BoJ Tankan & the week ahead

Chris Scicluna
Emily Nicol

Wall Street shrugged off the Italian-driven weakness seen in European equity markets on Friday, with the S&P500 closing flat and bond yields little changed despite a modest downside surprise in the US core PCE deflator for August. Even so, Asian markets got off to a soft start day as investors reacted initially to the weekend’s disappointing manufacturing PMI reports in China (more on these below). While markets in mainland China and Hong Kong were on holiday, Japan’s Topix opened down 0.5% with a slightly less upbeat BoJ Tankan survey also weighing (more on the Tankan below). However, those losses were erased – and the Topix eventually closed little changed on the day – as newswires reported that the US and Canada had reached a tentative deal that would allow Canada to join the revised NAFTA agreement already reached by the US and Mexico. News of the agreement – henceforth to be known imaginatively as the United States-Mexico-Canada Agreement (USMCA) – caused a modest rally in US equity futures and weakened the dollar against the peso and loonie, but the yen kept depreciating to close to ¥114/$. In the euro area, meanwhile, BTPs are still struggling to find a new level, with 2Y yields currently up more than 10bps from Friday’s close at 1.12%, but still down from Friday’s high above 1.20%.

The main data focus in Japan today was the aforementioned BoJ Tankan survey for the September quarter. In summary, the BoJ’s survey of just under 10,000 firms continued to cast Japan’s economy in a very positive light, notwithstanding the disruptive impact of recent natural disasters, ongoing worries about rising trade protectionism, and other potential downside risks to growth. That said, the most closely-watched business conditions diffusion indices were generally modestly below where they stood three months ago and a little below market expectations, tallying with what appears to have been a much softer quarter for economic growth than Q2. Consistent with other recent surveys, firms’ forecasts for capex remained upbeat amidst intensifying skill shortages but the survey’s pricing indicators continued to offer only limited evidence that firms’ output prices are responding to building pressures on spare capacity and direct pressures on firms’ input prices.

Turning to the detail, amongst all firms a net 15% of respondents considered business conditions to be favourable – down 1ppt from the June survey and now 2ppts below the 26-year high recorded at the start of this year. A net 12% of respondents were optimistic about business conditions over the next three months, although this too remains a very optimistic forecast by the standards of the past two decades or so. The large firm business conditions index for the manufacturing sector eased 2ppts to +19 (3ppts below market expectations) and the large firm business conditions index for the non-manufacturing index fell 2ppts to +22 (1ppt below market expectations). Looking ahead, firms in both sectors were equally optimistic about how business conditions would pan out over the next three months. That said, it is worth noting that the forecast of large manufacturers was based on an assumed exchange rate of ¥107.40/$ over FY18, so firms would likely be slightly more confident if the yen were to remain around its current much weaker level.

As is usual, medium- and small-sized firms were not quite as optimistic as their larger counterparts. The business conditions index for medium-sized manufacturers fell 5ppts to +15 this quarter while the index for medium-sized non-manufacturers fell 2ppts to +18. However, it was encouraging to see that the index for small manufacturing firms remained steady at +14, while the index for small non-manufacturers actually improved 2ppts to +10. Looking at the industry detail for large firms, consistent with other surveys, firms operating in the general purpose and production machinery industries were particularly likely to have reported favourable business conditions in September (a reading of +48 in each case), as were firms operating in the construction and business services sectors (+46 and +38 respectively). These industries were also the most optimistic about likely business conditions over the next three months.

Among the other key findings of the survey, for all industries aggregate sales are now forecast to rise 2.1%Y/Y in FY18, up from 1.5%Y/Y in the June survey. Sales in the manufacturing sector are forecast to rise 2.7%Y/Y, while sales in the non-manufacturing sector are forecast to rise 1.7%Y/Y. Aggregate current profits are forecast to decline 3.6%Y/Y in FY18, representing a small improvement on the 5.1%Y/Y decline that was forecast in the prior survey. Manufacturing profits are forecast to decline 4.9%Y/Y – a forecast that should prove too pessimistic if the yen remains at current levels – and non-manufacturing profits are forecast to decline 2.6%Y/Y. It is worth remembering that in both sectors the level of profitability (relative to sales) is far above that seen on average through history. Moreover, during periods of steady economic growth, forecasts made early in the fiscal year tend to be relatively cautious, so these forecasts may well improve further as the year goes on.

