Week ahead, w/c 1 April

Chris Scicluna
Emily Nicol
Mantas Vanagas

Overview:
Wall Street ended last week on a positive note, with the S&P500 advancing 0.7% on Friday (13.1% for the quarter) amidst positive remarks from both US and Chinese sources regarding progress made in trade deal negotiations (Chinese officials will return to Washington this week) and after the latest PCE deflators suggested that inflation remains well-behaved. So, Treasury yields nudged only fractionally higher (the 10Y yield closing the week at 2.40%) and the US dollar was only just a smidgen firmer.

Today markets reopened in a very positive mood, greatly assisted by the weekend’s improved official PMI readings in China and today’s Caixin PMI which seemed to confirm better conditions in the manufacturing sector at the end of Q1 (more on these below). US equity futures have moved up about ½% while the 10Y US Treasury yield has increased 4bps to 2.44%. Not surprisingly the strongest gains have been seen in China, with the CSI300 rising 2.7%. In Japan, the BoJ’s Tankan survey gave a clear signal of a weakening in business conditions – especially in the manufacturing sector – but somewhat less impact on firms’ capex plans (much much more on the Tankan below). As a result, the TOPIX began the quarter with a solid 1.4% advance and JGB yields have also moved fractionally higher. In Hong Kong the Hang Seng rose a similarly robust 1.6%, while slightly smaller gains were seen in South Korea and Singapore. Australian government bond yields were also up on the Chinese data (10Y yields just above 1.80%) but Aussie equities and the AUD posted a surprisingly muted reaction, with investors perhaps reluctant to take positions ahead of tomorrow’s RBA Board meeting and pre-election fiscal budget announcement.

Against that backdrop, markets in Europe are also set to start the week on the front foot, although a downwards revision to the already-weak March euro area manufacturing PMIs provides a reminder that the region’s economy remains troubled. This morning’s flash CPI data should also highlight the weakness of underlying inflation, while this evening’s second phase of indicative Brexit votes in the House of Commons will ratchet up the tension in what is set to be a pivotal week for the UK’s political crisis (more on this below too). And at the start of a busy week for top-tier US data, which culminates in the March labour report on Friday, today brings the latest retail sales and manufacturing ISM.

Japan:
The main data focus in Japan today was the aforementioned BoJ Tankan survey for Q119. In summary, the BoJ’s comprehensive survey of just under 10,000 firms cast Japan’s economy in a significantly less positive light than was the case in Q418, albeit with conditions remaining relatively favourable by historic standards. The weakening of business conditions was especially pronounced in the manufacturing sector, where developments in the key business conditions indices also fell short of market expectations and indicated that conditions are expected to become even less favourable over the current quarter. But while firms’ projections for capex in FY18 remained very positive, probably due to skill shortages that are continuing to intensify, they were predictably more downbeat for FY19. Unfortunately for the BoJ, but not surprisingly, the survey’s pricing measures indicate that over the past three months firms’ – especially those in the manufacturing sector – have had less success passing higher input costs through to their output prices.

Turning to the detail, there was a notable deterioration in the headline business conditions DI for all firms in Q1, with only a net 12% of respondents now considering current business conditions to be favourable, a fall of 4ppts from the previous survey, the largest drop since the April-2014 consumption tax hike and the lowest level since Q217. And a further deterioration in business conditions was expected over the next three months, with the DI forecast to drop to 7, the weakest forecast since Q117, but still an above-average outcome compared to historical responses over the past two decades or so. As had been expected, the greatest reduction in optimism has occurred in the manufacturing sector – with the total number of manufacturers assessing favourable condition declining 9ppts to 7%, the largest drop since the post-quake decline in Q211 – where firms are most exposed to weaker global economic conditions and ongoing risks concerning the global outlook. Amongst large manufacturers, only a net 12% of firms now have a favourable opinion of current business conditions – down 7ppts from the prior survey to a 2-year low. Meanwhile, only a net 8% of such firms expect business conditions to be favourable over the next three months – the least optimistic forecast since Q416.

By contrast, a net 21% of large non-manufacturing firms have a favourable opinion of current business conditions, down only 3ppts from the prior survey but still the least optimistic reading since Q117. A similar net 20% of such firms indicated that business conditions would remain favourable over the next three months. It is worth noting that the forecast of large manufacturers is based on an assumed exchange rate of ¥108.97/$ over FY19, so these firms would likely be slightly more confident if the yen were to remain around its current level of ¥111/$.

