The week ahead, w/c 3 December 2018

Emily Nicol
Mantas Vanagas

Overview:
Wall Street rallied on Friday, with both the S&P500 and DJI gaining a further 0.8%, as investors looked forward to the weekend’s Trump-Xi meeting with guarded optimism, the Chicago PMI impressed and 10-year Treasury yields closed below 3% (2.99%) for the first time since mid-September. Subsequently the Trump-Xi meeting appears to have de-escalated tensions for at least the next three months, with the leaders agreeing that there will be no new tariffs imposed over the next 90 days while intensive negotiations take place to break the current impasse. This also means the deferral of the scheduled increase on 1 January of the tariff rate applied to USD200bn of Chinese goods, although the White House has stated that it will be implemented after the 90-day period ends if no progress has been made (which remains a strong possibility).

For investors this outcome is just about as positive as might reasonably have been expected, and was met on the open by an immediate weakening of the yen and a rebound in commodity-sensitive currencies. As they have reopened, other markets have also expressed a “risk-on” tone. US equity futures have rallied 1½% and the 10-year Treasury yield has bounced 6bps to 3.04%. In Asia, China’s CSI300 has rallied 2.8%, with the Hang Seng +2.4 and TAIEX +2.5% not far behind. And on a day when the MoF’s corporate survey indicated that Japan’s GDP likely contracted by more in Q3 than the 0.3%Q/Q first estimated (more on this below), a weaker yen facilitated a further 1.3% rally in the TOPIX – a 7th consecutive advance. Australia’s ASX200 likewise rebounded 1.8%, more than erasing Friday’s sharp losses. In other markets, crude oil rallied 5%, further helped by news that Saudi Arabia and Russia had agreed to extend their OPEC+ arrangement to help manage the market (OPEC will meet in Vienna on Thursday and Friday). Canada’s Alberta also announced a production cut of 325k b/d.

Japan:
The domestic focus in Japan today was on the release of the MoF corporate survey for Q3 which, amongst other things, contained information that will be used by the Cabinet Office to drive the final estimates of Q3 GDP growth that will be published next Monday. In summary, while the survey continued to paint a better-than-average picture of the corporate sector, most of the key aggregates suffered much greater-than-expected payback from the very strong outcomes recorded in Q2 – a development that, at least in part, doubtless reflects the disruption to activity caused by Mother Nature during the quarter. In light of these results the forthcoming MoF Business Outlook Survey and BoJ Tankan Survey – both released next week – will take on added interest as indicators of how businesses perceive the near-term outlook.

Turning to the detail, of particular note, respondents indicated that their capex (excluding software) fell a much greater-than-expected 4.0%Q/Q in Q3 following a revised 6.1%Q/Q increase in Q2. As a result, annual growth in spending slowed to 2.5%Y/Y from 14.0%Y/Y previously – a far cry from the double-digit growth that had been expected by the market. Spending in the manufacturing sector fell 5.3%Q/Q while spending in the non-manufacturing sector fell 3.3%Q/Q. Growth in total capex spending also slowed to 4.5%Y/Y from 12.8%Y/Y previously. The preliminary national accounts estimated that real private non-residential investment fell a comparatively modest 0.2%Q/Q in Q3, so today’s report strongly suggests that the second reading – published a week today – will be much weaker and so will drive a larger contraction of GDP than the 0.3%Q/Q decline currently estimated (a revised 0.5%Q/Q decline would not be a surprise).

Elsewhere in the survey, we learned that business sales (excluding financial and insurance firms) rose 0.9%Q/Q in Q3, with a 1.1%Q/Q decline in manufacturing sales countered by a 1.7%Q/Q increase in non-manufacturing sales. After surging 16.9%Q/Q in Q2, ordinary profits fell 14.3%Q/Q in Q3, lowering annual growth to 2.2%Y/Y (operating profits fell 3.3%Q/Q but were up 2.3%Y/Y). In the manufacturing sector, ordinary profits fell 22.5%Q/Q and so were down 1.6%Y/Y. Non-manufacturing profits fell 8.8%Q/Q, fully reversing the increase recorded in Q2, but were still up 4.6%Y/Y. As a result, corporate profitability – measured as the ratio of ordinary profits to sales – fell back to 5.1% in Q3 from a very high 7.7% in Q2. This still compares favourably with an average profit margin of 4.4% over the past decade. Profitability in the manufacturing sector fell back to 6.6% from 10.6% previously (substantially above the decade-average of 5.0%) while profitability in the non-manufacturing sector fell to 4.5% from 6.5% previously (still above the decade-average of 4.2%).

