The week ahead, w/c 10 December 2018

Chris Scicluna
Emily Nicol

Overview:
After staging a remarkable recovery on Thursday, Wall Street faced renewed downward pressure on Friday, reacting to a combination of a slightly weaker-than-expected gain in non-farm payrolls, ongoing worries about the state of US-China relations (and thus the prospects for a negotiated solution to the trade dispute) and perhaps broader uncertainty about the future of the Trump presidency. By the close the S&P500 was down 2.3%, taking its loss for the week to 3.8% – this following a 4.9% recovery the prior week – while credit spreads had widened and the Treasury yields fallen (the 10-year yield closing the week at 2.85%).

The weekend news flow out of China has done little to assuage investor worries. Newswires reported that China’s Vice Foreign Minister had summoned the US ambassador to China, Terry Branstad, to explain last week’s arrest of Huawei CFO, Meng Wanzhou. In addition, China’s November trade data revealed growth in exports and imports that fell far short of market expectations (see below), adding to concerns about the outlook for the Chinese economy. Further adding to the market’s woes today was a larger-than-expected downward revision to Japan’s GDP growth in Q3, with the economy now estimated to have endured its worst quarter since Q214 i.e. the quarter that followed the last hike in the consumption tax rate (more on this data below).

Not surprisingly, therefore, Asian equity markets have made a very rough start to the new week, especially with US equity futures also opening down 0.8%. In Japan the TOPIX fell 1.9% – threatening this year’s October low – as a modest risk-aversion driven strengthening of the yen added to the worries created by the revised GDP report. Australia’s ASX200 fell an even greater 2.3%, to close at its lowest level in two years. Elsewhere declines of 1-1.5% were seen in mainland China, Hong Kong, South Korea and Singapore. In the bond market the US 10-year Treasury yield remains close to 2.85% and the 10-year JGB yield rallied to a new low of just 0.04% – now back to where it stood just before it began to pre-empt the tweak to policy settings that the BoJ announced at the end of July.

Moving to Europe, ahead of tomorrow’s scheduled House of Commons ‘meaningful vote’ on the Withdrawal Agreement and Political Declaration, this morning’s ECJ judgement on Brexit has confirmed last week’s initial opinion that the UK could unilaterally decide to revoke its Article 50 notice should Parliament so decided. With Theresa May currently looking set for heavy defeat, she’ll supposedly decide later today whether to press on with the vote. Other highlights of a busy week include the ECB’s latest policy announcement and forecasts on Thursday, an EU summit, and plenty of top-tier economic data including UK monthly GDP (today), US CPI (Wednesday), flash euro area PMIs (Friday) and BoJ Tankan (also Friday).

Japan:
A busy week for economic data in Japan kicked off today with the second release of the national accounts for Q3. Unfortunately, the downward revision to growth proved even larger than expected, with Japan’s contraction now estimated at 0.6%Q/Q (2.5% annualised) – twice as large as suggested by the preliminary estimate. Moreover, growth in Q2 was revised down 0.1ppts to 0.7%Q/Q. And while there was an upward revision to growth at the end of last year – so that annual GDP growth was revised down just 0.3ppts to 0.0%Y/Y – downward revisions in deeper history meant that the level of real GDP in Q318 was a cumulative 0.6% lower than estimated previously. While adverse weather and the Hokkaido earthquake clearly had a negative bearing on Q3, it is difficult to escape the conclusion that recent underlying momentum in the economy appears to have been no faster than Japan’s low trend rate, at best, rather than the above-trend growth that the BoJ has been seeking. Indeed, even if GDP growth was to rebound to 0.5%Q/Q in both Q418 and Q119, assuming no further revisions, the economy would only grow 0.7%Y/Y in FY18 – half of the pace forecast by the BoJ in the last Outlook Report. The disappointing news at the headline level flowed through to real gross national income (RGNI), which better measures residents’ spending power. This aggregate fell an even greater 1.0%Q/Q in Q3 and was down 0.9%Y/Y, reflecting a decline in investment income receipts from the rest of the world and an increase in investment income outflows.

