The week ahead, w/c 05 November

Chris Scicluna
Emily Nicol
Mantas Vanagas

Overview:
Momentum in US stocks went into reverse at the end of last week, with the S&P500 recording a 0.6% decline on Friday. That partly reflected weakness in technology stocks, as investors reacted to Apple’s disappointing guidance. But the very solid October employment report – with non-farm payrolls up 250k – saw Treasury yields move significantly higher with the 10-year yield rising 8bps to touch a one-month high of 3.22%. And speaking in Chicago, Larry Kudlow – Trump’s key economic adviser – played down the likelihood of a near-term deal China, saying that “…it will still be a long, tough process”.

Not surprisingly, that backdrop caused Asian equity markets to backtrack somewhat today. In China, the CSI300 is down about 0.8% – not helped by a disappointing Caixin services PMI – while Hong Kong’s Hang Seng is down a larger 2.3%. Neither market drew much comfort from critical remarks made by Chinese President Xi at a conference in Shanghai, as he warned that “As globalization deepens, the practices of law of jungle and winner take all are a dead end”. Meanwhile, after rallying less than most other markets on Friday, Japan’s TOPIX fell 1.55%, with little support offered by a firmer service sector PMI reading in October. There was little reaction to a speech by BoJ Governor Kuroda (more on all this and more below).

Looking ahead, the week is set to be dominated by events in the US, notably tomorrow’s mid-term elections and Thursday’s FOMC announcement. The week might well also bring a significant breakthrough in the Brexit negotiations between the UK and EU, should Theresa May’s cabinet members finally be able to agree a policy on the Irish border amongst themselves. And data-wise, after today’s services PMIs and Turkish inflation figures, notable releases include German IP and euro area retail sales (Wednesday) and the first estimate of UK Q3 GDP (Friday).

Japan:
A reasonably busy week for economic data in Japan kicked off today with the service sector and composite PMI reports for October. The good news is that overall business conditions in the service sector appear to have improved notably over the past month, albeit probably reflecting an element of catch-up after natural disasters weighed on activity through Q3. The headline business activity index rose 2.2pts to 52.4, marking the highest reading since April. Within the detail, the new orders index rose 1.9pts to 53.9 – the highest reading since the survey began in 2007 – whereas the future activity index rose a more modest 0.3pts to 55.8. Despite the generally improved tone of the survey, the employment index declined 1.1pts to 50.6. The news regarding prices was mixed, with the input prices index rebounding 1.3pts to 55.5 but the output prices index falling 0.8pts to a four-month low of 51.2. Combining today's results with this month’s slightly improved results from the manufacturing sector, the headline composite PMI output index rose 1.8pts to a-six-month high of 52.5 – payback from the 2-year low recorded last month. The composite output prices index was unchanged at 52.3, with today's weaker reading in the service sector balanced by a stronger reading from the manufacturing sector.

In other news, BoJ Governor Kuroda gave a speech to business leaders in Nagoya – one that largely stuck to the script offered by last week’s revised Outlook Report, but with Kuroda also offering broad anecdotes from the Bank’s businesses contacts to back up its latest economic forecasts. As regards monetary policy, Kuroda noted that in light of the Bank’s July policy tweaks there had been a significant decline in the number of respondents holding the view that the Bank will raise policy rates in the near future – a development that suggested that the Bank’s forward guidance is working. In the JGB market, Kuroda also stated that market functioning had improved, with both spot and futures transactions somewhat more active, and day-to-day price movements increasing since the Bank’s July policy decision.

As regards financial risks associated with the Bank’s monetary policy, Kuroda acknowledged potential impacts on financial system stability as well as the functioning of financial intermediation. In keeping with the recent Financial System Report, he argued that these risks are judged as not significant at this point but said that the Bank would be paying close attention in the future. Summing up, he concluded that “Japan's economic activity and prices are no longer in a situation where decisively implementing a large-scale policy to overcome deflation was judged as the most appropriate policy conduct, as was the case before.” However, he continued by noting that “….it has been taking time to achieve the price stability target of 2 per cent. In such a situation where economic and price developments have been somewhat varied, it has become necessary to persistently continue with powerful monetary easing while considering both the positive effects and side effects of monetary policy in a balanced manner.”

