Morning comment: UST plunge, Italian arithmetic & Aussie trade

Chris Scicluna

Yesterday brought a potent combination of very strong US economic data – a jump in the non-manufacturing ISM to the highest of the current expansion with a record employment component, as well as a 230k print in the ADP employment index – and some relatively hawkish comments from Jay Powell, who stated that the Fed “may go past neutral. But we’re a long way from neutral at this point, probably” and “There’s no reason to think that this cycle can’t continue for quite some time”. That precipitated a marked sell-off in the US Treasury market, with the 10-year yield rising 10bps to a 7-year high of 3.16% by the New York close. And so Wall Street erased most of its initial rally – the S&P500 closed up just 0.1% – while the US dollar got a boost.

Since the New York close the sell-off in US Treasuries has continued, with 10-year yields pushing up to 3.21% in Asian time. This sharp move pressured Asian bond yields higher, including in Japan where the 10-year JGB yield increased 2bps to 0.16% – towards the upper end of the BoJ’s new +/-20bps target range and a level last seen in January 2016 until the negative interest rate policy was announced. While the BoJ sat passively watching developments in the market unfold, tomorrow’s scheduled purchase operations of 10-25-year JGBs and 25-years+ will be closely watched, with the BoJ retaining the possibility of an unlimited fixed-rate purchase operation should it need to draw a line in the sand.

While Japanese equities initially opened higher benefiting from the weaker yen, those gains were steadily given up as UST and JGB yields continued to rise. And eventually the Topix closed down a small fraction on the day. Elsewhere, the prospect of tighter financial conditions weighed on markets, with Hong Kong’s Hang Seng slumping a further 1.9%, and benchmark indices falling 1.5% in South Korea and 1.3% in Taiwan at the time of writing. But while Aussie bonds followed the trend, new lows in the AUD allowed the ASX200 to also post a 0.5% gain.

The higher yield environment has followed through to the euro area this morning, with 10Y Bund yields currently up a further 5bps to 0.53%. But, for the second day, BTPs are outperforming, after Italian Prime Minister Conte and other leading members of the coalition government yesterday evening finally confirmed plans to reduce their planned deficit targets for 2020 and 2021. While it’s sticking to its guns to plan an increased budget deficit of 2.4% of GDP next year, the government has now reduced its deficit targets for 2020 and 2021 to 2.1% and 1.8% respectively, a touch below levels reported by the media this time yesterday.

The Italian government has not yet, however, confirmed the precise GDP growth assumptions underpinning those deficit forecasts – those figures are scheduled belatedly to be presented later this morning. Il Sole 24 Ore is reporting this morning that GDP will be forecast to rise in 2019, 2020 and 2021 by 1.5%, 1.6% and 1.4% respectively, but other reports have suggested slightly different figures. In our view, those forecasts are unreasonably high – indeed, they are little different to our forecasts for the euro area as a whole over those years – and would also suggest that any improvement in the deficit in 2020 and 2021 would be cyclical rather than structural, leaving Italy’s budget deficit at risk of a blowout as and when the economy slows.

All eyes will remain on Rome, and the expected formal presentation of the government’s long-delayed economic and fiscal arithmetic. Likewise, politics will remain in focus in the UK, with reports that Theresa May’s proposals to break the impasse on the Irish border backstop in the Brexit negotiations – i.e. a temporary all-UK customs union with the EU with some regulatory deviation between Northern Ireland and Great Britain – has perhaps importantly gained favour with the Irish Republic if not with the European Commission. Data-wise, there are no top-tier reports due out of the euro area, while only September new car registration figures are due in the UK.

In the US, August factory orders are due today along with the usual weekly claims figures, which seem bound again to be extremely low. In terms of orders, the already reported increase of 4.5%M/M in bookings for durable goods (just 0.1%M/M excluding transportation goods) is reflected in an expected 2.0% gain in overall factory orders, as bookings for nondurable goods are likely to dip overall principally reflecting  a price-led decline in petrol products. 

The key economic report in Australia today was the trade balance for August. A trade surplus of AUD1.60bn was reported – only slightly above market expectations and close to that reported in July. Exports rose 0.5%M/M – driven by a 3.3%M/M lift in receipts from the rural sector – raising annual growth to 15.3%Y/Y. Imports rose a similar 0.4%M/M and were up 12.0%Y/Y. Imports of intermediate goods fell 2.3%M/M but remained up 20.2%Y/Y. By contrast, after declining in July, imports of capex goods rebounded 9.2%M/M and were up 12.4%Y/Y.

In other news, the CBA services PMI edged up 0.4pts to 52.2 in September. In combination with the improvement registered in the manufacturing sector, the headline composite PMI rose 0.5pts to a three-month high of 52.5.

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