Turning to the detail, the largest source of revision related to non-residential investment, which is now estimated to have declined 2.8%Q/Q in Q3 – a far cry from the mere 0.2%Q/Q decline estimated in the preliminary report – and lowered annual growth in investment to just 1.2%Y/Y from 6.7%Y/Y in Q2. The decline in capex was broad-based, but was led by a 4.7%Q/Q decline in spending on transport equipment (albeit still up 2.5%Y/Y) and a 3.1%Q/Q decline in spending on non-transport machinery investment (now down 0.9%Y/Y). Spending on buildings fell 2.5%Q/Q while that on intellectual property fell 0.6%Q/Q. Elsewhere in the accounts, private consumption spending was also revised down 0.1ppts to a 0.2%Q/Q decline, while public investment spending was revised down 0.1ppts to now report a 2.0%Q/Q decline. Residential investment spending was revised up 0.1ppts to report a 0.7%Q/Q increase while public consumption spending rose an unrevised 0.2%Q/Q in Q3. There was no revision to net exports, which continued to make a 0.1%Q/Q negative contribution to growth, but private inventories were revised higher and are now estimated to have made no contribution to growth in Q3 – better than the 0.1ppt negative contribution estimated in the preliminary report.  

The revisions to the volume aggregates discussed above are responsible for most of the revisions to the current price estimates. Nominal GDP is now estimated to have contracted 0.7%Q/Q in Q3 to be 0.3% lower than a year earlier – clearly not consistent with PM Abe’s aim of presiding over a ¥600tn economy (nominal GDP amounted to just under ¥547tn in Q3). The implicit GDP deflator fell 0.1%Q/Q – revised down 0.1ppts – and was down 0.3%Y/Y. The domestic demand deflator rose an unrevised 0.3%Q/Q and 0.7%Y/Y, however. Elsewhere in the accounts, following two quarters of solid growth, compensation of employees rose an unrevised 0.1%Q/Q in Q3, although annual growth was revised up 0.2ppts to 2.7%Y/Y. In real terms, compensation fell 0.4%Q/Q but rose 1.8%Y/Y – the latter a little below the average pace recorded over the past three years but still much faster than 0.6%Y/Y lift in consumer spending. In that regard, over the past year the BoJ’s much vaunted ‘virtuous circle’ from income to spending does not appear to have operated with the desired force.

With the Q3 result now consigned to history, the focus for investors now is on trying to determine the magnitude of an expected rebound in activity in Q4 – doubtless also a key focus for the BoJ as it prepares for next week’s Board meeting. In that regard, today also saw the first of this week’s important survey-based indicators with the release of the Cabinet Office Economy Watchers survey for November. Thankfully, the news was more encouraging, with the overall current conditions index rising an unexpected 1.5pts to 51.0, marking the best result since December 2017. As with the improvement recorded in the previous month, the stronger reading was driven by the household sector index which rose a sharp 1.7pts to 50.6 (also the highest reading since December last year). By contrast the business sector index rose just 0.3pts to 50.0, with the reading for the manufacturing sector rising 1.0pts to 50.2 – the best since April, and somewhat at odds with last week’s Reuters Tankan survey. Looking forward, the overall expectations index – which tries to gauge the direction of conditions over the next month or so – rose a similarly encouraging 1.6pts to 52.2, marking the highest reading since January. The household sector index rose 1.6pts to 52.5, while the business sector index rose 1.1pts to 50.2 – a modest recovery following the 3.0pt slump see in October. Needless to say, developments in the US-China relationship and financial markets over the past week pose the risk of a pullback in the survey next month.

Looking ahead to the remainder of this week’s diary, the focus will remain on trying to gauging the size of the likely rebound in activity in Q4, together with prospects for the early part of next year. In that regard, there will be plenty of interest in tomorrow’s MoF/Cabinet Office Business Outlook Survey and – most importantly of all – Friday’s BoJ Tankan survey for Q4. As far as the Tankan is concerned, a modest decline in the key diffusion indices would be consistent with our view that the economy’s growth outlook is a little slower than that seen in recent years, not least due to biting capacity constraints. The week’s other key report is the October machinery orders survey on Wednesday – of particular interest given the record 18.3%M/M slump in core private orders reported in September and the pullback in capex now reported in the Q3 national accounts. The Tertiary Activity Index for October is also released on Wednesday, followed by the final IP report for October on Friday. The Cabinet Office Synthetic Consumption Index for October should also make an appearance at some point during the week. The only inflation data due this week will come from Wednesday’s goods PPI report for November, which should begin to reflect the recent slump in global oil prices. In the bond market, the MoF will auction 30-year JGBs tomorrow and 5-year JGBs on Thursday.