In other news, the final results of the manufacturing PMI survey for November were not quite as discouraging as the preliminary results. The headline business conditions index was revised up 0.4pt to 52.2, albeit leaving it 0.7pt below the final October reading and still the weakest reading seen for 15 months. Within the detail the output index was revised up 0.6pt to 52.4, but was still down 0.4pt from October. And while the new orders index was revised up 1.3pt to 50.9, this was still down a concerning 1.7pts for the month. In rounded terms, the new export orders index was unrevised at 50.8. Meanwhile, the employment index was revised down 0.8pt to 52.9, to now be marginally weaker than last month and thus now more in line with the tone seen elsewhere in the survey. Finally, the input prices index was revised down 1.2pts to 60.7, bringing its decline for the month to 1.9pts. And while the output prices index was revised up 0.1pt to 53.6, this is still down 0.9pt from October's 10-year high.

Looking out over the remainder of the week, the service sector PMI results for November will be released on Wednesday, followed by the latest Reuters Tankan survey on Thursday. On Friday the week concludes with the preliminary release of the Monthly Labour Survey for October and the MIC household income and spending survey for October. The BoJ’s Consumption Activity Index, released later in the day, will provide a more reliable indicator of how consumer spending has evolved in October. In the bond market, the MoF will sell 10-year JGBs tomorrow and hold an enhanced liquidity auction (with maturities of 15.5-39 years) on Thursday.

Euro area:
With respect to data, this week will bring several euro area releases of note, including the final November manufacturing and services PMIs (today and Wednesday respectively), October retail sales (Wednesday) and the final reading of Q3 GDP (Friday), all of which are likely to indicate slowing momentum in the economy. Indeed, today’s manufacturing survey is likely confirm that the headline euro area PMI fell to 51.5 in November, its lowest level since April 2013. So, the composite PMI is also expected to align with the flash reading of 52.4, down 0.7pt on the month to its lowest level in almost four years. Euro area retail sales, meanwhile, are expected to have risen by a modest 0.3%M/M in October, following no growth in September, although the weakness in Germany suggests that risks to this forecast are skewed to the downside. While the final reading of Q3 GDP is likely to confirm the slowdown in growth to 0.2%Q/Q, there are risks of a downwards revision and the first official expenditure breakdown is likely to show that net trade provided a notable drag.

At the country level, Germany’s factory orders for October (due Thursday) will be followed by the country’s latest IP data on Friday, which are expected to show that output moved sideways at the start of the fourth quarter. Also noteworthy on Friday are German labour costs figures for Q3. In addition, French and Spain IP numbers for October will be released on Friday and Wednesday respectively.

Beyond the data-flow, Italy’s fiscal plans will remain in focus. The Eurogroup will discuss all member states’ draft budgets later today, and, assuming it can make up its mind on its policy, Italy’s government may submit its proposals for a vote in the Lower House in the first half of the week. The Eurogroup will also prepare the forthcoming Euro summit discussion on measures to strengthen the euro area.

UK:
Ahead of the House of Commons ‘meaningful vote’ on the Withdrawal Agreement deal on 11 December, this week’s news flow will no doubt be dominated by Brexit, with the start of the debates on the draft EU-UK deal, and the tabling of amendments to the Government’s motion (including attempts to deliver a second referendum) in the UK Parliament. Certainly, today’s appearance of attorney-general Geoffrey Cox to discuss the Brexit legal advice will be closely watched. Meanwhile, tomorrow will see the European Court of Justice issue its preliminary opinion on whether, and if so how, Article 50 could be revoked by a Member State that has already triggered it. And following the release last week of the Government and BoE assessments of the economic impact of Brexit, the Treasury Select Committee hearings scrutinising their work will be of (some) interest too.

