Morning comment: China trade & Japan services

Chris Scicluna
Emily Nicol

Overview:
It was a case of more of the same in US and European markets yesterday. Despite a softer-than-expected US CPI report, the S&P500 fell a further 2.1% and yet the 10-year Treasury yield fell only modestly to about 3.15%. Further attacks on the Fed by US President Trump weighed on the US dollar, with DXY down to a two-week low, falling among others against the commodity currencies despite the “risk-off” tone in equity and commodity markets.

Nonetheless, equity markets have generally traded positively in Asia today. While this partly reflects payback for the very large declines that had been seen in many of these markets yesterday, investors also responded positively to a stronger-than-expected Chinese trade report (more on this below). In mainland China the CSI300 followed yesterday’s 4.9% loss with a moderate rebound circa 1½%, while the Hang Seng is up about 1.9%. In Japan, the TOPIX declined as much as 0.9% in early trade as the stronger yen (briefly through ¥112/$ yesterday) weighed. However, those losses were largely erased after market sentiment was lifted by China’s trade report, leaving the TOPIX index little changed on the day at the close. With the improved market mood, 10Y JGB yields edged up to 0.14%, while 10Y UST yields have risen back to 3.18%, and even BTPs are outperforming this morning, with the 10Y spread over Bunds now back below 300bps. Euro area equities are set to open higher, with futures pointing to a similar story in the US later today.

Japan:
The main economic report out of Japan today was the Tertiary Industry Activity Index for August. The overall index rose 0.5%M/M – 0.2ppt above market expectations. But the upside surprise was tempered by a 0.2ppt down revision to the index in July (now -0.1%M/M). Annual growth picked up to 1.3%Y/Y from 0.9%Y/Y previously, however. Within the detail, the personal services index rose 0.9%M/M and 1.1%Y/Y while the business services index fell 0.2%M/M but was still up 1.6%Y/Y. By industry, however, growth was fully accounted for by a 4.1%M/M rebound in the living and amusement-related sector, where activity had fallen sharply in July (at least in part due to the storms and floods in western Japan). Even with the pick-up in tertiary activity in August, however, average activity in the sector over July/August was 0.1% below the average level recorded through Q2. Given the likelihood that natural disasters impacted activity in September, a negative outcome for Q3 seems more likely than not. This is consistent with other indicators (including industrial production and consumption) suggesting that a soft Q3 GDP report can be expected next month.

China:
On the data front, the main focus in Asia today was China’s external trade report for September, providing further information on how US tariffs are impacting the Chinese economy and further insight into the likely outcome of next week’s Q3 GDP report. In contrast to the market’s expectations, China’s trade surplus widened to USD31.7bn from USD27.9bn previously. Most of the surprise was on the exports side of the ledger, where growth picked up unexpectedly to 14.5%Y/Y from 9.8%Y/Y previously (exports rose 17.4%Y/Y in CNY terms). Growth in imports declined to 14.3%Y/Y from 20.0%Y/Y previously (imports rose 17.4%Y/Y in CNY terms).

While on the face of it this result bodes well for next week’s GDP report (Daiwa forecast 6.5%Y/Y), it seems reasonable to suppose that growth in exports has been boosted by the front-running of orders by US purchasers. Looking at the export data by region, exports to the US rose 14.0%Y/Y, up from 13.2%Y/Y last month. That said, the past month saw a much larger pick-up in exports to the EU and Japan, with growth rising to 17.4%Y/Y from 14.3%Y/Y respectively from just 8.3%Y/Y and 3.7%Y/Y previously. Meanwhile, China’s imports also provide some early pointers on the yet-to-be reported export performance of some of its key trading partners. For example, we note that imports from Japan rose just 3.1%Y/Y in September (about 4%Y/Y in yen terms), although the three-month average remains much stronger at 11.9%Y/Y. By contrast, growth in China’s imports from the US fell 1.2%Y/Y – a result that will not please President Trump. Indeed, China’s bilateral surplus with the US rose to a new record high of USD34.1bn in August.