Euro area:
The main event in the euro area this week will be the conclusion of the ECB’s latest policy meeting on Thursday. This will give Draghi an opportunity to acknowledge the recent deterioration in the performance of the euro area economy, not least as the Governing Council will discuss new Eurosystem macroeconomic projections, which will incorporate a view about 2021 for the first time. Since the last projections were published in September, Q3 GDP data surprised significantly on the downside, with euro area growth of just 0.2%Q/Q representing the weakest quarter since 2013 and just half the ECB’s central forecast. Most surveys have suggested a further loss of momentum in Q4 while the global outlook appears to have clouded too. So, while the lower oil price might be expected to provide some extra support to future demand, the ECB’s central euro area GDP growth forecasts will need to be revised down from 2.0%, 1.8% and 1.7% in 2018, 2019 and 2020 respectively. Core inflation has also recently come in weaker than policymakers had expected. And so, given also the marked decline in oil prices and softer growth outlook, despite a pickup in labour costs, the ECB will also need to revise down its forecasts for headline inflation from 1.7% in each year from 2018 to 2020.     

Recognition from Draghi that the economic outlook has deteriorated somewhat, and that the external risks to the outlook are skewed to the downside, would suggest an increased probability that the ECB will not manage to raise rates at all in 2019. Nevertheless, on this occasion, the ECB might be unwilling to amend significantly its main forward guidance, likely restating that its key interest rates are expected “to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary”. And certainly, the ECB is bound to confirm the end of net asset purchases at the end of this month. However, as it has been reviewing its reinvestment policy, greater flexibility might be introduced into the rules governing that process, e.g. with respect to the time that national central banks have available before reinvestments of maturing principal have to be completed. The ECB might also provide a reminder that maturing proceeds will be reinvested in full until rates have been hiked to well above current levels. And the recent revisions to the capital key will have no significant impact. Finally, Draghi might signal that, over coming months, the ECB will review options regarding its liquidity provision, not least given the need, by June 2019, to announce new very long-term refinancing operations to mitigate the impact of the scheduled redemptions of loans conducted under the first TLTRO-II operation.

In terms of other policy, the latest European Council meeting kicks off on Thursday with heads’ discussions to include a first exchange of views on the next EU budget. And the Euro Summit on Friday will discuss measures to ‘deepen EMU’, i.e. strengthen the policy framework for the single currency, including reform of the ESM bailout fund, banking union, and (where progress is likely to be minimal) possible budgetary instruments for the euro area. Meanwhile, although Italy’s lower house approved the budget bill in a confidence vote on the weekend, detail on contentious policy priorities remains to be agreed, with reports suggesting the cabinet will meet today to discuss costings of the guaranteed minimum income plan and pension reforms.

Data-wise, this morning’s German goods trade report for October saw the seasonally adjusted trade surplus narrow very slightly to €17.3bn. Despite a pickup in the value of exports (0.7%M/M), import growth was again stronger (1.3%M/M) suggesting that net trade remained a drag on GDP growth at the start of Q4. In France, meanwhile, the latest Bank of France business survey signalled a further loss of momentum in the manufacturing sector in November, with the headline index down to 101, still above the long-run average but nevertheless a six-month low. In contrast, sentiment among services and construction firms was little changed. So, the Bank of France assessed today’s survey to be consistent with GDP growth of 0.2%Q/Q in Q4, half the pace recorded in Q3.

Looking ahead, the most notable new releases arguably come on Friday, with the flash December PMIs, Q3 labour cost figures, and final Italian and Spanish inflation numbers for November. Should the euro area composite PMI come in close to November’s reading of 52.7, the Q4 average will be the weakest since 2014 strongly suggestive of another subdued quarter of GDP growth. Among other data due this week,

Wednesday brings reports for euro area IP in October and employment in Q3. In the markets, Germany will sell 2Y Schatz tomorrow, while Italy and Spain will sell bonds on Thursday.

UK:
All eyes in the UK will be on tomorrow evening’s scheduled House of Commons ‘meaningful vote’ on the Withdrawal Agreement deal. All indications so far are that the Prime Minister will face a substantive defeat if the vote goes ahead as planned. But while several Cabinet members and loyal Conservative backbenchers have thus advised her to postpone it, reports suggest that May remains determined to carry on regardless.  In keeping with the shambolic nature of her management of the Article 50 process, May herself probably doesn’t even know yet whether she intends to press on with the vote, nor what her strategy will be if and when she loses.

