The week ahead: Brexit, Japan inflation, China GDP

Chris Scicluna
Emily Nicol

Overview:
A rollercoaster session on Wall Street saw the S&P500 eventually close with a 1.4% gain on Friday, trimming its loss for the week to 4.1%. Technology stocks led the market higher with sentiment underpinned by China’s stronger-than-expected trade report earlier in the day. This rebound caused Treasury yields to nudge only slightly higher while the US dollar was modestly firmer too.

But judging by how the major markets have re-opened in Asia, it seems that investors are sceptical that Friday’s rally on Wall Street can be sustained. In China the CSI300 is down about 1.3%, thus erasing much of Friday’s gain, with President Trump leaving open the possibility of imposing more tariffs on China in an interview aired on Sunday by CBS. Tensions between the US and Saudi Arabia concerning the disappearance of Washington Post writer Jamal Khashoggi took some of the focus off the US-China standoff, but weighed on sentiment more broadly (oil has traded only modestly higher today with Brent crude up above $81pb, still about $4 down from last week’s high).

In Japan, the TOPIX fell 1.6%, reaching the lowest level since July. JGB yields declined modestly, reacting mainly to the risk-off environment rather than to remarks made by BoJ Governor Haruhiko Kuroda in a Bloomberg TV interview on Saturday. Kuroda stated that the Bank’s policy stance is now communicated only by yield curve control (i.e. the BoJ’s targets for the interest rate on banks’ excess reserves and 10-year JGBs), adding that “The amount of JGB purchases is no more the monetary operating target.” These comments confirm that the BoJ’s commitment to buy ¥80tn of JGBs each year should not be taken literally – hardly a revelation given that the Bank purchases have been running well below that rate for almost the last two years.

Elsewhere, sterling is down less than ½ cent against the dollar, at $1.311, after yesterday’s breakdown in the Brexit negotiations over the Irish border backstop. It remains to be seen whether the collapse of the talks reflects mere theatrics for the domestic UK audience, or whether May’s severe political constraints – boxed in by the Northern Irish DUP on plans for a different regulatory regime between Great Britain and the Province, the Tory Brexiters opposing her proposal for open-ended UK membership of the customs union, as well as the handful of remainers left within her own party – which raise significant doubts over her ability to get any deal ratified in Parliament, have caused her to hold out for a different deal. However, things may be little clearer after Wednesday’s Summit.

Japan:
A quiet day for economic data in Japan saw just the release of the final IP report for August and the Reuters Tankan for October.

Turning first to the IP report, an already disappointing preliminary 0.7%M/M rebound in output was, unfortunately, revised down 0.5ppts to just 0.2%M/M. Annual growth was revised down 0.4ppts to just 0.2%Y/Y. As a result, even if firms’ forecast of a 2.7%M/M in September was to prove correct, this would leave output down 0.5%Q/Q in Q3. If firms’ forecast proves way too optimistic – as is typically the case – output is likely to have declined as much a 1¼%Q/Q (assuming no revisions).

Revisions elsewhere in the report were also unfavourable. In particular, growth in shipments was revised down 0.4ppts to 1.7%M/M, taking annual growth to just 0.5%Y/Y. Firms’ inventory levels were confirmed to have declined a modest 0.4%M/M in August – a third consecutive decline – but annual growth was revised up 0.1ppts to 3.0%Y/Y. The overall inventory ratio fell 2.1%M/M in August but annual growth was revised up 0.2ppts to 4.1%Y/Y – a statistic that thus continues to suggest that inventories will remain a weight on output in the near term at least. The new data released for the first time today concerned firms’ operating rate (i.e. capacity utilisation), which was reported to have increased 2.2%M/M but still be down 1.1%Y/Y. Despite increasing capital spending, productive capacity was reported to be unchanged for a third consecutive month and down 0.6%Y/Y.

More happily, the Reuters Tankan for October, based on a relatively small sample of just over 250 firms, reported a 2pt rise in the manufacturers’ diffusion index to a healthy +28 in October. The forecast index, which captures firms’ outlook three months ahead, also stood at +28. By contrast, the non-manufacturers index fell 9pts to +24, weighed down by the transport/utility and retail/wholesale sectors. The forecast index stood at +29, suggesting that firms expected some improvement over the next three months.

Looking ahead to the remainder of the week, the main focus will be Thursday’s external trade report for September (for which provisional data showed the value of exports up just 1.0%Y/Y but imports up a robust 17.2%Y/Y to leave the headline trade balance back in deficit) and Friday’s national CPI report for August (for which we expect the BoJ’s forecast core CPI measure (excluding fresh food) to rise 0.1ppt back to 1.0%Y/Y). The BoJ’s Regional Economic Report – the rough equivalent of the Fed’s Beige Book – is also released on Thursday. In the bond market, the MoF will auction 5-year JGBs tomorrow and 20-year JGBs on Thursday.

UK:
Brexit will continue to dominate attention this week, with Wednesday’s EU Council meeting the principal focus. EU27 leaders will discuss over dinner on Wednesday evening the state of the negotiations on the terms of the Brexit Withdrawal Agreement, and should decide then whether to hold a special summit on 17-18 November to try to reach a final deal or whether to use that event to prepare for a ‘no deal’ Brexit. Whether or not yesterday’s break-down in talks was sincere or not, the chances that no agreement will be reached by November certainly appear to have increased.  And even if there is an eventual breakthrough in the EU/UK talks, we continue to believe that the ratification of any deal through the UK Parliament represents the bigger obstacle to progressing smoothly to a Brexit transition next March.