Looking ahead to the remainder of this week’s diary, tomorrow we will receive MIC’s household spending survey for September – unfortunately an unreliable indicator of the national accounts measure of private consumption. On Wednesday the BoJ’s Consumption Activity Index will provide a more accurate picture of consumer spending in September (the Cabinet Office Synthetic Consumption Index – more accurate still – will likely follow a few days later) while the Monthly Labour Survey will cast light on developments in labour incomes during September. On Thursday the focus will be on the machinery orders report for September, with core orders highly susceptible to a pull-back given the strong growth reported over the previous two months. The same day, the BoJ will release the Summary of Opinions from the past week’s Board meeting, along with the October bank lending and September Balance of Payments reports. Thursday will also bring the Cabinet Office Economy Watchers survey for October, with the previous month’s surprisingly resilient readings likely to be challenged given recent developments in financial markets. The BoJ’s October money supply data completes a busy diary on Friday. In the bond market, the MoF will auction 10-year inflation-indexed bonds on Tuesday and enhanced liquidity (maturities of 1-to-5 years) on Thursday.

UK:
The weekend brought plenty of media reports suggesting progress in the UK’s Brexit negotiations with the EU, with some talk that Theresa May’s cabinet will discuss a draft deal this week with an eye to reaching full agreement at a special Summit later this month. Other reports, however, suggest that there is still plenty of work to do. And it still seems questionable whether Theresa May’s cabinet members will be able to agree among themselves if and when the UK and EU sides reach agreement.

Nevertheless, the key elements likely to be in any agreement on the Irish backstop, which aims to avoid a hard border in Ireland if no new arrangement can be found be found after the transition period (presumably from end-2020), have certainly become clearer. Most notably, the deal would likely see the legally-binding Withdrawal Agreement include the outline of a “bare-bones” customs union covering the whole of the UK, to apply after the transition period (presumably from end-2020). So, while Great Britain would leave the single market for goods at end-2020 – something that would still imply significant non-tariff barriers and major costs for manufacturers – it would continue to apply the same tariffs as the EU on imports from outside the Union, and at the same time would eschew the right to agree new deals on goods trade with third countries. The UK’s freedom of manoeuvre on a range of other policy areas, including state aid, taxation, labour and environmental standards, could also be constrained.

Moreover, as Northern Ireland would stay in a full customs union, applying the whole of the EU’s “customs code” and following single market regulations for goods and agri-food products, there would remain the need for extra regulatory and VAT checks on shipments between Northern Ireland and Britain, so a harder border would be implemented down the Irish Sea – something that the Northern Irish DUP, upon whose support Theresa May relies to pass legislation in the UK parliament, has been vehemently opposed.

So, while the deal to be discussed might well allow May to break the impasse with her EU interlocutors, it would undeniably imply significant extra economic and political costs, and with little evidence of the UK taking back the control that the ‘Leave’ campaign promised voters in the referendum.  New reports this morning that the Brexit Secretary Dominic Raab is advocating the need for an exit clause to allow the UK to withdraw from any backstop plan at just three months’ notice – something that won’t be a runner in Brussels not least as the UK government previously accepted that arrangements should run “’unless and until’ a close future relationship eliminates any need for border infrastructure or related checks and controls” – illustrate the difficulty May is likely to face getting her Cabinet to line up behind any agreement.

Beyond Brexit, the UK’s data calendar this week kicks off with the remainder of the October PMIs with the services and composite indices due this morning. The services headline PMI has been moving broadly sideways this year fluctuating around the level of 54. A decline of about ½pt to 53.4 is expected this time around. But, following the sharp deterioration in the manufacturing survey, the risks around that estimate are skewed to the downside. And the composite PMI index looks set to fall from 54.1 in September, perhaps to the lowest since 2016.