Of course, if she’s defeated in the vote by a very significant margin, say by more than 100 votes, her future as PM would be in question. But given the legislation, whoever is Prime Minister would have 21 days to present an alternative plan for Brexit. Assuming May remains in office, we would expect her intentions to be made clear sooner rather than later, not least to facilitate a further vote next week. Nevertheless, on Thursday, she is set to attend the European Council summit in Brussels, where she might be expected to sound out the EU27 leaders over the possible ways forward. It is worth reminding, however, that following the government’s defeat on a motion in the House of Commons last week, her proposal for next steps would be amendable by Parliament, so MPs would have scope to direct the government to take a certain action, which could involve a second referendum or an attempt to renegotiate the Brexit deal to facilitate future Norway-style EEA membership, enhanced with a customs union. (There was no surprise this morning when the ECJ confirmed, in a final judgement, the Advocate General’s initial opinion of last week that the Article 50 notice could be revoked unilaterally by the UK if Parliament so decides.)

In addition to the Brexit drama, this week will bring a few top-tier data releases, including key output indicators for October today, and the labour market figures tomorrow. With the latest sentiment surveys having taken a turn for the worse, the data seem likely to be consistent with a loss of economic momentum at the start of Q4. Indeed, having moved sideways in the previous two months, the monthly GDP estimate is set to show another weak reading – we expect an increase of just 0.1%M/M. Meanwhile, the labour market figures are unlikely to bring much more positive news. In September we saw a small increase in employment of slightly more than 20k3M/3M, and the rise in October is unlikely to be any more significant. The headline unemployment rate looks set to remain unchanged at 4.1%, while average hourly earnings growth should also be very similar to the rate of 3.0%3M/Y (3.2%3M/Y excluding bonuses) seen in September. Beyond these releases, the RICS Residential Market survey, due on Thursday, will be worth a look too.

US:
Turning to the US, this week’s diary begins quietly today with just the JOLTS jobs report for October. Tomorrow, the headline PPI inflation figures for November will be weighed down by the slump in energy prices, as will Wednesday’s headline CPI for November. The expected 0.2%M/M increase in the core CPI would likely nudge the respective annual inflation rate back up 0.1ppt to 2.2%Y/Y, however. Finally, on Friday the retail sales and IP reports for November will cast further light on how activity is tracking during Q4, with October business inventory data and the little-followed flash December PMIs also released that day. With the 18-19 December FOMC meeting looming there are no Fed speaking engagements over the coming week. In the markets, the US Treasury will issue 3Y notes tomorrow, 10Y notes on Wednesday and 30Y bonds on Thursday.

China:
Over the weekend China released its trade and inflation reports for November. Beginning with the former, China’s trade surplus widened to a much greater-than-expected $44.7bn from $35.0bn previously. Negative surprises were seen on both sides of the ledger, but were largest with regards to imports where growth slowed to just 3.0%Y/Y from 20.8%Y/Y previously – a far greater deceleration than the market had expected. Growth in exports also disappointed, slowing to just 5.4%Y/Y from 15.5%Y/Y previously – the weakest outcome in almost two years when distortions associated with the Chinese New Year holiday are excluded. Looking at the export data by region, exports to the US rose 9.8%Y/Y, down slightly from 13.2%Y/Y last month, but likely continuing to benefit from a front-loading of orders in advance of possible further increases in tariffs. Exports to the EU rose 6.0%Y/Y, down from 14.6%Y/Y previously, while exports to Japan rose 4.8%Y/Y, down from 7.9%Y/Y previously. Meanwhile, China’s import data also provided some early pointers on the yet-to-be reported export performance of some of its key trading partners. For example, imports from Japan rose fell 1.3%Y/Y in November, pointing to no growth when measured in yen terms – the weakest outcome since June. By contrast, China’s imports from the US slumped 25.0%Y/Y – a result that will greatly displease President Trump. As a result, China’s bilateral surplus with the US stood at $35.6bn in November – a new record high.