As is usual, medium- and small-sized firms were even less optimistic than their larger counterparts. In the manufacturing sector the direction and magnitude of the movement in the current conditions and forecast indices was broadly in line with that seen at larger firms (for example, a net 6% of small manufacturers hold a favourable opinion of current business conditions – down 8ppts from the prior survey). By contrast, in the non-manufacturing sector the net proportion of medium- and small-sized firms reporting favourable conditions actually increased by 1ppt apiece to 18% and 12% respectively – the latter actually the best reading since Q491. But looking ahead, these firms are less optimistic about the coming quarter, with a net 12% of medium-sized firms and a net 5% of small-sized firms expecting favourable business conditions to prevail.

Looking at the industry detail for large firms, the majority of industries have reported less favourable conditions than in the prior survey. The biggest decline in optimism occurred in the general purpose machinery industry, where net optimism declined a substantial 27ppts to 20% – an outcome that is not surprising in light of the weakness seen in both production and exports data with respect to demand for capital goods. Other industries to experience very large declines in net optimism were: petroleum/coal, wholesaling, non-ferrous metals and pulp/paper (in the case of the latter two industries, on balance firms now hold an unfavourable opinion of business conditions). Double-digit declines were also seen in the chemicals and electrical machinery sectors.

Turning to the other key findings of the survey, for all firms aggregate sales are now forecast to have increased 2.4%Y/Y in FY18, down from 2.7%Y/Y in the prior survey – this change largely due to a downward revision in the manufacturing sector. The first forecast for FY19 posits that sales will rise 0.8%Y/Y – an understandably cautious forecast given current economic uncertainties. Aggregate current profits are now expected to have declined 1.5%Y/Y in FY18 – almost twice as much as forecast previously – with an upward revision in the non-manufacturing sector more than offset by a large downward revision to expected profits in the manufacturing sector (both sectors now forecast profits to have fallen 1.5%Y/Y). Profits are forecast to decline a further 0.7%Y/Y in both the manufacturing and non-manufacturing sector in FY19. That said, in the case of the manufacturing sector that forecast may prove too pessimistic if the yen remains at current levels. The overall profit margin for all firms is forecast to have been 5.61% in FY18, down only slightly from 5.83% in FY17, with a further decline to 5.52% forecast in FY19. Importantly, such outcomes would remain far above the historical average, especially in the manufacturing sector where profit margins of 7.04% and 6.95% are forecast for FY18 and FY19 respectively.

Separately, and unsurprisingly in light of last Friday’s employment report, the Tankan indicated that firms continue to face substantial labour shortages. Amongst all firms, a net 35% of respondents reported an employment deficiency – unchanged from the prior survey, which had depicted the tightest conditions since 1992. Labour shortages remain especially acute amongst medium- and small-sized non-manufacturers. And looking ahead, firms indicated that they expect conditions in the labour market to get even tighter over the next three months. A net 5% of firms reported that they have insufficient production capacity to meet demand – an outcome that was unchanged from the prior survey – with the same proportion expecting to face capacity constraints over the coming quarter too.

Encouragingly, given those capacity constraints, and notwithstanding uncertainties about the outlook for the global economy, firms maintained a positive assessment of investment spending last fiscal year. Capex spending (including land but excluding software and R&D) by all firms was forecast to have increased 10.4%Y/Y in FY18, which was unrevised from the prior survey and if unchanged in June’s ‘final’ estimate would be the strongest annual growth since 1991. Large firms forecast capex growth of 13.9%Y/Y in FY18, which was down only slightly from 14.2%Y/Y previously. But while large firms projected positive growth of 1.2%Y/Y in FY19, overall firms predicted a decline of 2.8%Y/Y in investment spending in FY19. And while the first capex estimate of each new fiscal year is generally too pessimistic, this was the weakest comparable forecast for three years, albeit fractionally firmer than the average forecast made in the post-GFC period. Considering the current global environment and the high absolute level of investment spending at present, this has to be regarded as a robust result.

Turning to the outlook for inflation, the Tankan pointed to a weaker pricing environment, especially in the manufacturing sector. A net 17% of large manufacturers reported a rise in input prices, down 7ppts from the December survey. Moreover, only a net 1% of such firms reported passing on these pressures in the form of higher output prices, down 5ppts from the prior survey. Among large non-manufacturers, a net 16% of firms reported higher input prices (down 4ppts from Q418). These firms had relatively more success in passing price rises through to customers, although the net 7% of firms reporting higher output prices was down 1ppt from the prior survey. As usual smaller firms appear to be facing more widespread upward pressure on input prices, and yet also reported very limited success in raising output prices. And looking ahead, on balance large manufacturing firms indicated that they expect to face downward pressure on their output prices, while fractionally fewer firms in the non-manufacturing sector expect to have scope to raise their output prices. Firms’ specific forecasts for inflation and their own output prices will be released tomorrow, alongside additional industry detail from the survey.