Data-wise, the most notable release will be the November PMIs, with the surveys for manufacturing, construction and services out today, tomorrow and Wednesday respectively. With respect to the former, the headline manufacturing PMI is expected to have risen slightly from the 27-month low of 51.1 in October. So, with the composite index having declined by 2pts in October to 52.1, which was also the lowest level since the Brexit referendum in 2016, a similarly weak reading or, if we’re lucky, a small improvement, is likely this month. We will also get the BRC Retail Sales Monitor (tomorrow), which will provide more insights into how consumer spending evolved in November. On the monetary policy front, MPC members Haldane and Vlieghe are scheduled to speak today and tomorrow respectively. In the bond market, tomorrow will see the DMO sell 5Y Gilts.

US:
Turning to the US, the manufacturing ISM report for November will be the key focus today, with October construction spending and November auto sales reports also due that day. The following day is free of top-tier releases, but on Wednesday the ADP employment and non-manufacturing ISM reports for November will be of interest. That day will also see the release of revised estimates of labour productivity for Q3, while the full trade balance and factory orders reports for October will follow on Thursday. On Friday, the week will conclude with the official employment report for November, with developments in the unemployment rate and wage growth certain to be scrutinised closely as attention begins to turn towards the year’s final FOMC meeting on 18-19 December. Our US economist Mike Moran expects an increase in non-farm payrolls of around 185k, a decent showing but below the average of the past twelve months, to leave the unemployment rate unchanged at 3.7%. Meanwhile, annual growth in average hourly earnings is also expected to be unchanged at 3.1%, which was the strongest since mid-2009. The preliminary results of the University of Michigan survey for December will also be released on Friday, together with final wholesale inventory data for October.

This week’s Fedspeak include Chair Jerome Powell’s testimony before the Joint Economic Committee on Wednesday, while the Fed’s latest Beige Book of economic anecdotes will also be released that day. The US Treasury’s issuance programme includes only T-bills over the coming week.

China:
Following Friday’s disappointing official manufacturing PMI report, today’s November Caixin manufacturing PMI, which is more focused on the SME sector, was marginally more positive. The headline index rose 0.1pt for a second consecutive month to a still barely expansionary 50.2. Within the very mixed detail, the output index fell 0.1pt to 50.0 – the lowest reading since June 2016 – but the future output index rose 0.8pt to 53.9. In a similar vein, the new orders index rose a modest 0.5pt to 50.9, but the new export orders index fell 1.1pts to 47.7. Meanwhile, ahead of this coming weekend's inflation indicators, the input prices index fell 3.4pts to 53.2 and the output prices index fell 2.1pts to 49.8 – the latter the lowest reading since May last year.

Looking ahead to the remainder of the week, the Caixin services PMI for November will be released on Wednesday. However, this week’s most important reports are released over the coming weekend, with the November trade balance due on Saturday and the November CPI and PPI reports to follow on Sunday. According to Bloomberg’s survey, investors expect a marked slowdown in export and import growth to 9.4%Y/Y and 13.4%Y/Y respectively, following the surprisingly robust growth rates reported in October (15.6%Y/Y and 21.4%Y/Y respectively). Meanwhile the inflation reports are forecast to portray weaker prices pressure – not surprising in light of the slump in energy prices – with CPI inflation expected to ease to 2.4%Y/Y from 2.5%Y/Y previously and PPI inflation expected to ease to 2.7%Y/Y from 3.3%Y/Y previously.

Australia:
A very busy week in Australia kicked off today with the release of further partial indicators of the economy’s performance in Q3, together with indicators of more recent trends in activity and inflation.

Starting with the former, the ABS released its Business Indicators report for Q3. The report pointed to no change in inventories (weaker than market expectations of a 0.4%Q/Q increase), a 1.9%Q/Q increase in company operating profits (also slightly below market expectations) and a 0.9%Q/Q increase in wages and salaries (no consensus estimate available). Given these outcomes, company profits rose 13.5%Y/Y while growth in wage and salaries continued to lag at 4.3%Y/Y. On balance, this report might suggest a small degree of downside risk to earlier-surveyed expectations for Q3 GDP growth (see below), at least ahead of the final partial indicators that will be released tomorrow.

Moving ahead in time, the total number of dwelling approvals fell 1.5%M/M in October – right in line with market expectations – and was down 13.4%Y/Y. The number of house approvals rose 1.7%M/M (but was down 4.9%Y/Y), but the approvals in the ‘other dwellings’ category (i.e. apartments) fell 5.4%M/M (down 22.6%Y/Y). Given increases in average construction costs, the value of all residential approvals declined a slightly less-pronounced 11.5%Y/Y. Meanwhile, after growing strongly last year, non-residential approvals continued their recent much weaker run, with the value of approvals declining 24.9%Y/Y despite a modest uptick in the month. As a result, the value of all building approvals issued fell 16.7%Y/Y.

