Morning comment: Brexit summit, Japanese trade and Aussie labour market

Mantas Vanagas
Emily Nicol

Overview:
After declining as much as 1% in early trade, the S&P500 rallied back to close unchanged on Wednesday led by gains in the financials and communications sectors. However, both US Treasury yields and the US dollar moved higher, receiving additional impetus following a set of FOMC minutes that contained no real surprises but which did state that “a number” of participants expected that policy would need to become modestly restrictive for a time “in order to reduce the risk of a sustained overshooting of the Committee's 2% inflation objective or the risk posed by significant financial imbalances”. In commodity markets, crude oil posted a sharp decline following the release of the latest EIA US inventory data.

Notwithstanding the eventual stability on Wall Street, equity markets have weakened moderately across Asia today. The decline was most pronounced in mainland China, with the CSI300 falling 2.3% even after the US Treasury’s semi-annual FX report again concluded that China was not manipulating the yuan (China, along with several other countries – including Japan – remains on the US Treasury’s watchlist, however). Declines in other markets were generally moderate, with Japan’s TOPIX down 0.5%, Hong Kong’s Hang Seng down 0.7% and Singapore’s Straits Times down 0.4%. Australia’s ASX200 closed little changed even as the AUD firmed following an unexpected decline in the unemployment rate in September (more on this below).

Unable to reconcile the competing interests of the DUP, hardline Brexiters and the different factions in her own Cabinet, Theresa May’s speech to EU leaders last night on the Brexit negotiations offered no new proposals to reinvigorate the negotiations, which have become deadlocked over the contentious issue of the Irish border backstop. Theresa May is, however, reportedly considering an option to extend the proposed transition period, whereby the UK would effectively remain in the EU even after formally leaving on 29th March 2019, for an additional year to the end of 2021. While this would be a sensible step to give both sides more breathing space to work out the details of the future trading relationship – the currently proposed twenty-one month period is hardly adequate to achieve the ambitious trade deal the UK government is seeking – this proposal has not gone down well with Tory Brexiters, who have been on the airwaves this morning employing their usual threatening language (threats that, as yet, have not delivered any action). And it is hard to see how extending the transition will help find a solution to the main sticking point of the Irish border backstop. So, while the tone and sentiment on both sides appears more positive than in the wake of the Salzburg summit, unless May finds a way to find a compromise at home and brings new proposals to the EU, negotiations are going to remain deadlocked. Reflecting that, EU leaders therefore did not agree to set a date for a special summit in November, which had been slated to sign off the withdrawal agreement. As such, December now looks the next date for reaching agreement.

Japan:
The key economic report in Japan today concerned the trade balance for September. In unadjusted terms, Japan reported a small trade surplus of ¥139.6bn. However, after adjusting for seasonal factors, this outcome equated to a trade deficit of ¥238.9bn – the fourth deficit recorded in the past five months. This deficit was only slightly wider than that recorded in August and was about ¥100bn less than the market had expected. After adjusting for seasonal factors, export values fell 2.5%M/M in September while import costs fell 1.7%M/M. In part, these outcomes are due to the impact of Typhoon Jebi and the Hokkaido earthquake, so it seems reasonable to expect that some sort of rebound will have taken place in the current month. Compared with a year earlier, exports fell 1.2%Y/Y, the first negative reading for almost two years, while imports rose 7.0%Y/Y.

Within the detail, growth in export values was down across all major categories. For example, exports of manufactured goods fell 2.2%Y/Y, compared with the 10.5%Y/Y growth reported last month. Similarly, growth in general machinery slowed to 0.1%Y/Y from 9.7%Y/Y previously and exports of electrical machinery fell 2.4%Y/Y compared with growth of 5.6%Y/Y previously. As regards to imports, a significant driver of aggregate growth continues to be mineral fuels (up 42.1%Y/Y), largely reflecting higher prices. Imports of general machinery rose just 0.2%Y/Y, compared with 13.0%Y/Y the previous month, while growth in imports of electrical machinery declined to 0.7%Y/Y compared with 7.1%Y/Y previously.

As usual a better sense of the underlying trend in external demand was provided by the BoJ’s estimates of export and import volumes, which, unfortunately, painted a bleaker picture of developments in September. Real exports slumped 5.5%M/M, causing annual growth to slow to 0.2%Y/Y from 1.4%Y/Y previously. As a result, real exports fell 1.9%Q/Q in Q3, the most since Q215. Meanwhile, real imports fell 2.8%M/M in September but remained up a steady 2.7%Y/Y. Moreover, this still left imports up 1.2%Q/Q in Q3, rebounding from a 1.6%Q/Q decline in Q2. This means that net goods exports are certain to make a negative contribution to GDP growth in Q3, with tourist spending data released earlier this week –- also influenced by Japan’s natural disasters – suggesting a small drag from the services sector too. 