Finally, in the section of the survey completed by just over 200 financial institutions, there was also a deterioration in the headline business conditions indices, with a net 9% of such institutions reporting favourable conditions over the past three months – down 3ppts from the prior survey – with the same proportion expecting favourable business conditions over the next three months. Bank respondents were slightly less positive, with 8% of these respondents reporting favourable conditions – down 5ppts from the last survey – and only a net 6% expecting favourable conditions over the coming quarter. Importantly, there were no signs that firms are finding financial institutions unwilling to supply credit. Indeed, a net 24% of firms described the stance of financial institutions as “accommodative” – unchanged from the previous two surveys. In addition, on balance, a tiny fraction of firms reported receiving lower interest rates on loans. So while in recent times the BoJ has expressed increased concern about possible negative side effects on the financial sector from sustained ultra-easy monetary policy settings, there remains limited evidence of such in the Tankan survey. This is just as well considering the lack of progress that the Bank is making towards meeting its inflation target, which suggests that current monetary policy settings are likely to be required for some time yet.

The other economic news released in Japan today concerned the final results of the manufacturing PMI survey for March. The headline index was revised up 0.3pt from the preliminary reading to 49.2, and so is now also 0.3pt above where it stood in February. More importantly, the detail of the survey painted the sector in a slightly less negative light. While the output index was revised up just 0.1pt to 47.0 (still down 0.4pt on the month), the new orders index was revised up 1.0pt to 47.7 (now up 0.3pt on the month). Moreover, the index measuring new export orders was revised up an even larger 1.4pts to a 3-month high of 48.1 (now up 0.5pt for the month). On the other hand, the employment index was revised down 0.4pt to 51.4 (down 0.2pt for the month) and the input prices index was revised down a huge 1.8pts to 55.3 (now the weakest reading since August 2017). The output price index was revised down 0.1pt to 52.0, but was still up 0.3pt compared with February.

Looking ahead to the remainder of this week’s diary, aside from the aforementioned additional detail from the BoJ’s Tankan surveys, Wednesday will bring the service sector PMI for March, which should continue to cast the sector in a more favourable light than the manufacturing sector. The week will conclude with the release of news regarding consumer spending and household incomes. Information on the former will be provided by the BoJ’s Consumption Activity Index for February and the less reliable MIC survey of household spending. Information on the latter will come from the MHLW Monthly Labour Survey for February, with the final results of the January survey to be belatedly released at the same time. The BoJ will also release the results of its quarterly survey of consumer sentiment on Friday. In the bond market the MoF will auction 10-year JGBs on Tuesday and 30-year JGBs on Thursday.

China:
Over the weekend China released the results of its official PMI surveys for March. The closely-followed manufacturing index increased 1.3pts to a 6-month high of 50.5, with weaker conditions for large firms outweighed by an apparent marked improvement in conditions faced by medium- and small-sized firms. This outcome was well above market expectations – Bloomberg’s survey indicated that analysts expected only a small improvement – but this may yet partly reflect volatility associated with the impact of the LNY holiday rather than signs of a genuine sharp improvement in fortunes. The detail of the survey suggested some holiday impact, as the production index jumped 3.2pts to 52.7 while the new orders index rose a more subdued 1.0pts to 51.6. The export orders index improved 1.9pts to 47.1, which is still contractionary but a 6-month high nonetheless. Meanwhile the non-manufacturing PMI rose 0.5pts to 54.8 and the composite PMI rose 1.6pts to 54.0 – also reaching respective 6-month highs.

Today the Caixin manufacturing PMI, which focuses mainly on SMEs, has also painted China’s factory sector in a firmer light. The headline index rose 0.9pts to an 8-month high of 50.8 in March, led by a 1.1pt increase in the output index to a 7-month high of 51.3. The new orders index increased 0.7pts to a 4-month high of 50.9 and the new export orders index increased 0.8pts to 50.2. The future output index rose 0.6pts to 55.7, just beating the January reading to be the best outcome since May last year.

Looking ahead to the remainder of the week, the only diary entry is Wednesday’s Caixin services PMI for March. Therefore, most interest will centre on continuing US-China trade negotiations, which will resume in Washington DC.