Separately, and unsurprisingly, the Tankan continued to indicate that firms are facing substantial labour shortages. Amongst large firms, a net 23% of respondents reported an employment deficiency – the tightest conditions have been since 1992 – with an even greater deficiency reported by medium- and small-sized firms. Equally unsurprisingly, firms’ indicated that they expect conditions in the labour market to get even tighter over the next three months. A net 5% of firms reported that they have insufficient production capacity to meet demand – an outcome that was unchanged from the June survey. Faced with increasing capacity constraints, firms still seem very willing to boost investment spending. While spending plans for large firms declined very modestly compared with the June survey, capex spending (including land but excluding software and R&D) by all firms is now forecast to grow 8.5%Y/Y in FY18, up from 7.9%Y/Y previously. This result owed to especially large upward revisions in capex plans amongst small firms, where capacity constraints appear most severe. Not surprisingly, the outlook remains especially positive in the manufacturing sector where firms now forecast capex to rise 16.5%Y/Y, whereas non-manufacturing firms expect capex to increase 4.0%Y/Y.

Turning to the outlook for prices, the Tankan indicates a slight improvement in the pricing environment. A net 27% of large manufacturers reported a rise in input prices in the September survey (albeit down 3ppts from the June survey). While only a net 7% of such firms reported passing on these pressures in the form of higher output prices, this was up 2ppts from the June survey and was the strongest reading seen in 10 years. Amongst large non-manufacturers, 18% of firms reported higher input prices (up 2pts from the June survey) and a net 7% of firms reported charged higher output prices (up 2ppts to a 3-year high). However, amongst smaller firms increases in input prices were even more widespread and yet these firms’ success in raising output prices was less than at large firms. Data on firms’ specific forecasts for inflation will be released tomorrow, alongside additional industry detail from the survey. While inflation pressures are clearly stronger than they have been for some time, at this stage it seems that firms continue to have limited downstream pricing power.

Finally, there remained little evidence that the BoJ’s extraordinary monetary policy settings are having an unduly negative impact on the financial sector. In the section of the survey completed by just over 200 financial institutions, a net 12% of such institutions reported improved conditions over the past three months – albeit down 3pts from the June survey – and a further 14% forecast improved business conditions over the next three months. From the perspective of firms’, there was no signs that they are finding financial institutions unwilling to supply credit. Indeed, a net 24% of firms described the stance of financial institutions as “accommodative” – down just 1ppt from the June survey. And a net 1% of firms reported receiving lower interest rates on loans. The BoJ’s next Senior Loan Officer Opinion Survey will be released on 22 October and will cast more light on this issue, which may also receive further consideration in the BoJ’s next Outlook Report at the end of this month.

In other news, today also saw the release of the final results of the manufacturing PMI for September. Unfortunately the preliminary 0.4pt improvement in the headline index was revised away, thus leaving the index steady at the final August reading of 52.5. In the detail the revisions were even more disappointing, with the output index revised down 1.0pt to a 14-month low of 51.8; the new orders index revised down 0.8pt to 52.5 (now up just 0.1pt from August); and the new export orders index revised down 1.1pt to 49.8 (also now up just 0.1pt from August). Elsewhere in the survey there was some downward revision to the pricing indices too. The input prices index was revised down 1.0pt to 60.2 (now down 0.7pts for the month) and the output prices index was revised down 0.1pts to 52.7 (down 0.2pts for the month but nonetheless amongst the strongest reading seen this decade).

Looking ahead to the remainder of this week’s diary, tomorrow we will receive further detail from the Tankan survey, including firms’ inflation expectations, together with the Cabinet Office consumer confidence survey for September. On Wednesday the service sector and composite PMI readings for September will be released. After a break on Thursday, the data flow resumes again on Friday with the release of the Monthly Labour Survey for August and both the BoJ and MIC measures of consumer spending for August. Given the current issues with the MIC survey, the BoJ measure will be of greatest interest although we note that this too painted a much more positive picture of developments in July than the Cabinet Office Synthetic Consumption Index (revisions could bring these measures more into line). In the bond market the MoF will auction 10-year JGBs on Tuesday and enhanced liquidity (maturities of 15.5-39 years) on Thursday.

Euro area:
In the euro area, the fall-out from the Italian government’s decision last Thursday to increase the 2019 budget deficit target will continue to be watched, with Finance Minister Tria set to face criticism at today’s Eurogroup meeting. Data-wise, the first half of the week brings the final PMIs for September for the euro area and member states, with the manufacturing surveys due shortly, and the equivalent services and composite indices due on Wednesday. These are expected to confirm the flash estimates showing the headline euro area composite PMI declining 0.3pt to 54.2, the second-lowest reading since the end of 2016, on the back of a notable weakening in manufacturing sector confidence. Euro area unemployment figures for August are also due for release today, with the unemployment rate expected to have fallen 0.1ppt to 8.1%, its lowest rate in almost a decade.

Wednesday will also bring further insight into the euro area’s economic performance in Q3 with August’s retail sales figures expected to report a modest increase on the month to reverse the weakness in July – the German figures released earlier were again disappointing, with sales down 0.1%M/M in contrast to the expected 0.5%M/M gain to leave them broadly unchanged on a 3M/3M basis. Among other data due this week, German factory orders, French trade, Italian retail sales and Spanish industrial production figures, all for August due on Friday. Supply-wise, France and Spain will sell bonds with various maturities on Thursday.