The BoJ will publish export volume data by region and commodity next week. For now, the MoF’s own export volume index fell 4.8%Y/Y (this compares with a modest 1.1%Y/Y advance in August). The MoF’s breakdown indicates that exports volumes fell across all major markets. In particular, exports to China fell 8.7%Y/Y, while exports to the rest of Asia fell 4.6%Y/Y. Shipments to the US fell 2.6%Y/Y, while those to EU fell 4.5%Y/Y.

In other news, the BoJ released the latest edition of its quarterly Regional Economic Report (the equivalent of the Fed’s Beige Book), making public some of the anecdotal information that the Policy Board will consider when it next meets at the end of this month. All nine regions reported that their economy had been either expanding or recovering. However, compared with the previous assessment in July, the Hokkaido and Chugoku regions revised down their assessments, reflecting the respective impacts of the Hokkaido earthquake and the heavy rains seen back in July. At this stage the Kinki region maintained its assessment that its economy had been expanding moderately, with effects of Typhoon Jebi still being observed. As in the previous report, the BoJ’s commentary argued that that these reports were based on the assessment that “the virtuous cycle from income to spending had been maintained”, as labour market conditions had continued to tighten steadily, private consumption had been increasing moderately, while exports had been on an increasing trend with overseas economies growing firmly. So looking ahead to the Outlook Report at the end of this month, while natural disasters have been impacting the economy’s recent performance, there appears to be nothing in today’s report that would motivate a change in the BoJ’s medium-term outlook for the economy or inflation, and therefore in monetary policy too.

Euro area:
With no data of note due from the euro area, focus today will no doubt be on the concluding statements from the EU Council’s two-day meeting. Most notably, the Euro Summit will discuss possible future reforms to the policy framework of the euro area, although Italian fiscal policy will cast a pall over deliberations. In the markets, France will sell fixed-rate and index-linked bonds, while Spain will sell bonds with various maturities.

UK:
Following mixed data releases earlier this week, which showed stronger than expected pay growth, but brought a downward surprise to the UK inflation, September figures from the retail sector will take centre-stage in the UK today. Following a period of particularly rapid sales growth over the summer, the latest surveys suggested some moderation last month and so a drop in sales of nearly ½%M/M looks on the cards. That would be the lowest reading since March, but would still leave its quarterly and annual rates of growth elevated at above 1.0%Q/Q and around 3½%Y/Y respectively.

US:
In the US, meanwhile, alongside the weekly jobless claims figures today will bring the Philly Fed Index for October and the Conference Board’s Leading Index for September. In the markets, the Treasury will sell 30Y TIPS.

Australia:
The focus in Australia today was on the Labour Force survey for September. After surprising on the high side of expectations in August, employment grew a weaker than expected 5.6k in September. As a result, annual growth slowed 0.2ppts to a still very strong 2.3%Y/Y. The detail was slightly more favourable with full-time employment rising a further 20.3k – now up strongly for four consecutive months – raising annual growth to 2.6%Y/Y. Part-time employment fell 14.7k but was up 1.6%Y/Y. The number of hours worked rose 0.4%M/M and was up 1.9%Y/Y. Given the trend in GDP growth, this continues to suggest that growth in labour productivity has improved to about 1%Y/Y.

Perhaps the biggest surprise this month was on the supply side of the ledger, with the labour force participation rate declining 0.3ppts to 65.4%. As a consequence, while employment grew only weakly in the month, the unemployment rate fell a very-unexpected 0.3ppts to 5.0% – the lowest reading since April 2012. Given the month-to-month volatility – something highlighted by RBA Deputy Governor Debelle in his speech yesterday – we would hesitate to conclude that the unemployment rate will definitely end the year below the RBA’s forecast of 5½% (rounded to the nearest quarter point). That said, at least in part today’s result seems to have been influenced by sample rotation, with the ABS noting that the incoming subgroup – comprising one-eighth of all respondents – had an unemployment rate 0.5ppts lower than the whole sample and 1.2ppts lower than the outgoing subgroup. This suggests at least some of today’s reported decline is likely to be enduring.

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