UK:
After Friday saw Theresa May’s Withdrawal Agreement rejected by the House of Commons by a majority of 58 MPs (with 34 Conservative MPs continuing to vote against), Brexit will inevitably continue to dominate in the UK this week with a wide range of scenarios – including a softer Brexit, second referendum, General Election or even eventual victory for a variant of May’s deal – still possible amid the ongoing political crisis. The only thing that’s certain is that a second phase of MPs’ indicative votes will be held later today to try to find a majority in favour of an alternative path forward. This process, which will likely focus on a narrower range of scenarios than considered last Wednesday, will see votes take place at 8pm UK time, with the results expected around 10pm.

Beyond this evening’s votes, however, there’s major uncertainty as to what might unfold. Judging from the outcome of last week’s first phase of indicative votes, as well as Friday’s vote on the current Withdrawal Agreement, there could well exist a majority of MPs in favour a softer Brexit involving a permanent customs union or another variant of Theresa May’s deal, particularly if subject to a second referendum. However, today’s process might well again prove inconclusive, and so a third round of MPs’ indicative votes is already pencilled in for Wednesday.

Of course, while MPs continue to try to find their own solution to the current impasse, Theresa May hasn’t completely given up hope of getting her own much maligned deal through Parliament. Indeed, as soon as tomorrow we might see the PM bring back her own proposal, amended to allow MPs a role in influencing subsequent negotiations on the future relationship, for a fourth vote in the House of Commons (although at this stage, the Parliamentary arithmetic still looks unfavourable for that). But if she fails to win support for her deal at this late stage, and MPs were either today or Wednesday finally able to signal a majority in favour of any single option, the preferred approach could well prove dynamite for the Conservatives. So, May has insisted that she would not feel compelled to accept it. And if, indeed, she remained intransigent, Wednesday could also see MPs move to legislate to force the PM to demand an Article 50 extension at the EU summit on 10 April predicated on their chosen option.

Of course, despite the further votes set for this week, Parliament might still remain in a state of stale-mate, unable to indicate support for any one Brexit scenario. In that case, there might be little alternative to the House of Commons voting for the early General Election with which Theresa May threatened her own party’s MPs over the weekend – although with the latest opinions suggesting that the Conservatives are now lagging some 5ppts behind Labour, many Tories would be turkeys voting for Christmas. Whatever, assuming that neither the PM nor MPs choose to revoke Article 50, we fully expect an extension of the Brexit deadline to be requested and agreed at the EU summit on 10 April, and thus see a minimal probability of a disorderly no-deal scenario unfolding at the end of next week.

Beyond Brexit, it should be another relatively quiet week on the economic data front, with only a few notable releases due. The March PMIs for manufacturing, construction and services, out today, tomorrow and Wednesday respectively, will almost certainly show that activity remained subdued this month. Indeed, today’s manufacturing index is likely to have been held up merely by ongoing stockpiling in preparation for possible disruption to supply chains in the event of no deal. And, overall, the composite PMI is likely to have been little changed from the February reading of only 51.5 and consistent with GDP growth in Q1 no stronger than in Q4. The BRC Shop Price index of retail prices (due on Wednesday) and the Q4 labour productivity figures (on Friday) are also due for release. Supply-wise, the Treasury will sell 5Y bonds tomorrow.

Euro area:
The data focus in the euro area today will be the flash estimate of March inflation, which we expect to report a drop in the headline measure by 0.1ppt to 1.4%Y/Y. But with services inflation having eased in the three largest member states last month, we expect a slightly larger decline in the core CPI rate, by 0.2ppt to 0.8%Y/Y, which would be the lowest reading since last April. This morning will also bring euro area unemployment figures for February. But the day has got off to a soft start, with the final manufacturing PMIs for March confirming a further marked deterioration in the sector at the end of the first quarter, with downwards revisions to the headline indices for Germany (down 0.6pt from the flash to 44.1), France (down 0.1pt from the flash to 49.7) and the euro area as a whole (down 0.1 to 49.7), all suggestive of ongoing contraction.

Over the remainder of the week, Wednesday will see the release of the respective services and composite PMIs, which are likely to confirm that the headline composite index slipped back this month to 51.3 despite a modest improvement in the services sector surveys. That day will also see the release of February retail sales figures, which, in light of Friday’s German figures, are likely to report a modest increase that month following solid growth at the start of the year. Focus at the back end of the week will turn to Germany’s manufacturing sector, with February factory orders data due Thursday and IP figures for the same month due Friday.

Thursday’s publication of the ECB account from the most recent Governing Council meeting will also be worth watching for any further insights into any discussions surrounding a potential tiered interest rate policy strategy that was hinted at by President Draghi earlier this week. Supply-wise, France will sell bonds with various maturities on Thursday.

