The week ahead, w/c 11 June

Chris Scicluna

Following on from modest gains on Wall Street on Friday – the S&P500 rose 0.3%M/M – Asian equity markets have made a relatively quiet but still mostly positive start to the new week. While maintaining concerns about trade-war risks and raising existential questions about the future of the grouping, headlines from the poisonous G-7 leaders meeting arguably provided little surprise and investors are now awaiting tomorrow’s historic meeting of Donald Trump and Kim Jong-un in Singapore, together with the important central bank meetings (and some top-tier economic data) to come later this week in the US, Europe and Japan. In the latter, a much stronger-than-expected April machinery orders report provided some cause for optimism today and helped the Topix to a 0.3% gain while South Korea’s Kospi rose 0.75% ahead of tomorrow’s summit.

More notable, perhaps, is the recovery in risk appetite in Europe this morning, with BTPs rallying – 2Y yields are currently down about 60bps to 1.10% and 10Y yields are down more than 25bps to about 2.85% - following the weekend’s first published interview of Italian Finance Minister Tria, in which he insisted that leaving the euro is not under discussion within the government, downplayed the notion that the government might issue ‘mini-BoTs’ as a parallel currency, and paid lip-service to the need for a sustainable pension system and the target of reducing the debt stock as a share of GDP. Quite how that can all be squared with the M5S-League published programme for government, however, is another matter altogether.  

The main focus in Japan today was on the machinery orders report for April. Following a weak March outturn, the latest month’s reading was very encouraging – a result that had in fact been signalled by last month’s survey of firms, but which markets had understandably discounted as being perhaps a bit too optimistic. Total machinery orders rose 12.6%M/M in April, more than reversing the 7.9%M/M decline reported in March, and so were up 9.7%Y/Y. Importantly, core private orders – which exclude ships and other volatile categories – increased 10.1%M/M and were up 9.6%Y/Y. Within the detail, orders by manufacturers rebounded 22.7%M/M after a surprisingly large 17.5%M/M slump in March and so were up a very sturdy 23.5%Y/Y. Core orders in the non-manufacturing sector edged up 0.4%M/M and are now down just 1.1%Y/Y. Foreign orders rose 10.0%M/M following declines of about 7%M/M over each of the previous two months. Meanwhile, public sector orders rose 6.2%M/M and were up 3.4%Y/Y.

This strong outcome took the level of core orders in April 8.0% above the average monthly level reported in Q1. The Cabinet Office’s latest survey of firms, released last month, had indicated that firms expected core orders to rise by a substantial 7.1%Q/Q in Q2. On the face of it, today’s report suggests that orders are on track to post an outcome that is in the vicinity of that forecast, even though it would not be surprising to see some negative payback in the May report. Certainly, recent PMI readings and last Friday’s Economy Watchers survey suggest that sentiment weakened in May. Tomorrow’s MoF/Cabinet Office Business Outlook Survey will cast some further light on how firms are viewing the business environment. With the economy operating at high rate of capacity utilisation, including an exceptionally tight labour market, the environment remains conducive to a continued uptrend in business capex provided that overall demand conditions in the global economy remain favourable.

The main Japanese event this week will, of course, be Friday’s conclusion of the BoJ’s latest Board meeting. While the growth and inflation picture certainly appears weaker than the BoJ presented in its Outlook Report published following the Board’s last meeting in April, a policy change seems very unlikely. And, while downside risks will be acknowledged, the BoJ will most likely maintain its constructive baseline outlook. The post-meeting statement and Kuroda’s press conference will nevertheless be scrutinized for any signs that the BoJ’s confidence in the appropriateness of current policy settings has been eroded. And, at the very least, external member Kataoka will doubtless again call for additional easing. Meanwhile, after the amount of purchases of JGBs of 5-to-10-year maturities was cut on 1 June, we suspect that the BoJ’s JGB purchase target (officially still an annual increase of about ¥80trn in its holdings, while the actual rate at end-May was less than ¥50trn) and strategy will again come under scrutiny.

Among other data releases this week, the Tertiary Industry Activity Index for April and the goods PPI for May will be released tomorrow along with the aforementioned MoF/Cabinet Office survey. On Thursday, the final IP report for April will be released. In the latter part of the week we will also be keeping an eye out for the appearance of the Cabinet Office Synthetic Consumption Index for April. In the bond market, the MoF will auction enhanced liquidity (maturities of 5 to 15.5 years) tomorrow.