While Brexit will gain the headlines, it will also be a busy week for top-tier UK economic data, kicking off with the latest labour market report tomorrow. With employment growth expected to have remained around zero in the three months to August, the unemployment rate is expected to have moved sideways at 4.0%, the joint-lowest rate for 43½ years. The latest developments in labour income might be of more interest, not least given that in the previous month average regular wage growth rose to its joint-highest rate since mid-2015 (2.9%3M/Y). The data focus on Wednesday, meanwhile, will be September’s inflation release. While CPI unexpectedly rose 0.2ppt to 2.7%Y/Y in August, we expect headline inflation to fall back to 2.5%Y/Y in the latest month. We also forecast core CPI to slip back to 2.0%Y/Y.

September’s retail sales figures, due Thursday, are likely to prove to be weaker than of late. The past week’s BRC retail sales monitor indicated a loss of momentum and a drop in September seems likely given the strength in the first two months of the quarter. But a drop of more than 4½%M/M in September would be required for retail sales to drop over the third quarter as a whole. Finally data-wise, Friday will bring the latest public sector finance figures. In addition, the BoE’s Governor Carney is scheduled to speak in New York on Friday, while Deputy Governors Broadbent and Cunliffe also have public engagements – the latter will appear before the Treasury Select Committee on Wednesday.

Euro area:
As well as Brexit, the European Council meeting should also see leaders discuss ongoing work on the development of the policy framework for the euro area. So, with the Commission now getting down to the business of studying member states’ draft budgetary plans, Italy’s proposals for a loosening of policy – which is just the thing to deter Germany and other Northern Europeans from bankrolling proposals for a euro area fiscal instrument and/or deposit insurance scheme – will no doubt be discussed, at least tangentially.

Data-wise, it should be a fairly quiet week for top-tier releases from the euro area with perhaps most notable Wednesday’s release of final euro area inflation figures for September. These are expected to confirm the flash estimates showing headline CPI rising 0.1ppt to 2.1%Y/Y, while core CPI declined 0.1ppt to 0.9%Y/Y. An upwards revision of 0.1ppt to the core rate, however, is possible. Wednesday will also bring new car registration figures for September and construction output data for August. Euro area trade numbers for August are due tomorrow along with the first insight into investor sentiment regarding the region’s largest member state at the start of Q4 with the German ZEW survey for October. In the markets, Germany will sell 2Y bonds on Tuesday, followed by 25Y bonds on Wednesday, while France and Spain will auction bonds with various maturities on Thursday.

US:
In the US, today brings the retail sales and federal budget reports for September, business inventories for August and the New York Empire manufacturing survey for October. In particular, we expect to see a solid retail sales report (0.6%M/M total sales, 0.4%M/M ex autos), supported by a pickup in sales of new autos as well as respectable growth in most other areas. Tomorrow, meanwhile, brings the August JOLTS report, September IP report and October NAHB housing index, followed by September housing starts and permits and the minutes from the September FOMC meeting on Wednesday. The Philadelphia Fed’s manufacturing survey for October will be released on Thursday, followed by existing home sales for September on Friday. In the bond market, the Treasury will auction 30-year TIPS on Thursday.

China:
There were no economic reports released in China today (at least so far – the September money and credit aggregates could be released at any time). Looking ahead to the remainder of the week, the September CPI and PPI reports take centre stage tomorrow but most interest this week will centre on Friday’s national accounts for Q3. Together with a number of high frequency activity indicators for September also due that day (e.g. IP, retail sales), the national accounts will cast light on how China’s economy is being impacted by US tariffs and related uncertainty. Our China economist expects GDP growth to have slowed 0.2ppts to 6.5%Y/Y – a forecast that is 0.1ppts more pessimistic than market expectations. Meanwhile, China will also release September home price data on Saturday.

Australia:
Australia’s economic diary was empty today. Looking out over the remainder of the week, tomorrow’s release of the minutes from the RBA’s September Board meeting should pass with the usual lack of fanfare given the absence of any notable developments in the post-meeting press statement. The only economic report of any market relevance this week is Thursday’s Labour Force survey for September. After posting a surprising 44k gain last month, Bloomberg’s survey suggests that the market expects a more trend-like 15k gain in employment in September, leaving the unemployment rate steady at 5.3%.

Looking ahead to the weekend, it is worth noting that a by-election will take place on Saturday in the seat of Wentworth, which was vacated following the ousting of former PM Malcolm Turnbull. Should the Liberal Party lose this seat – which is possible, but not the most likely outcome based on recent polls – the Government would lose its one seat majority. This would not necessarily lead to a General Election, however. Newly-installed PM Scott Morrison will likely want as much time as possible to build his profile with the electorate, suggesting that the most likely timing for the next election remains in May next year.

New Zealand:
New Zealand’s services PMI rose 0.6pts to 53.9 in September – an expansionary reading but still 0.6pts below the average recorded since this survey began in 2007. In the detail the activity/sales index rose 2.1pts to 56.1 (close to the survey average) but the new orders index fell 2.5pts to 56.1 (about 2.5pts below the survey average). Meanwhile, employment index fell 0.5pts to at 49.4, thus remaining below 50 for a fourth consecutive month (a run last seen 8 years ago).

Looking ahead to the remainder of the week, by far the most important report is tomorrow’s CPI result for Q3. According to Bloomberg, the market expects the CPI to have increased 0.7%Q/Q, raising annual inflation by 0.2ppt to 1.7%Y/Y. Such an outcome would be 0.3ppt above that forecast by the RBNZ in its August Monetary Policy Statement, albeit much of that difference is likely accounted for by high fuel prices (reflecting the rise in global crude prices and the weakness of the NZ dollar). A significant point of interest later in the day will be the publication of the RBNZ’s preferred “sectoral factor model” measure of core inflation, which rose to a 7-year high of 1.7%Y/Y in Q2. Once the CPI is out of the way, the only other report scheduled in New Zealand this week is Friday’s migrant and tourist count for September.

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