US:
Turning to the US, a busy week kicks off today with the release of the retail sales report for February and the ISM and PMI manufacturing reports for March. The construction spending report for February and the business inventories report for January, also due today, will cast further light on how GDP is tracking in Q1. Tomorrow we will receive the advance durable goods orders report for February. On Wednesday attention will turn to the service-sector with the release of the non-manufacturing ISM and services PMI for March. In addition, the ADP employment report will cast light on developments in private payrolls during March. The official employment report for March will follow on Friday, with our US economist Mike Moran expecting an increase of 170k in non-farm payrolls, a rebound from February’s small increase of 20k but still some way down on the 2018 average of 223k. Mike also sees a small increase in the unemployment rate, related to a pickup in the number of individuals entering the labour force, as possible, as well as another firm (0.3%M/M) increase in wages. The consumer credit report for February will conclude the US diary for the week. In the bond market, the US Treasury will issue only bills this week.

Australia:
A busy start to a busy week of data and events in Australia saw the release of news concerning business sentiment and on the prices of both general consumer purchases and homes.

The main focus was the release of the NAB Business Survey for March. While the headline business confidence index fell a disappointing 2pts to 0 – the weakest reading since July 2013 – the closely-watched business conditions index rose 3pts to +7 – reversing the decline reported in February and leaving the index fractionally above its long-run average. Within the detail, this month respondents were slightly more positive about trading conditions and profitability, but less positive about capex. Importantly, given the RBA’s strong focus on developments in the labour market, the employment index increased 2pts to +7 – a level that is slightly above the long-run average. On the pricing side, firms indicated a 0.6% lift in labour costs over the past three months. However, for a second consecutive month they reported a mere 0.3% lift in their output prices over this period – the weakest outcome since July 2017.

Turning to other pricing news, the Melbourne Institute of Applied Economic and Social Research reported that its monthly inflation gauge increased 0.4%M/M in March, lifting annual inflation to a 6-month high of 2.1%Y/Y. The trimmed mean also rose 0.4%M/M but annual inflation on this measure remained soft at an unchanged 1.6%Y/Y – well below the midpoint of the RBA’s inflation target range. Meanwhile, CoreLogic reported that the median house price across Australia’s capital cities fell 0.7%M/M, marking the 17th consecutive monthly decline. This was the smallest decline since October, but base effects saw the annual decline steepen to 8.2%Y/Y from 7.6%Y/Y previously, led by a 10.9%Y/Y decline in Sydney. As emphasised in its various communications, the main focus of the RBA is how these home price declines, coupled with relatively weak growth in household incomes, impact the behaviour of consumer spending. The next update on the latter will come in the form of Wednesday’s retail sales report for February.

In other news, the twin manufacturing PMI reports – which tend not to be followed closely – pointed to only modest expansion in the factory sector in March. The final CBA index was unrevised at its preliminary reading of 52.0, which was down from 52.9 in February. Meanwhile, the much longer-running but more volatile AIG index fell 3.0pts to a 3-month low of 51.0.

Looking out over the remainder of the week, the key focus tomorrow will be on the outcome of the RBA’s latest Board meeting and the evening release of the Government’s pre-election federal budget. The RBA is widely expected to leave the cash rate at 1.5%, but there will be plenty of interest in the contents of the accompanying short statement in light of last week’s dovish turn by the RBNZ. Given that the labour market remains firm – indeed with the unemployment rate reaching a new low of 4.9% in February – the RBA will most likely retain a largely neutral stance pending the release of the Q1 CPI later this month and a full economic update when the next Statement on Monetary Policy is released next month.

Regarding the budget, with the Government struggling in the polls, we would expect to see some pre-election stimulus announced. However, the degree of stimulus will very likely be limited given the small underlying surpluses that were forecast in the last fiscal update and the Government’s indication that it will deliver a budget in surplus. The building approvals report for February will also be released tomorrow, while the February retail sales and trade reports will follow on Wednesday. Given the RBA’s focus on potential downside risks to consumer spending, the retail sales report will be of particular interest following the soft 0.1%M/M growth reported in January. The twin service sector PMI reports for March will also be released on Wednesday, followed by the AiG construction PMI on Friday.

New Zealand:
There were no economic reports released in New Zealand today. The remainder of the week should also be very quiet with the only scheduled reports of any note being tomorrow’s quarterly NZIER business survey – which should simply confirm the pessimism evident in the monthly ANZ business survey and – and Wednesday’s QV home price report for March.

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