Euro area:
Market-moving Italian political developments aside, the main event of the coming week in the euro area will, of course, be the conclusion of the ECB’s Governing Council meeting on Thursday. We already know, from Chief Economist Peter Praet’s speech on Wednesday, that the policymakers will discuss issues related to the future of the QE programme. And we suspect that the rest of the Governing Council will agree with Praet’s assessment that a sustained adjustment in the path of inflation towards target is within reach “to warrant a gradual unwinding of [the ECB’s] net purchases”. But the ECB will not be complacent about recent soft economic data, which suggest that downside risks to the economic outlook have increased, while bond markets – in particular BTPs – remain volatile. So, we also expect a final agreement and announcement of its plans of how it intends to bring those purchases to an end to be postponed to the July meeting. Our baseline scenario, of a gradual tapering of net asset purchases over the course of Q4 to zero by end-December – perhaps amounting to a total of about EUR30bn over the quarter – remains in place. 

The ECB’s updated economic forecasts, also to be unveiled on Thursday, will in due course be used to justify the winding up of the net asset purchase programme. Admittedly, the weakening of the dataflow justifies a downwards revision to its GDP forecast for this year. But perhaps that will merely be nudged lower by just 0.1ppt to 2.3%Y/Y, thus reversing the upwards revision made in March. And we think the ECB might still wish to leave its growth forecasts for 2019 and 2020 unchanged at 1.9%Y/Y and 1.7%Y/Y. Moreover, we suspect that the headline inflation forecast for this year and next might be shifted slightly higher, by 0.1ppt to 1.5%Y/Y in both years. That, however, will partly reflect the impact of the higher oil price, for which the assumed average price this year will be pushed up by more than $5 per barrel to more than $70. However, the ECB might also be tempted to push the forecast for core inflation this year higher too, while leaving the profile for future years unchanged, so that in 2020 it reaches 1.8%Y/Y – close to but below 2%Y/Y, arguably in line with the ECB’s target.

On the euro area data front, the Bank of France business sentiment survey for May, released earlier today, was just the latest of a series of indicators signaling softer growth momentum in the euro area’s second-largest member state. Within the detail, the survey’s business sentiment indicators for manufacturing and services both declined, to the lowest levels since October 2016 and September 2017 respectively. And while the survey indicator for construction picked up, the overall survey results saw the Bank of France maintain its Q2 GDP growth forecast of 0.3%Q/Q, which is bang in line with our own forecast. The remainder of the day should be relatively quiet for new data, with just the Italian IP figures for April due on Monday.

The rest of the week brings a mixed bag of releases from the euro area, none of which, however, will prove a show-stopper. Tomorrow brings the German ZEW investor survey for June, which seems set to remain downbeat against the backdrop of Italian political risks and BTP market turbulence. Wednesday brings euro area IP figures for April – given the data released for Germany, France and Spain, we expect this to show a decrease in excess of 1.0%M/M. Q1 employment data are due the same day and seem likely to show ongoing steady jobs growth, albeit probably a touch down on the 0.4%Q/Q average rate in 2017. Wednesday will also will bring final Spanish inflation figures for May, with the equivalent numbers from Germany and France due the following day and the euro area numbers out on Friday: we expect the flash estimates to be confirmed with euro area headline CPI up to 1.9%Y/Y and core CPI up to 1.1%Y/Y, thirteen- and eight-month highs respectively. Euro area figures for labour costs in Q1, goods trade in April and new car registrations in May will also be published on Friday.  

This week will be the busiest of the month in terms of the UK dataflow, with a steady stream of top-tier releases. The BoE’s Deputy Governor Dave Ramsden signalled last week that he believes that the slowdown in GDP growth to just 0.1%Q/Q in Q1 was temporary (and possibly overstated). And the data to be released this week will be key in judging whether the rebound is emphatic enough to warrant – notwithstanding Brexit-related uncertainty – an August rate rise. In this context, today’s manufacturing figures for April are expected to show a more solid start to Q1 for the sector, while the same month’s trade and construction output figures will also be hoped to reveal an improved performance after a period of weakness.

Tomorrow, the latest labour market data should reveal that real wages continued to rebound in April, albeit at a subdued pace, with the unemployment rate remaining at 4.2%. We expect the May CPI inflation release on Wednesday to show the headline rate nudging up by 0.1ppt to 2.5%Y/Y, partly in light of higher fuel prices. But we expect core CPI to inch higher too. The rise in oil prices will also impact other parts of the inflation pipeline, boosting both producer price input and output readings, which are due out at the same time. Finally data-wise, on Thursday, the official May retail sales data will be released. Despite April’s hefty 1.6%M/M expansion, the underlying trend in spending is almost flat. As the list of struggling UK retailers grows, contrary to the consensus view, we expect the stagnation to have continued.

