Morning comment: Japanese orders & French IP ahead of ECB & Brexit summit

Chris Scicluna
Emily Nicol
Mantas Vanagas

Wall Street closed somewhat weaker on Tuesday – the S&P500 falling 0.6% following eight consecutive positive sessions. While a pull-back was probably overdue, sentiment wasn’t helped by President Trump’s threats to raise tariffs on the EU – aired after the Monday’s market close – and the IMF’s further downgrade of its global growth forecasts. There was little in the way of first-tier economic data to impact proceedings and trading volumes were even lighter than had been the case on Monday. Given the slight ‘risk-off’ tone, Treasury yields drifted lower with the 10Y yield falling to 2.49%. The US dollar was little changed overall.

Despite that background, bourses in the Asia-Pacific region were mixed today, with gains in China’s CSI300 and Korea’s KOSPI contrasting with declines in Japan, where the TOPIX fell 0.7%. A slightly disappointing February machinery orders report continued a soft start to Q1, while a slightly firmer yen (back to about $/¥111) didn’t help matters. Reflecting developments in the US Treasury market, JGB yields moved fractionally lower with BoJ Governor Haruhiko Kuroda telling the Diet that negative bond yields reflected developments in global financial markets rather than in Japan. ACGB yields also initially fell, although the moves at the front end of the curve were subsequently more than reversed as RBA Deputy Governor Guy Debelle said that, at present, he does not expect that a rate cut will be required for the Bank to meet its twin objectives – a stance that continues to contrast with the market’s pricing of at least one 25bp easing by the end of this year. 

In Europe, after some upbeat French manufacturing data this morning, attention will shift the ECB’s latest policy announcement, although we expect Draghi to be relatively uninformative in his press conference. In the US, the latest Fed minutes and CPI data will be watched too. And this evening’s key EU summit on Brexit is set to agree an extension of the Article 50 deadline beyond Friday’s cliff-edge, although the precise duration and conditions to be attached will be argued over. More on this below:

The main domestic focus in Japan today was on the machinery orders report for February, especially in light of the disappointingly weak January outcome reported last month. Unfortunately, while the key aggregates picked up in February, they failed to erase the declines reported in January.

Total machinery orders – which are especially volatile from month to month – increased 5.4%M/M in February. Following a 7.9%M/M decline in the previous month, total orders remained down 3.1%Y/Y. The more closely-watched series of core private orders – which excludes ships and other volatile categories – increased a less-than-expected 1.8%M/M. Coming after a 5.4%M/M decline in January, core private orders were down a disappointing 5.5%Y/Y in February. Within the detail, private orders from manufacturers rose 3.5%M/M in February but were still down 9.1%Y/Y. Core private orders from the non-manufacturing sector fell 0.8%M/M and were down 2.0%Y/Y. More positively, following two months of extraordinary declines, foreign orders rebounded 19.0%M/M in February. Even so, foreign orders were still down 1.9%Y/Y. Meanwhile, public sector orders rose 2.2%M/M but were down 3.7%Y/Y.

Taking the January and February outcomes together, core private orders are now running 4.8% below the average recorded in Q4. The Cabinet Office’s last survey of machinery manufacturers, published with the December 2018 machinery orders report, had seen firms forecast a much smaller 1.8%Q/Q decline in core private orders in Q1. So unfortunately, barring a substantial lift in orders in March (circa 8½%M/M), it still appears likely that firms’ pessimistic expectations may prove to have been not pessimistic enough.

Today’s other two reports were released by the BoJ. First up, the goods PPI rose a fractionally larger-than-expected 0.3%M/M in March. Combined with a slight upward revision to historical data, this meant that annual growth lifted 0.4ppt to a 3-month high of 1.3%Y/Y. As was the case in February, the largest price rises were seen in the petroleum/coal and non-ferrous metals sectors, which recorded growth of 2.9%M/M and 1.4%M/M respectively. In a similar vein, measured in yen terms, import prices rose 1.6%M/M in March and were up 2.5%Y/Y, led by a 3.9%M/M increase in prices for energy products and a 2.3%M/M increase in prices for metals. Meanwhile, final prices for consumer goods rose 0.3%M/M for a second consecutive month, so that annual deflation slowed to 0.3%Y/Y from 1.1%Y/Y in February (prices for durable goods fell 1.5%Y/Y, accounting for all of the overall decline).