Euro area:
The most noteworthy euro area data today will be the industrial production report for August. While Germany’s manufacturing sector put in another disappointing showing with a third consecutive monthly decline, industrial output was firmer in France (0.3%M/M), Italy (1.7%M/M) and Spain (0.7%M/M). And so, we expect euro area IP to have risen by a little more than ½%M/M, to leave production broadly flat over the first two months of Q3. Meanwhile, this morning brought the final reading of German CPI in September – there was, however, no revision made to the flash estimate, which had already provided an upside surprise to the EU-harmonised rate, up 0.3ppt on the month to 2.2%Y/Y.

UK:
There are no new UK economic data on the docket today, but Brexit noise continues unabated. Most notably, moves by PM May to compromise on the knotty Irish backstop problem appear in jeopardy. The Northern Irish Democratic Unionist Party, upon whose fickle support the government relies on to pass legislation, is suggesting that May’s plan for different regulatory arrangements between Northern Ireland and Great Britain is a betrayal and is thus threatening to withdraw its backing. And at least one Cabinet member – reportedly the Leader of the House of Commons Andrea Leadsom – is threatening to resign over her intention to agree to an indefinite customs union with the EU as part of the Irish backstop. So, even if a deal is eventually reached between the UK and EU at one of the forthcoming summits, whether the draft agreement could make it through the House of Commons would remain highly uncertain.

US:
In the US, this afternoon will bring the preliminary reading of the University of Michigan’s consumer sentiment survey for October. The headline index will doubtless remain historically high – the elevated level in September was only slightly below the high for the current expansion of 101.4 reached in March. Import price figures for September are also due.

Australia:
Today the RBA released its semi-annual Financial Stability Review (FSR). As regards the macroeconomic backdrop, the FSR was unsurprisingly upbeat. The Bank noted that economic growth has been strong, with unemployment falling. And while wages growth has been low, strong employment growth has helped to support household incomes. Meanwhile, in the corporate world, businesses were said to be earning solid profits. And with most businesses lowly geared, few were having difficulty in servicing their debt. Against that backdrop, the RBA believes the main financial stability risks as coming from: global economic and financial volatility; high levels of household debt (albeit well secured and general not high-LVR lending); the risk that the current slowdown in housing debt and prices – viewed as a positive development – could turn severe; and bank culture and operating risks (the latter including cyber risk).

As far as the banks are concerned, the RBA noted that their resilience has increased, with capital ratios around 50% higher than they were a decade ago earlier and well within the range that has historically helped to withstand financial crises. It was also noted that banks have substantially strengthened their liquidity management in recent years. Meanwhile, the RBA assesses that the tightening in housing lending standards in recent years has improved the quality of the household sector’s balance sheet. In a special chapter discussing the issue, the RBA appeared to take some comfort that some borrowers who would have been more likely to experience difficulty repaying their debt are now constrained to borrow more. And while lending by non-prudentially regulated lenders has picked up, the RBA notes that these lenders must still comply with responsible lending laws and are too small to fully offset the tightening from other lenders.

In other related news, the ABS reported that the number of home loan approvals fell 2.1%M/M in August – a weaker than expected outcome following a flat July (revised down from 0.4%M/M previously). The value of those approvals also fell 2.1%M/M, with investor approvals down 1.1%M/M and owner-occupier approvals down 2.7%M/M. Excluding the refinancing of existing dwellings, the value of approvals fell a steeper 2.9%M/M.

New Zealand:
New Zealand’s manufacturing PMI fell 0.3pts to 51.7 in September, to be just 0.5pt above this year’s July low. In the detail the production index fell 2.9pts to 49.6 – the second sub-50 reading in the past three months – and the new orders index fell 0.7pt to 52.4. Countering those developments, the employment index rose 1.5pts to 50.5. In short, these results indicate that the manufacturing sector is continuing to expand, but at a slower pace than seen in recent years.

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