The Conservative Party conference, its debates on Brexit policy and associated attempts to undermine the Prime Minister, will no doubt dominate attention this week with Theresa May’s keynote speech scheduled for Wednesday. We do not expect a formal attempt to unseat May this week – instead, the efforts to force a change in Brexit policy (and/or remove the PM) will likely come if and when she fails to deliver at the EU summit on 18 October.

The latest UK economic data will also attract attention this week with the manufacturing, construction and services PMIs due for release today, tomorrow and Wednesday respectively. Having declined in seven of the past eight months, the headline manufacturing PMI is expected to have edged lower again in September to 52.5, which would be the lowest reading since the post-referendum low in July 2016. But with the services PMI expected to signal still steady expansion in the sector (54.0), the composite PMI is likely to remain close to its level in August (54.2), which was bang in line with the average of the previous three years and consistent with GDP growth of 0.4%Q/Q. Other releases include the Bank of England’s latest bank lending figures for August today, with new car registrations data for September on Thursday and unit labour costs numbers for Q2 on Friday. In the markets, the DMO will sell 2024 Gilts on Thursday.

Another busy week in the US kicks off today with the release of the manufacturing ISM and auto sales reports for September, together with August construction spending. While Tuesday has no new data releases of note, the following day brings the ADP employment estimate for September and non-manufacturing ISM for the same month. The August factory orders report is the only monthly release due on Thursday. However, all eyes on Friday will be on the official labour market report for September. Another solid increase in non-farm payrolls could see the unemployment rate return to its cyclical low of 3.8%. And, after last month’s upside surprise, there will be great interest in developments in average hourly earnings (a high base effect will likely see a temporary declining in annual wage inflation from the 2.9%Y/Y growth recorded in August). Daiwa US Chief Economist Mike Moran forecasts a gain in payrolls of 185k, but notes the uncertainty (particularly to the wage and workweek-length figures) associated with the impact of Hurricane Florence. The full trade balance for August and consumer credit data for August will also be released on Friday. The coming week also brings numerous Fed speakers, with Chair Jay Powell in action tomorrow and Wednesday. In the bond market there are only bill auctions scheduled this week.  

Over the weekend China released its official PMI reports for September. The official composite PMI rose 0.3pts to a three-month high of 54.1, thanks to a 0.7pt rise in the non-manufacturing PMI to 54.9. However, the closely-watched manufacturing PMI fell a much larger-than-expected 0.5pt to a 7-month low of 50.8, led by a 1.7pt decline the PMI for medium-sized firms (to 48.7). The production index fell 0.3pts to 53.0, reversing last month’s increase and the overall new orders index fell 0.2pts to 52.0. In a sign that US tariffs might be impacting the economy, the export orders index fell 1.4pts to 48.0 – the lowest reading since February 2016. Meanwhile the September Caixin manufacturing PMI, which is more focused on the SME sector, was also released over the weekend and proved similarly disappointing. The headline index fell 0.6pts to a 16-month low of 50.0 in September. In the detail the output index fell 1.4pts to an 11-month high of 51.1 and the future output index 1.1pts to a 9-month low 54.0. The new orders index fell 0.5pts to a 25-month low of 50.1. The new export orders index fell 1.2pts to 47.6 – a level last seen in February 2016.

In mainland China markets are closed all week for a national holiday so there will be no further data releases this week.

Australian fixed income markets were closed for a public holiday today but there were still several lower-tier economic reports released. First, Corelogic reported that the median house price across Australia’s eight capital cities fell 0.6%M/M in September. This marks the eleventh consecutive monthly decline and means that prices are now down 3.7%Y/Y, led by a 6.1%Y/Y decline in Sydney. Second, the volatile AIG manufacturing index rose 2.3pts to 59.0 in September, with the new orders index rising 3.0pts to 62.6. Third, the Melbourne Institute monthly inflation gauge rose 0.3%M/M in September, leaving annual inflation steady at 2.1%Y/Y – just inside the lower bound of the RBA’s CPI target range (the trimmed mean rose just 1.8%Y/Y, however).

Looking ahead to the remainder of the week, tomorrow another RBA Board meeting is likely to come and go with no change in either the Bank’s policy settings or policy stance i.e. while the next move is likely to be a rate hike, that move is likely some way off as the Bank patiently awaits an expected gradual tightening of the labour market and related uplift in inflation. On the data front the focus will be on the latest developments in building approvals (Wednesday), external trade (Thursday) and retail sales (Friday).

New Zealand:
There were no major economic reports released in New Zealand today. Indeed, the remainder of this week is likely to prove similarly quiet, with Wednesday’s QV house price index and ANZ job ads reports the only scheduled economic releases of any interest.


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