Morning comment: PMIs, ECB minutes and Aussie labour market

Mantas Vanagas
Chris Scicluna

Wall Street made only modest forward progress on Wednesday, with gains in the materials sector helping the S&P500 to a 0.2% gain at the close. Following some initial noise, there was little reaction to the minutes of the January FOMC meeting, which portrayed a committee that appeared to be evenly divided on the need for a further rate hike later this year. In the meantime, all members saw no risk in leaving policy unchanged to allow current uncertainties to perhaps resolve. And if further monetary policy support was required, the minutes indicated that the hurdle to adjusting the Fed’s balance sheet normalisation policy might be smaller than previously conveyed and, in fact, the process could end relatively soon. Indeed, the minutes noted that security redemptions are likely to end “at some point over the latter half of this year”. Of course, this all fitted with the existing market narrative and so the Treasury market was little changed.

With that background, Asian equity markets have advanced to varying degrees today. The largest gains were seen in mainland China and Hong Kong, with the former up more than 1%. Optimism regarding a potential US-China trade deal was boosted by newswire reports citing people familiar with the current meetings taking place in Washington between US and China officials. According to those reports, the US and China are drafting six memorandums of understanding that would form the basis of a deal, including areas such as agriculture, non-tariff barriers, intellectual property and services. Reuters reported that officials are also looking at a list of shorter-term measures to address the bilateral trade imbalance.

Elsewhere in Asia, Japan’s TOPIX and JGB yields were unchanged despite a further worrying decline in the manufacturing PMI in February (more on this below). Australia’s ASX200 rose 0.7% and ACGB yields declined after economists at one major domestic bank changed their forecast to include two 25bp rate cuts by the RBA this year, notwithstanding news of a stronger-than-expected lift in employment in January (more on this below too). In addition, late in the day after Reuters reported that China’s Dalian port had placed a cap on imports of Australian coal – a move that some commentators have suggested might be evidence of tensions in the relationship between China and Australia as a result of the Australian Government’s decision to block Huawei from rolling out a domestic 5G network. It is worth noting that Dalian processes only a fraction of Australia’s total coal exports.

As far as data is concerned the main domestic focus in Japan today was on the flash manufacturing PMI for February. Unfortunately the PMI tallied with the downbeat tone in Tuesday’s Reuters Tankan survey, suggesting that conditions in the manufacturing sector have indeed taken a notable turn for the worse this year. After declining 2.3pts last month, the headline index fell a further 1.8pts to 48.5 in February – the first contractionary reading since August 2016 and the lowest outcome since June 2016. The detail of the report was generally similarly downbeat, with the output index falling 2.4pts to 47.0 and the new orders index falling 1.6pts to 47.1 – the lowest readings since May 2016 and June 2016 respectively. Perhaps surprisingly, the overseas orders index rose 0.9pts to a still weak 46.9, but this followed an exceptionally steep decline last month. Meanwhile, the employment index fell 0.8pts to 50.7, signalling positive but slowing jobs growth in the sector. Finally, with respect to inflation, the output price index fell 0.6pts to 51.5 and the input price index fell 1.3pts to 56.3 – the latter the lowest reading for 16 months. Given this week’s soft survey outcomes, next week’s January IP report – and the forecasts made by firms for the remainder of the quarter – will take on added interest.

In other news, METI released the All Industry Activity Index for December. While METI had already reported a 0.1%M/M decline in industrial production and a 0.3%M/M decline in tertiary activity, the overall All-Industry Activity Index fell a slightly greater-than-expected 0.4%M/M due to a 2.1%M/M decline in construction activity. And with the decline in November now also 0.2ppts larger than estimated previously (0.5%M/M), the index was down 0.3%Y/Y in December. Even so, given the post-disaster rebound seen back in October, the index rose 1.0%Q/Q and 1.1%Y/Y in Q4 – a finding that didn’t receive much support from the preliminary estimate of GDP growth released last week.

Euro area:
Today the ECB will release the account of the most recent Governing Council meeting. It will be worth watching for any further insight into likely changes to the Governing Council’s interest rate guidance at the next meeting in March as well as views on the case for a new round of TLTROs.  In his speech in Frankfurt yesterday, ECB chief economist Praet confirmed that the Governing Council will discuss the issue of TLTROs in the next Governing Council meeting on the 7 of March. However, he also noted that it remains unclear if any decision is going to be made in that meeting. Not least as banks’ funding with a maturity of one year or more counts towards their net stable funding ratios for regulatory purposes, the ECB is expected to announce a new round of the refinancing operations by the middle of this year, ahead of the maturity of the first loans borrowed under the TLTROs-II in the middle of 2020.

Data-wise, the primary focus today will be on the preliminary February PMIs. Euro area business conditions deteriorated very significantly last year and in January the euro area composite PMI edged lower further to just 51.0, the lowest level since mid-2013. And at the country level, the German manufacturing PMI and French services PMI indices plunged firmly in contraction territory. But the French flash PMIs just released showed improvements across the board – with the services PMI up 2pts to a three-month high of 49.8, the manufacturing PMI up 0.2pt to a four-month high of 51.4, and the composite PMI up 1.7pts to 49.9, the best since November – pointing to stability in the current month.