Finally, the BoJ reported that growth in bank lending picked 0.2ppt to 2.4%Y/Y in March, returning to the pace seen in January. Loan growth at the major city banks increased 0.3ppt to a 16-month high of 1.8%Y/Y, but growth at shinkin banks – serving SMEs – and at regional banks slowed 0.1ppt to 1.6%Y/Y and 3.0%Y/Y respectively.

All UK eyes will be on Brussels tonight as EU leaders meet to discuss how to respond to Theresa May’s request for an extension of the Article 50 deadline beyond Friday’s cliff-edge. Not least out of solidarity for Ireland and to avoid a significant negative economic shock, the EU leaders seem bound to offer Theresa May a delay to Brexit. But the length of duration and the conditions to be attached are unclear.  

EU President Tusk’s letter to EU leaders ahead of the meeting make clear that the extension to 30 June requested by May will be considered unrealistic and given short shrift. So – assuming that the UK PM doesn’t alienate the other leaders when she presents her plans for further cross-party talks and new votes in the House of Commons – he instead proposes “a flexible extension, which would last only as long as necessary [i.e. until both sides have ratified the Withdrawal Agreement] and no longer than one year”, with the extra time “removing the threat of constantly shifting cliff-edge dates”.

To ensure that the UK (which might soon be led by a less co-operative Prime Minister) doesn’t disrupt EU policymaking throughout the period of the extension, Tusk also proposes a range of conditions to be attached, including no re-opening of the Withdrawal Agreement; no start of the negotiations on the future relationship, except for the Political Declaration; and a mechanism to that the UK to “maintain its sincere cooperation” with the EU also during this crucial period, in a manner that reflects its situation as a departing member state.

We doubt that this evening’s negotiation will be a short one. And, certainly, French President Macron will want to be seen to be playing tough. Nevertheless, once the Summit concludes, we strongly expect the leaders to endorse a flexible extension of either nine months or one year (i.e. to end-2019 or end-March 2020), with regular reviews (every two or three months) to ensure that the UK is continuing to behave itself in EU policy-making forums. The draft conclusions prepared for the summit also incorporate a reminder that, should it so wish, the UK could still choose to revoke its Article 50 notice and end the tortuous Brexit for good.   

Aside from Brexit, it will be a busy day for UK data, with the latest output indicators, including a monthly GDP estimate for February. Overall economic output rose by 0.5%M/M in January, reversing a drop of a similar magnitude in December, as an increase in retail and wholesale sector activity provided a boost. We expect that GDP growth will have fallen in February to zero, with the pace of growth easing in all major output components – services, IP and construction. And that would leave the 3M/3M rate unchanged for a third consecutive month at a pedestrian 0.2%3M/3M. Against the backdrop of subdued global demand and concerns over Brexit, the latest trade data are also set to be unimpressive. In January, the headline trade deficit increased to a five-month high of £3.8bn and a similar reading is on the cards for February. While goods exports will be harmed by subdued external demand a further deterioration of the services balance – long a source of strength for the UK – should be watched due to the need for firms to shift activities abroad to mitigate Brexit risks.

Euro area:
The main event in the euro area today will be the conclusion of the latest ECB policy meeting. The previous meeting in March saw the ECB revise down significantly its forecasts for GDP and inflation. And so, the Governing Council amended its forward guidance to make clear that its key interest rates are expected “to remain at their present levels at least through the end of 2019”. And it also confirmed its intention to hold a new round of quarterly targeted long-term refinancing operations (TLTRO-III), starting in September 2019 and ending in March 2021. The maturity of each operation will be two years, half that of the previous TLTRO-II programme, while counterparties will be entitled to borrow up to 30% of the stock of eligible loans as at 28 February 2019 at a rate indexed to the refi rate over the life of each operation. Other precise details of the TLTROs‑III, including the incentives for credit conditions to remain favourable, were to be announced in due course.

