Morning comment: Eyes on the ECB

Chris Scicluna

Overview:
Wall Street hit the skids yesterday, with the S&P500 eventually closing down 3.1% after an especially poor last hour of trade to leave it down 0.7% for the year. With the Wednesday’s corporate earnings reports proving mixed – and more big tech names due to report today, including Intel, Amazon and Alphabet – it seemed that investors were keen to flee stocks exposed to a peaking growth cycle and rising input costs. This was especially so in the technology and communications sectors, leading the Nasdaq to an even sharper 4.4% decline – its worst day since 2011. Not surprising bond yields were pressured lower, with the 10-year Treasury yield falling 7bps to 3.10% and US credit spreads wider too. However, given the poor PMIs out of the euro area earlier in the day, the US dollar ended firmer against most counterparts. The notable exceptions were a risk-aversion driven strengthening of the yen (back to ¥112/$) and a firmer Canadian dollar after the BoC hiked the overnight rate by the expected 25bps to 1.75% but surprised investors with an explicit statement that it was appropriate to move policy settings back to a neutral level (regarded by the Bank as an overnight rate of 2.5-3.5%).

The poor performance of Wall Street inevitably roiled Asian equity markets today, notwithstanding the fact that almost all key bourses in the region are already well in the red for this year. Losses were largest in Japan, where a stronger yen contributed to a 3.1% decline in the TOPIX – a fresh 13½ month low. Australia’s ASX200 fell 2.8% to a new 12-month low. Losses elsewhere were slightly less severe. Indeed, the battered Shanghai composite closed little changed, albeit still down in the year-to-date more than 21% (more than 26% in US dollar terms). But the Hang Seng fell 1.7% to extend its year-to-date loss to over 17%. Looking ahead to today, all eyes will be on Mario Draghi as the latest ECB policy meeting concludes. Expect him to pay lip-service to growing downside risks. But don’t expect a substantive shift in policy.

Euro area:
Given recent market and political events, and with euro area economic activity, inflation and survey indicators having started to surprise on the downside again over the past few weeks – indeed, yesterday’s flash PMIs for October were particularly disappointing, with the composite PMI down to its lowest in more than two years and the manufacturing output PMI falling to its lowest since 2014 – today’s ECB policy announcements and press conference are likely to be watched more closely than they otherwise might have done. Certainly, Draghi will need to acknowledge that the downside risks to the economic outlook have increased. Indeed, he might go so far as to state explicitly that the risks to the outlook are skewed to the downside.

But Draghi certainly won’t yet disown the ECB’s most recent economic forecasts, which we consider overoptimistic but were updated only last month. By the same token, we don’t expect him to announce any changes to ECB policy, with the expectation of an end to net asset purchases at the end of the year to be confirmed, albeit still ‘subject to incoming data’. After all, the ECB’s self-imposed limits on the programme are now starting to bind, limiting scope to keep on adding to its bond holdings, while the Governing Council would see little macroeconomic benefit from extending the net asset purchases anyway. Moreover, the policy statement will likely leave the forward guidance on rates unchanged too, reiterating the expectation that key interest rates will remain at their present levels at least through the summer of 2019. But with Draghi having signalled that the Governing Council would discuss its reinvestment policy by the end of the year, we might get clues as to what kind of additional flexibility – which could provide scope to add further policy support next year should it be required – is under consideration.  However, we think that any agreement on precise measures in this respect is most likely to emerge in December.

With respect to economic data, with Q3 having looked to be a weak quarter for German GDP, and following yesterday’s disappointing German PMIs, which saw the composite index plunge more than 2pts to its lowest since May 2015, today’s German Ifo business survey will be closely watched for further evidence of slowing momentum in the euro area’s largest member state at the start of the fourth quarter. Ongoing concerns about developments in the auto sector might be expected to weigh.   

US:
In the US, the data focus will be on the advance September readings for durables goods orders, merchandise trade and wholesale inventories. There will also be some interest in the pending home sales report for September, while the weekly jobless claims figures are also due. In addition, Fed Vice Chair Richard Clarida is due to speak on the outlook for the US economy and monetary policy in Washington, while the Treasury will auction 7-year notes. 

Japan:
This week’s drip-feed of lower-tier domestic economic reports continued today with the BoJ releasing the service sector PPI for September. In aggregate, prices rose 0.1%M/M, but base effects still saw annual inflation decline 0.1ppt to 1.2%Y/Y – an outcome that was in line with market expectations. In the detail, inflation in the transportation sector was steady at 2.3%Y/Y, while that in the real estate sector was steady at 1.3%Y/Y (growth in office rents increased to 2.1%Y/Y, however). But, inflation in the information and communication sector eased 0.1ppt to 0.7%Y/Y while prices for volatile advertising services fell 0.4%Y/Y and rising 1.1%Y/Y in August.

New Zealand:
New Zealand reported a merchandise trade deficit of NZD1.56bn in September – about NZD0.2bn larger than market expectations and up slightly from a deficit of NZD1.47bn last month. As was the case last month, a good portion of the deficit is explained by seasonal factors with primary exports yet to move into full swing and imports lifting ahead of the festive season. The seasonally-adjusted deficit of NZD0.58bn was only slightly larger than the average deficit reported over the past year. Most of the September surprise was on the imports side of the ledger, where values surged a seasonally-adjusted 11.6%M/M to be up 18.8%Y/Y. This growth was substantially driven by a sharp rise in imports of aircraft and crude oil, which are very volatile from month to month. Indeed, imports of consumer goods rose just 4.3%Y/Y and imports of machinery and plant rose just 1.9%Y/Y – growth that can be readily explained by a 6%Y/Y depreciation of the effective exchange rate.

UK:
With Theresa May seemingly having come out of last night’s 1922 Committee meeting of backbench Conservative MPs in finer fettle than might have appeared likely over the weekend when her opponents were briefing prominently against her across the media, today should be a quiet day in the UK, with little political noise expected and no major economic data releases due either.

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