Wednesday will also be a key day for political news, with the culmination of two days of debate and votes in the House of Commons on the EU Withdrawal Bill. There are 16 amendments for MPs to vote on – most notably those concerning membership of the EEA and a customs union. If they were so minded, a coalition of the known pro-Remain opposition MPs would only need 15 or so Conservative members to vote alongside them in order to uphold the amendments. A defeat for the government would not only impact its Brexit strategy but would also herald a period of heightened political uncertainty. However, the Labour Party leadership’s strategy appears vague and no less muddled than the government’s, which could well – by accident or design – play into Theresa May’s hands.

The key event in the US will obviously be the two-day FOMC meeting, which concludes on Wednesday. A further 25bp rate hike, lifting the target fed funds range to 1.75-2.0%, is fully priced by the market. Most interest will centre on the Fed’s update projections and Chair Powell’s post-meeting press conference for clues on how policy is likely to evolve over the remainder of this year. The recent economic data-flow would suggest that the Fed’s median forecasts for GDP and inflation this year will be revised up, while the median forecast for the unemployment rate will be revised down. However, given the deterioration in the external environment over the past quarter, the dot-plots for the fed funds rate at end-2018 might provide to be a touch more dovish than those published three months ago.

Ahead of the FOMC meeting, tomorrow’s CPI report for May will be of significant interest to the markets – core CPI is likely to benefit from above-potential economic growth to post a rise of 0.2%M/M in line with the recent trend, while the headline index might rise 0.3%M/M on the back of higher fuel and food prices too – as will be elements of Wednesday’s PPI report for May. On Thursday, the advance retail sales report for May will cast light on how consumer spending is evolving in Q2. On Friday, the week will end with the IP report for May, the New York Fed’s manufacturing survey for June and the preliminary results of the University of Michigan’s consumer survey for June. Meanwhile, in the bond market, the US Treasury will auction a total of $68bn of 3Y and 10Y notes (today) and 30Y bonds (tomorrow), $4bn than the equivalent round two months ago.

Over the weekend China released its CPI and PPI reports for May. The headline CPI fell 0.2%M/M, leaving annual inflation steady at 1.8%Y/Y – an outcome that was in line with market expectations. While non-food inflation edged up 0.1ppts to 2.2%Y/Y, food inflation slowed 0.6ppts to a four-month low of just 0.1%Y/Y. Excluding food and energy, annual inflation slowed 0.1ppts to 1.9%Y/Y. Meanwhile, as expected, the PPI pointed to an increase in pipeline inflation pressures. Indeed, the headline PPI rose 0.4%M/M, lifting annual inflation by 0.7ppts to 4.1%Y/Y – an outcome that was slightly above market expectations. The pace of producer price inflation picked up across the mining, materials and manufacturing sectors. However, consumer goods prices rose just 0.3%Y/Y, albeit up 0.2ppts from a month earlier, with consumer durables prices falling 0.7%Y/Y.

There were no major economic reports in China today. Looking out over the rest of this week the key day is Thursday when the remainder of the key activity indicators for May are scheduled for release (IP, retail sales, fixed investment etc). Bloomberg’s survey suggests that analysts expect these indicators to at least maintain the growth rates reported in April, consistent with recent PMI readings. The NBS will release May home price data on Friday and the PBoC should release money and credit data for May at some point over the next few days.

Australian markets were closed today for the Queen’s Birthday holiday. Over the remainder of the week the focus initially will be on the latest readings of the NAB business survey (tomorrow) and Westpac consumer confidence index (Wednesday). However, the highlight this week is the Labour Force Survey for May, released on Thursday. Bloomberg’s survey suggests that the market expects employment to have grown about 20k last month – similar to the April outcome – and the unemployment rate to have remained at 5.6%. Such an outcome would have no implications for the RBA’s firmly ‘on hold’ monetary policy.

New Zealand:
Ahead of next week’s full national accounts, Statistics New Zealand reported that the volume of manufacturing sales rose a solid 1.4%Q/Q in Q1. Coming after upwardly-revised growth of 1.5%Q/Q in Q4, this lifted annual growth to 3.1%Y/Y. The primary food sector was again a strong contributor to growth in overall production. Excluding meat and dairy products, sales rose 0.6%Q/Q and 2.1%Y/Y. This report comes following subdued outcomes in the retail, building and export sectors. In advance of the final partial indicators, at this stage real GDP growth in Q1 seems likely to be weaker than the 0.7%Q/Q outcome estimated by the RBNZ last month.

Looking out over the remainder of the week, there will be some interest in tomorrow’s consumer spending report for May in light of the very soft April reading. The May Food Price Index is released on Wednesday and the May manufacturing PMI is released on Friday (the latter rising to a surprisingly robust 58.9 last month). The REINZ housing report for May should also be released at some point this week.

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