Turning to inflation, the headline CPI fell 0.3%M/M, in November lowering annual inflation by a greater-than-expected 0.3ppts to 2.2%Y/Y. Food price inflation eased to 2.5%Y/Y from 3.3%Y/Y previously. While non-food inflation fell 0.3ppts to 2.4%Y/Y, this reflected the influence of lower energy prices. Service sector inflation was steady at its prior 2-year low of 2.1%Y/Y. Excluding food and energy, annual inflation was also steady at 1.8%Y/Y. Moving further up the production pipeline, the headline PPI index fell 0.2%M/M in November, causing annual inflation to decline by 0.6ppts to 3.3%Y/Y – an outcome that was in line with market expectations. For producer goods, annual inflation in the manufacturing sector eased a further 0.3ppts to 2.2%Y/Y. Consumer goods prices rose 0.8%Y/Y, up 0.1ppts from October, with prices for consumer durables declining 0.1%Y/Y.

Looking ahead, the key day in China as far as data is concerned is Friday, when we will receive the remainder of China’s key activity indicators for November. Bloomberg’s survey indicates that analysts expect IP growth to be steady at 5.9%Y/Y, but that growth in both retail spending and capex will improve marginally from their October readings. China will release home price data for November on Saturday while the November money and credit aggregates should make an appearance towards the end of this week.

Australia:
The only economic report in Australia today concerned housing finance approvals in October. The ABS reported that the number of home loan approvals rose a surprising 2.2%M/M. Excluding the refinancing of existing dwellings, the number of approvals rose 2.3%M/M – the first positive growth reported since May. The value of those loans rose 4.8%M/M but was still down 6.0%Y/Y. The stock of outstanding residential loans at all ADI’s rose 0.3% M/M and 4.5%Y/Y (investor loans rose 0.6%Y/Y while owner-occupier loans rose 6.4%Y/Y).

In other news, RBA Assistant Governor Chris Kent gave a speech in Sydney in which he discussed how monetary policy decisions taken elsewhere influence interest rates in Australia. Kent noted that Australia retains a substantial degree of monetary policy autonomy by virtue of its floating exchange rate. And while Australian banks raise significant amounts of funding in offshore markets (albeit less than used to be the case), he noted that banks are able to insulate themselves – and thus Australian borrowers – from changes in interest rates in other jurisdictions. As far as the outlook for domestic monetary policy is concerned, during the Q&A Kent stuck to the RBA’s well-worn script. According to Kent, “What we’ve been saying for a while now is we’re making some progress on bringing down the unemployment rate and lifting the inflation rate, but it’s gradual, so the next move is likely to be up, but not anytime soon”.

Looking out of the remainder of this week, an update on business sentiment will be provided by tomorrow’s NAB business survey for November, while and consumer sentiment will follow a day later with the release of the Westpac confidence index for December. This week’s other releases include the ABS quarterly house price index for Q3, released tomorrow, and the flash December PMI readings, released on Friday. 

New Zealand:
The only economic report released in New Zealand today was the quarterly manufacturing survey for Q3, which provided further pointers on activity ahead of the release of the national accounts next week. The overall volume of manufacturing sales fell 1.6%Q/Q, weighed down by a 6.7%Q/Q decline in sales in the meat and dairy product sector. However, Statistics New Zealand uses directly measured production data when estimating GDP for this sector, rather than sales data from this survey. Core manufacturing sales, which exclude the meat and dairy sector, rose a modest 0.2%Q/Q and 1.4%Y/Y in volume terms in Q3, assisted by a 7.0%Q/Q rebound in sales in the chemicals & plastics sector after a maintenance shutdown weighed on sales last quarter. Core manufacturing finished goods inventories rose 1.1%Y/Y following a 0.2%Y/Y decline in Q2. So all up it appears that the core manufacturing sector will make only a small positive contribution to GDP growth, adding to signs that the economy has expanded at a pace far slower than the 1.0%Q/Q growth registered in Q2, and probably slower than the RBNZ pegged in last month’s Monetary Policy Statement.

Looking out over the remainder of the week, tomorrow sees the lease of the Electronic Card Transactions report for November – the key monthly indicator of non-cash consumer spending. On Thursday the Government will release its Half-year Economic and Fiscal Update, providing a progress report on how the economy and fiscal outlook has evolved since the Budget forecasts issued back in May. An already strong fiscal outlook has been helped by a much larger-than-expected surplus in FY17/18, although we imagine that some of gains will be pegged back in the current fiscal year. The manufacturing PMI for November will be released on Friday and the REINZ housing report for November will also like make an appearance towards the end of the week. 

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