From trade war to currency war?

Chris Scicluna
Emily Nicol

Overview:
The US followed the trend elsewhere yesterday, with the S&P500 closing down just shy of 3.0% and the NASDAQ down 3½%, and so the tone in Asian markets today was inevitably downbeat. The mood was hardly helped by the evening’s announcement by the US Treasury that labelled China a currency manipulator, further suggesting that Trump’s trade war might yet escalate to a full-blown currency war too. Nevertheless, the PBoC set today’s daily currency fix stronger than expected at less than 7/$ to suggest that the authorities wish to slow the pace of depreciation. The central bank also subsequently insisted that it wouldn’t weaponise the exchange rate in the trade war. So, the renminbi still merely oscillated broadly sideways today, and is currently little different to its level this time yesterday both on- and off-shore.

Elsewhere, with moves in CNY having important ramifications for other currencies, particularly in the Asia-Pacific region, and after yesterday’s sharp appreciation of the yen, Japan’s Vice Minister for international affairs at the MoF – Yoshiki Takeuchi, who is nominally responsible for foreign exchange market policy – today offered some mild verbal intervention, stating that “Excessive moves in foreign-exchange rates aren’t desirable… and [we will] take appropriate action if we judge [yen appreciation] is likely to have a negative impact on our economy”. The yen briefly eased back to 107/$ before rising back to around 106.5/$, and the BoJ as well as the MoF will be watching closely.

So, with unease all-pervasive, the main Asian equity markets were largely down across the board today, although the declines were typically less marked than yesterday. Despite some rather mixed domestic Japanese economic data (including a drop in the Cabinet Office’s leading indicator to its lowest since early 2010 but some better-than-expected spending and wages figures), the slightly weaker yen saw the Topix close down a relatively mild 0.4%. Meanwhile, China’s CSI300 fell 1.1%. And Korea’s markets were yet again among the worst performers (e.g. KOSDAQ again fell more than 3.0%), squeezed by acute currency- and trade-war concerns alike.

Fixed income markets, however, have become more measured as the day has progressed. Having dipped below 1.70% in early Asian time, 10Y UST yields are now back within yesterday’s range at 1.75%. Japan’s 10Y yields have edged up slightly to -0.19%, to take a little immediate pressure of the BoJ. And ACGBs initially rallied before giving up roughly half of those gains (10Y yields opened down more than 10bps at 0.98% but subsequently rose back close to 1.04%) as the RBA left its cash rate unchanged at 1.0% but signalled the likelihood of further easing to come (see below).

In Europe, meanwhile, markets are mixed, with gains in German and French equities contrasting a drop in the main UK index. After falling to record lows yesterday, Bunds (10Y at -0.522%) are little changed despite a better than expected German factory orders report. But despite another weak UK retail survey (more on this and the Japanese and German data too below) and no let-up in the negative Brexit noise from UK and EU policymakers alike, Gilts are a touch firmer (10Y yields up from yesterday’s record lows to 0.520%).

Japan:
There were mixed messages from the latest Japanese data released earlier today. On the positive side, June’s wage figures came in much stronger than expected, with average earnings growth rising 0.9ppt to 0.4%Y/Y, the first year-on-year increase this year. This in part reflected a pickup in regular earnings, which similarly posted the first year-on-year increase since 2018, albeit by just 0.1%Y/Y, while bonus payments rose 0.9%Y/Y. Average earnings growth for full-timers was also stronger at 1.0%Y/Y. But this contrasted with ongoing weakness in earnings of part-time employees, which saw average wages decline for the third consecutive month and by 1.1%Y/Y.

Admittedly, part of the weakness in part-time earnings seemingly still relates to sampling issues. Indeed, data based on a common sample suggests that the decline was more limited at just 0.2%Y/Y. And so, total average earnings growth on this basis maintained a steady upwards trend in June, rising 0.2ppt to 1.1%Y/Y, a six-month high. Of course, while this is above the average of the past two years, it still remains well below levels that would be consistent with shifting inflation onto a higher path. Indeed, underlying (regular) wage growth has largely moved sideways over the past six months at less than ½%Y/Y. And with real wage growth barely positive, underlying consumption growth is likely to remain subdued too.

In terms of consumption, today’s family expenditure survey for June reported a notable drop in household spending, with total and core spending down almost 3% on the month, the largest drop in core spending for more than four years. And the weakness was broad based, with a pickup in spending on medical care and food the only exceptions. But the decline was less than had been expected and hardly surprising given the surge in May – total and core spending rose 5½%M/M that month. Indeed, compared to a year earlier, spending was still up 2.7%Y/Y. Moreover, spending was up more than ½%Q/Q over the second quarter as a whole. Admittedly, this survey has been particularly volatile over the past couple of years and not necessarily followed the same trend as the national accounts measure of consumption. So, tomorrow’s BoJ consumption activity index will likely offer a more accurate guide to recent household consumption growth ahead of Friday’s first estimate of Q2 GDP.