At the back end of the week, we will receive the first estimate of Q3 GDP. We expect growth to have accelerated slightly from 0.4%Q/Q in Q2 to 0.5%Q/Q, although the risks to that forecast look to be skewed to the upside. Retail sales increased notably that quarter, while new car sales also provided a positive contribution. And while business investment is set to have remained subdued against the backdrop of Brexit-related uncertainty, net trade seems to have provided a positive contribution to growth for the first time in three quarters. Alongside the GDP data we will receive the usual monthly activity indicators for September and trade figures for that month too. Ahead of that on Thursday, the RICS Residential Market survey is due, while tomorrow will see more details about the retail sector performance last month from the latest BRC Retail Sales Monitor. 

Euro area:
After a day with no top-tier euro area figures today, tomorrow will bring the final October services and composite PMIs for the euro area and member states. And like last week’s manufacturing survey, the headline euro area indices are expected to broadly align with the flash estimates, with the services and composite PMIs down 1.4pts to 53.3 and 52.7 respectively, both their lowest readings for more than two years. Wednesday, meanwhile, will provide more insight into euro area household consumption in the third quarter, with September’s retail sales figures expected to post a modest increase on the month (0.1%M/M) following two months of decline.

With respect to national data, Germany’s industrial sector will be back in focus with September factory orders and IP data due on Tuesday and Wednesday respectively, with the latter expected to post a fall for the fourth consecutive month to leave industrial output down almost 1½%Q/Q in Q3. German and French September trade reports are due on Thursday, alongside Spanish IP figures for the same month, while French IP data are due Friday. In addition, on Thursday the European Commission will publish updated economic forecasts. In the markets, Germany will sell 10Y bonds on Wednesday, and France and Spain will auction bonds with various maturities on Thursday.

US:
The main focus this week will be the US, with tomorrow’s mid-term elections and Thursday’s post-FOMC announcement. Regarding the former, polls indicate that the Democrats will most likely win over the House but that the GOP will retain control of the Senate. As far as the Fed is concerned, given that there is little prospect of an actual change in policy settings, investor interest will centre on the accompanying short statement to see whether there is any sign that recent financial market developments might cause the Fed to refrain from tightening policy at the subsequent December meeting.

The remainder of the economic diary is very sparsely populated, as is typical in a month where the official employment report has been released early. The non-manufacturing ISM and Markit services PMI for October will be released today, followed by the September JOLTS survey tomorrow and September consumer credit on Wednesday. On Friday we will receive the PPI for October, along with the preliminary results of the University of Michigan’s consumer survey for November and final wholesale inventory data for September. At this stage there are no Fed speeches scheduled and the corporate earnings season will begin to wind down from the hectic pace seen over the past fortnight. However, a busy week for Treasury bond issuance includes auctions for 3-year notes today, 10-year notes tomorrow and 30-year bonds on Wednesday.

China:
The only economic report released in China today was the Caixin service sector PMI for October, which confirmed the weakening of conditions that had been indicated by the earlier official PMI report. Indeed, the headline services index fell a sharp 2.3pts a 13-month low of 50.8, with the detail generally weaker too. Most worryingly, the new orders index slumped 2.3pts to 50.1 – the weakest outcome since November 2008. However, the future activity index declined a much more modest 0.4pt to 57.8, and so remains well above this year's low of 55.2 recorded in July. In addition, after slumping last month, the employment index rebounded 2.1pts to 51.0. The pricing indices were mixed this month, with the input prices index falling 1.5pts to 53.3 but the output prices index rising 0.8pt to 50.7. Combined with information from the manufacturing sector (where the headline index had increased just 0.1pts to 50.1), China’s Caixin composite output index fell 1.6pts to 50.5 – the weakest outcome since June 2016 – and the composite future output index fell 0.6pt to 55.5.