We do not, however, expect to receive additional information on the TLTROs-III, and Draghi’s post-meeting press conference seems likely to be relatively unenlightening. Not least after the Trump administration’s publication on Monday of a list of EU products that would be the subject of potential new US tariffs if WTO-inconsistent EU subsidies to Airbus are not removed, Draghi will no doubt emphasise that the Governing Council remains alive to the downside risks to the economic outlook. But there will probably be no signal of any further action over the near term. Of course, in the post-meeting press conference, Draghi seems bound to be probed about his statement in his Frankfurt speech in late March, that “if necessary” the ECB would consider measures to “preserve the favourable implications of negative rates for the economy while mitigating the side effects”, which suggested that the Governing Council could at some point introduce a tiered interest rate system on similar lines to those conducted by the BoJ and SNB if the deposit rate was sustained at the current level or below throughout next year. However, Monday’s report from Bloomberg, that the Governing Council is in no hurry to consider refinements to its negative rate policy framework, suggests that Draghi might also have nothing new to offer on this today.

Data-wise, today’s focus is on manufacturing, with French and Italian industrial production reports for February on the docket. The French figures, just released, surprised on the upside, with total output rising for the third consecutive month and by 0.4%M/M. And in the absence of the 4½%M/M drop in energy production, the outcome would have been even stronger. Indeed, manufacturing production rose more than 1%M/M in February, to leave it almost 3% higher than a year earlier, with production of intermediate and capital goods continuing to trend higher, while there was a notable rebound in production of consumer non-durable goods in part offsetting another soft showing from the durable goods sector. So, over the first two months of the year, the level of manufacturing output was on average more than 1% higher than the average in Q4, in line with the increase in total IP over the equivalent period too. So, while we would expect to see some payback in March, today’s release suggests that the industrial sector boosted growth in Q119 having been a modest drag at the end of last year.

Meanwhile, Italian manufacturing output is expected to have declined in February, albeit insufficient to reverse fully the increase of more than 1.0%M/M reported in January. But despite the more positive start to the year (with economic indicators currently signalling GDP growth of 0.1%Q/Q in Q1) the Italian Treasury yesterday confirmed that it has revised down markedly its full-year growth forecast in 2019 to just 0.1%Y/Y, bang in line with our own forecast, having in its budget plan originally projected growth of as much as 1.0%Y/Y this year. Given a less favourable budgetary starting point and the GDP forecast downgrade, the Treasury also projected a further rise in government debt this year (to a hefty 132.6% of GDP) and an overshoot in the Government’s revised deficit target of 2.04% of GDP to 2.4% – bang in line with the coalition government’s original target last autumn that was deemed unacceptable to the European Commission. So, the European institutions will likely, in due course, want to see corrective budgetary action to get back on track.

In the bond market today, meanwhile, Germany will sell 5Y Bunds.  

In the US, today will bring economic highlights for the week including the minutes of last month’s FOMC meeting and the March CPI report. In particular, as some temporary factors weighing on prices in February reverse, the monthly increase in core CPI is expected to tick back up to 0.2%M/M, albeit leaving the annual rate unchanged at 2.1%Y/Y. And a surge in gasoline prices should lead to an above-average increase in the energy component and a step up in headline inflation to 0.3%M/M (taking the annual rate 0.3ppt higher to 1.8%Y/Y. Federal budget data for March are also due. In addition, the Treasury will sell 10Y Notes.

The only economic report in Australia today was the Westpac consumer confidence survey for March. After falling 4.8%M/M in February, the headline index rebounded a modest 1.9%M/M to 100.7 in March – a level that remains slightly below the long-term average for this series. Within the detail respondents were once again less positive about recent developments in family finances, but this month were more upbeat about the outlook for family finances and the general economy over the year ahead.

In other news, as was to be expected, a speech on “The State of the Economy” given by RBA Deputy Governor Guy Debelle was fully consistent with the economic outlook and policy stance communicated at last week’s Board meeting. Much of the speech dealt with the various uncertainties surrounding the Bank’s central projection of a gradual lift in wage growth and inflation. As before, Debelle highlighted the effectiveness and extent of stimulus measures in China and developments in trade policy as key sources of uncertainty external to Australia. Domestically, Debelle highlighted the conflicting signals provided by the labour market, the GDP data and the business surveys, and said that how those tensions are resolved will play a critical role in determining whether Australia continues to make satisfactory progress towards achieving full employment and the Bank’s inflation target. During the Q&A Debelle said that the Bank could ease monetary policy if required, but – consistent with the Bank’s central projection – stated that, at present, he did not think that this would be needed. 

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