While the weakness in household spending in June at least in part no doubt represented payback for the strength in May, the Cabinet Office’s latest composite indices of business conditions today suggested that, on the whole, the economic backdrop was much softer at the end of the second quarter. In particular, the coincident index fell 3pts in June, the steepest monthly drop since the consumption tax was last hiked in April 2014, to 100.4, matching the more-than two-year low hit in January. But not least given heightened uncertainty regarding the global environment, the near-term outlook remained clouded too, with the equivalent leading index declining to its lowest level since early 2010.

Euro area:
This morning’s German factory orders figures provided a rare upside surprise from the euro area’s manufacturing sector, reporting an increase of 2.5%M/M in June – the biggest rise since August 2017 following a favourably revised decline of 2.0%M/M the previous month. The detail, however, was decidedly mixed. Domestic orders reversed the previous month’s rise by falling 1.0%M/M in June, and new orders from the euro area fell for a third successive month (down 0.6%M/M) to suggest a notable weakening in demand conditions in other member states. In contrast, new orders from countries beyond the euro area were up a whopping 8.6%M/M, rebounding vigorously from a drop of more than 5.0%M/M the prior month.

In terms of the sectoral detail, despite a second successive monthly decline in orders of autos, growth was led by new orders of capital goods, up 3.7%M/M following a period of protracted weakness. And orders of intermediate items were also higher, up 1.3%M/M, supported by increased demand for chemicals. But new orders of consumer goods, which have performed better than other categories over recent months, fell 0.4%M/M.

German factory orders data, however, are notoriously volatile, and often distorted by one-offs and bulk items. Indeed, despite the headline increase, orders excluding major items fell 0.4%M/M in June, with a drop of 1.9%M/M in domestic orders and a relatively muted increase of 0.7%M/M in orders from abroad. And even including such volatile items, total orders were still down a hefty 3.7%Y/Y in June and down 1.0%Q/Q in Q2. And judging from the July surveys, orders look set for a weak third quarter too.

Meanwhile, this morning’s data release also showed that German manufacturing turnover fell for the third consecutive month in June, albeit by a very modest 0.1%M/M. That, however, left it down a sizeable 1.5%Q/Q in Q2, and further suggests that tomorrow’s IP release (consensus forecast for a drop of 0.5%M/M) will be soft.

UK:
While yesterday’s services PMI signalled a modest improvement in conditions at the start of Q3, today’s BRC retail sales monitor remained extremely downbeat in July despite the record temperatures recorded last month. In particular, it suggested that total retail sales were up just 0.3%Y/Y, the lowest growth recorded for a July since the series began in 1995. And this followed the worst June on record, when the survey’s measure showed sales declining 1.3%Y/Y. Like-for-like sales were even softer, with the 0.1%Y/Y rise in July following a 1.6%Y/Y decline in June. Moreover, smoothing out monthly volatility, like-for-like sales on a three-month basis took a notable step down, with the 1½%3M/Y decline the steepest since the start 2009.

While the weakness in the BRC’s survey in June contrasted with the jump in the official retail sales figures that month, it was consistent with the softer growth seen over the second quarter as a whole. And against the backdrop of ongoing political uncertainty, today’s survey perhaps predictably suggests a further marked slowdown in the underlying spending trend in the current quarter too.

In the bond market, the DMO will sell 5Y Gilts.

US:
In the US, a quiet day for top-tier data brings just the JOLTS job openings and turnover figures for June. In addition, FOMC voting member James Bullard – the most dovish member of the Committee this year – is due to speak on the US economy. In the markets, the US Treasury will sell 3Y notes.

Australia:
There were no surprises from the conclusion of the RBA’s policy meeting today, with the cash rate left unchanged at a record low 1.00%. But the accompanying statement by Governor Lowe still offered a dovish stance, inevitably emphasising, among other things, that increased geopolitical uncertainty left risks to the global outlook tilted to the downside, and flagging the RBA’s readiness to cut rates further.

Indeed, while the RBA recognised some stabilisation in the housing market, with domestic growth having been weaker than previously expected, the RBA revised down its GDP forecast in 2019 to 2½%Y/Y (from 2¾%Y/Y previously) with growth expected to rise to just 2¾% in 2020. And with still large amounts of spare capacity thus expected to persist in the labour market, and little upward price pressures from wage growth, the RBA conceded that inflation – in both headline and underlying terms – is again likely to take longer to return to 2% than previously anticipated. Indeed, its central forecast is for headline and underlying inflation to remain just under 2% throughout 2020 and rise to only a little higher than 2% in 2021, barely consistent with the RBA’s 2-3% inflation target.

As such, Lowe stated that it would now be “reasonable to expect an extended period of low interest rates”. He also reiterated that the RBA would continue to monitor developments in the labour market closely. And his statement was clear that the Board “will ease monetary policy further if needed to support growth and the achievement of the inflation target”. Judging from the RBA’s forecasts, that easing of policy will indeed be necessary. And given geopolitical events, a further cut in the cash rate in September is now in our baseline, along with one further cut thereafter to take the cash rate to 0.5% by year end.

 

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