The French business sentiment survey from the INSEE this morning likewise suggested that overall business conditions in the second largest euro area member state improved slightly this month with the headline survey indicator ticking up by 1pt to103, still nevertheless the second-lowest reading since late 2016. The business sentiment index for services, however, reversed the increase of the previous month and fell back to 102, while the equivalent indicator for manufacturing was unchanged again at 103. The construction and retail sentiment gauges were slightly stronger. The employment climate index, which had declined in the second half of last year, also reported a small improvement in labour market conditions in February.

In other news, the final January inflation figures from Germany and France this morning confirmed their preliminary estimates. In the former, inflation on the EU-harmonised measure stood at 1.7%Y/Y at the beginning of the year, unchanged from December, but significantly lower than the rates above 2%Y/Y seen in the previous seven months.  In France, headline inflation in January was 1.4%Y/Y, down from 1.9%Y/Y in December.

Ahead of next week’s further debates and votes in the House of Commons on Brexit, Theresa May’s discussion with European Commission President Jean-Claude Juncker last night ended with little significant progress. They committed to further work on new guarantees to underline “the temporary nature” of the Irish backstop through “appropriate legal assurance”, changes to the political declaration on the future relationship to “increase confidence in the focus and ambition of both sides”, and work on “the role alternative arrangements could play in replacing the backstop in future”. Brexit secretary Stephen Barclay and Attorney General Geoffrey Cox will take things further with meetings with EU counterparts in Brussels today. But when they come to fruition, the amendments to the negotiated deal to be proposed from all this process seem likely to be more presentational than substantive. And despite the ongoing talks, in an unscheduled announcement yesterday Fitch Ratings put its UK AA rating on Rating Watch Negative, citing increased uncertainty and the possibility of a very disruptive no-deal Brexit scenario as the main factors for their decision.

The most notable economic data release in the UK will be the public finance figures. Large payments of self-assessment income tax and corporation tax are due in January, so we will probably see that net public sector borrowing fell last month, likely by around £10bn, which would be a slightly bigger decline compared to the same month a year ago.

The highlight of today’s economic calendar in the US is the December durable goods orders data, which should post a healthy increase of 1.0%M/M or more. However, it will probably be driven by volatile aircraft orders, and excluding those, underlying orders growth should be more moderate. Existing home sales figures – expected to show a recovery following a drop to 4.99m in December – the Philly Fed business condition index and preliminary February PMIs will be worth watching too.

The domestic focus in Australia today remained on the labour market, with the ABS releasing the Labour Force survey for January. In summary, the report provided no support for the rate cut scenario mooted by the RBA in this month’s Statement on Monetary Policy, which required a sustained rise in the unemployment rate to motivate an easing of monetary policy. Employment grew a much stronger-than-expected 39.1k during the month – more than double the long-term trend – following slightly downwardly-revised growth of 16.9k in December. Annual growth in employment was steady at a very robust 2.2%Y/Y. The detail of the report was also favourable with full-time employment rising a very strong 65.4k, lifting annual growth to 2.8%Y/Y from 1.9%Y/Y previously. Part-time employment fell 26.3k, reversing a similar-sized increase in January, and was up 0.9%Y/Y. The more favourable composition of employment meant that the number of hours worked rose a solid 0.4%M/M, with base effects helping to lift annual growth to 3.2%Y/Y. Elsewhere in the report, the labour force participation rate rose 0.1ppts to 65.7. As a result, the unemployment rate was steady at its previous cyclical low of 5.0% – the latter matching market expectations.

Attention will now turn to tomorrow’s semi-annual testimony to Parliament by RBA Governor Philip Lowe. That said, with the reports released over the past two days casting the labour market in a generally positive light, it seems highly unlikely that the Governor will abandon the constructive central forecast for the Australian economy that was depicted in the Statement on Monetary Policy.

New Zealand:
The main focus in New Zealand today was on the release of the final report of the Tax Working Group – a committee set up by the Government with the implicit objective of producing a recommendation to introduce a wide-ranging capital gains tax on all physical and financial assets with the notable exception of the family home (some other issues such as environmental taxes were also looked at by the committee). The committee duly obliged, recommending that such a tax be introduced from April 2021 with capital gains to be taxed at the income earner’s highest tax rate. In addition to the family home, certain other assets would be exempt from the tax (e.g. cars, boats, jewellery and art). According to the committee such a tax could raise NZD8.3bn over 5 years. Given the Government’s claim that it would not seek to increase the overall tax take as a result of adopting any changes recommended by the committee, any proceeds would likely be used to fund modest tax cuts for low and middle income earners. The Minister of Finance has said that the Government will respond to the committee’s recommendations in April, with the major government party – Labour – needing to consult on potential tax changes with its coalition partners. It is likely that objections raised by one of those partners – New Zealand First – will result in the Government watering down the recommendations somewhat (this may include a lower fixed rate of capital gains tax). Meanwhile, the introduction of a broad-based capital gains tax is opposed by the opposition National Party, so whatever measures the Government proposes are sure to be hotly debated in the lead up to next year’s General Election.

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