps, without committing to a pre-defined path.

The fixed-income market was arguably the most accurate mirror of this macroeconomic tension. In May, sovereign yields fluctuated as investors assessed whether the energy shock would prove transitory or persistent enough to prompt the Fed and the ECB to maintain—or even reinforce—their hawkish bias. The yield on the 10-year US Treasury note hovered around 4.6%, marking its highest level in over a year at several points during the month, while the G7 10-year yield average approached 4%. The transmission mechanism is direct: more expensive oil, supply chains under pressure, and more deeply entrenched inflation elevate term premiums and reduce the leeway for rate cuts. The May inflation reading reinforces this asymmetry, given that the acceleration in headline CPI makes it politically and economically more difficult for the Fed to signal swift cuts, even though the more benign behavior of the core component prevents, for the time being, an aggressive repricing toward further rate hikes. Conversely, any credible progress in negotiations with Iran would unlock rapid relief across yield curves.

In terms of the medium-term outlook, the baseline scenario remains one of positive yet slower growth, with inflation running above target and markets still supported by earnings and liquidity—albeit with increased vulnerability stemming from energy, international trade, and the cost of capital. May illustrated this dynamic with precision: the favorable narrative has not vanished, but it has become conspicuously more dependent on geopolitical developments, the capacity to contain the energy shock’s pass-through into core inflation, and the behavior of long-duration yields.