In other news, the ANZ job ads index fell 0.3%M/M in November, causing annual growth to slow to 2.3%Y/Y from 3.7% Y/Y previously. While the RBA has played down this indicator of late given the rising importance of other means of advertising (including social media), the recent softening is consistent with the peaking of other hiring indicators such as that in the NAB business survey. Turning to the factory sector, the CBA manufacturing PMI for November was revised 0.1pts from its flash reading to 54.6, leaving it 0.1pt for the month but still slightly below the average reading over the surveys short history. By contrast the more-volatile AIG manufacturing index slumped 7.0pts to a 13-month low of 51.3, with the new orders index falling an even greater 10.1pts to a contractionary 48.7.

Turning to prices, the Melbourne Institute of Applied Economic and Social Research monthly inflation gauge recorded no change in November, causing annual inflation to decline 0.3ppt to a 2-year low of 1.6%Y/Y. The trimmed mean rose 0.1%M/M but the annual increase declined 0.4ppt to just 1.3%Y/Y – also a 2-year low. With regard to house prices, the news here was also weak. Corelogic reported that the median price across Australia’s eight capital cities recorded a 0.9%M/M decline in November – the largest decline yet in a negative run that has now been in place for 13 months. As a result prices are now down 5.3%Y/Y, compared with a decline of 4.6%Y/Y in October. The largest drop was in the expensive Sydney market where prices fell 1.4%M/M and 8.1%Y/Y. Prices also fell 1.0%M/M in Melbourne and 0.7%M/M in Perth, but rose elsewhere. To date the RBA has been sanguine about the decline in house prices, which is largely viewed as a desirable development (certainly more desirable than rampant increases fuelled by credit). However, the RBA is also mindful that a large downward adjustment to prices could have repercussions for the broader economy and the inflation outlook, so the performance of the housing market will be watched with interest over the coming summer months. 

Looking towards the remainder of the week ahead, tomorrow the final RBA Board meeting for this year (indeed, the last until February) seems almost certain to deliver yet another unchanged cash rate of 1.5% and messaging that continues to suggest that eventual expected rate hike is perhaps a year away or more. Tomorrow will also see the release of information on net exports and government spending for Q3, which will be used by analysts to refine their expectations for Wednesday’s release of the national accounts for Q3. Ahead of those final indicators, Bloomberg’s survey indicates that the market expects GDP growth of 0.6%Q/Q – with about half of that growth to come from net exports – which would lower annual growth by 0.1ppt to a still very healthy 3.3%Y/Y. The twin service sector PMI reports for November will also be released on Wednesday, followed by the October retail sales and external trade reports on Thursday. According to Bloomberg, the market expects retail sales to have advanced 0.3%M/M – about in line with the recent trend – and another large trade surplus of around AUD3.0bn.

New Zealand:
New Zealand’s merchandise terms of trade fell 0.3%Q/Q in Q3, modestly weaker than market expectations but leaving the index still close to an all-time record high. Import prices rose 2.6%Q/Q, propelled by a 6.4%Q/Q increase in fuel costs – a factor that will clearly reverse sharply in Q4. Export prices rose 2.3%Q/Q and 8.1%Y/Y to reach their highest level in almost 10-years. By contrast, the services terms of trade declined a further 4.0%Q/Q in Q3 – a weaker exchange rate contributing to higher prices for imported transport and travel – and were down 6.0%Y/Y. Given information on export and import values, these price movements meant that merchandise export volumes increased 1.8%Q/Q in Q3, whereas import volumes declined 0.9%Q/Q. Annual growth in export volumes was a respectable 3.3%Y/Y, but import volumes grew a much stronger 8.6%Y/Y. With the economy pushing up against capacity constraints, imports of non-transport capital goods rose 13.7%Y/Y, whereas imports of consumption goods rose just 0.5%Y/Y. Imports of passenger cars rose 3.6%Y/Y, however. 

Looking out over the remainder of the week, most interest will likely centre on Wednesday’s construction report for Q3, which provide further information ahead of the full national accounts on 20 December. The QV house price index and ANZ job advertising index for November are also released on Wednesday in what is otherwise shaping up to be a quiet week.

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