Looking out over the remainder of the week, the key focus will be Thursday’s external trade data for October, followed a day later by the CPI and PPI reports for October (it is possible that the money and credit aggregates for October could be released as soon as the weekend). The former, in particular, will be of interest as investors attempt to gauge the impact of US tariffs. That said, with national holidays making for a short month – thus adding to the potential for volatility – and US buyers likely front-running tariffs decisions, it remains the case that the full impact of current tariff policy is unlikely to be apparent until early next year. According to Bloomberg’s survey, the market expects China’s export growth to slow to 12.0%Y/Y from the surprisingly firm 14.5%Y/Y growth recorded in October. 

Australia:
There were a number of lower tier economic reports released in Australia today. The final CBA services PMI reading for October printed at 51.7 in October – down 0.5pts for the month but 0.9pts above the flash estimate. In combination with results from the manufacturing sector, the headline composite PMI also fell 0.5pts to 52.0, matching the August outcome as the lowest recorded in the survey’s short 2½ -year history. The much longer-running but more volatile AiG services index fell 1.4pts to a similarly lacklustre 51.1 in October, marking the lowest reading since February last year.

In other news, the ANZ job ads index rose a slight 0.2%M/M in October, causing annual growth to slow to 3.6%Y/Y from 4.7% Y/Y previously (that said, the RBA have played down this indicator of late given the rising importance of other means of advertising, including social media). In inflation news, the Melbourne Institute of Applied Economic and Social Research monthly inflation gauge rose just 0.1%M/M in October, causing annual inflation to decline to 1.9%Y/Y – the slowest pace since December 2016.

Looking out over the remainder of the week the main focus will be on the RBA. That said, notwithstanding last week’s slightly weaker-than-expected CPI report, it seems unlikely that the Bank will materially alter its long-held stance that the next move in policy is likely to be a hike, albeit probably not for some time. The outcome of the Bank’s latest Board meeting will be announced tomorrow. Given that there is virtually no chance of a change in the Bank’s cash rate (which has sat at 1.5% since August 2016), the main focus for investors will be on the accompanying short policy statement which may foreshadow modest changes to the forecasts that the Bank will present in the quarterly Statement on Monetary Policy on Friday. It is worth noting that in recent months the unemployment rate has tracked slightly lower than the RBA had expected, providing some counter to a Q3 CPI report that may have been on the soft side of the RBA’s expectations (but not clearly inconsistent with the RBA’s year-end forecast). 

New Zealand:
There were no major economic reports in New Zealand today. Looking out over the remainder of this week there are two key diary entries of note: the Q3 labour market report (released on Wednesday) and the RBNZ’s final OCR review and Monetary Policy Statement for this year (Thursday). Regarding the former, while some business sector surveys have pointed to much-reduced hiring intentions, job advertising has remained firm. Perhaps as a result, Bloomberg’s survey indicates that the market expects household employment to have grown a solid 0.5%Q/Q – the same as in Q2 – and the unemployment rate to have fallen 0.1ppts to 4.4%. At least as important will be developments in wages, with the market expecting private sector labour costs to have increased 0.5%Q/Q in Q3 (this measure can be thought of as a proxy for unit labour costs).

A day later the RBNZ will doubtless decide to keep the OCR at 1.75% – a level it will have occupied for two years. But with the recent Q2 GDP and Q3 CPI reports proving much stronger than the RBNZ had expected – indeed headline outcomes were at least double the RBNZ’s expectation – there is more uncertainty about whether the RBNZ will retain its view that the direction of the next OCR move could be up or down. Regardless of whether that near-term neutrality is retained, it is likely that the Bank’s central economic projection will show a first rate hike slightly sooner than the H220 timing indicated in the August Monetary Policy Statement.

As far as the remainder of this week’s Kiwi diary is concerned, there will be some interest in the inflation forecasts contained in the RBNZ’s quarterly Survey of Expectations, released on Wednesday. On Friday we will receive the Electronic Card Transactions report for October (the key monthly indicator of consumer spending), together with the ANZ Truckometer for October (a traffic flow indicator that tracks overall economic activity).

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