A downbeat Tankan

Chris Scicluna
Emily Nicol

Saturday’s decision by Donald Trump to suspend plans to hike tariffs on additional imports from China was broadly in line with expectations. But as it removed the immediate tail risk of increased barriers to trade, Asian equity markets have rallied today despite some notably soft economic surveys from the region. So, while China’s Caixin manufacturing PMIs today tallied with the weekend’s official PMIs to suggest ongoing weakness in output and new orders in the sector, the CSI300 was almost 3% higher. Likewise, although the latest BoJ Tankan survey showed a further substantive deterioration in manufacturing confidence (detail below), Japan’s Topix closed up 2.1% as the yen depreciated to touch ¥108.50/$ for the first time in ten days. In bond markets, meanwhile, UST yields are about 3-4 bps higher across the curve (10Y yields up close to 2.04%) while JGBs lost ground too (10Y yields up almost 2bps to close at -0.15%).

European markets have picked up the baton this morning, with equities opening higher across the board and bonds softer. But question marks about the identity of Mario Draghi’s successor ECB President hang over the market, with EU leaders still yet to conclude their marathon summit discussions aimed at finalising the appointments to institutions’ top jobs. Notably, however, the euro has weakened half a cent (to about $1.33) on reports that France is pushing the case for one of its nationals, and a female, to head the central bank. That suggests that Christine Lagarde – who should be expected to maintain broad continuity of monetary policy from Draghi’s pragmatic approach – rather than the hawkish Jens Weidmann – whose commitment “to do whatever it takes” to preserve the euro must be in doubt – is now be in pole position to take over the reins in Frankfurt.

With the Tankan and Chinese PMIs out of the way, looking ahead, the most notable new data of the week come from the US, starting with the latest manufacturing ISM survey today and culminating in the June payroll report on Friday. Elsewhere, the UK PMIs (kicking off with the manufacturing indices today) seem highly likely to signal an absence of economic growth, or even contraction, in Q2.

While the BoJ at its recent policy meeting left its economic assessment unchanged – most notably stating that the economy “is likely to continue on a moderate expanding trend” – there is little doubt that we would expect some downwards adjustments to its growth forecasts later this month, not least given today’s results of the latest BoJ Tankan survey, which tallied with the broadly downbeat tone of other recent indicators in Q2.

Certainly, the impact of the more challenging external environment was evident in today’s survey, with the headline index for large manufacturers down for the fifth quarter out of the past six in Q2 and by 5pts to +7, its lowest level since Q316. And the weakness was most evident in the export-oriented sectors with, for example, the indices in the production machinery sector down 14pts to +17, the autos sector down 10pts to +5 and the processed metals sector down 19pts to -11. In contrast, large non-manufacturers assessed conditions to have remained broadly stable in Q2, with the equivalent index rising 2pts to +23. This in part reflected a notable improvement in hospitality-related services – with the relevant index up 9pts to +17, its highest level since the start of 2017 – possibly reflecting the extended Golden Week celebration, while retailers were also their most upbeat for six quarters. But while large manufacturers expected conditions to remain broadly unchanged over the coming quarter, large non-manufacturers were more downbeat about the near-term outlook.

As is the norm, smaller firms were more downbeat about current and future business conditions. And among manufacturers the pessimists outweighed the optimists for the first time in almost three years – in particular, the relevant index fell 7pts to -1. With the equivalent index for small non-manufacturers declining 2pts to +10, the overall index for small firms was down 4pts to +6 and expected to fall a further 7pts in Q3. Overall, the headline diffusion index for all firms declined 2pts in Q2 to +10, its weakest reading since the start of 2017 and was forecast to fall a further 6pts in Q3 as firms become more apprehensive about conditions ahead of the scheduled consumption tax hike in October.

Against this backdrop, manufacturers were on the whole more downbeat about their expectations for profits growth in the current fiscal year – for example, large manufacturers revised down their forecast by almost 6ppts to a drop of 8.1%Y/Y. And while non-manufacturers were less pessimistic than three months ago, they were also still forecasting a decline over the year as a whole. But as is the norm for this time of year, firms were broadly more upbeat about their fixed investment plans for the current year – in particular, large manufacturers forecast an increase of 12.9%Y/Y, while in aggregate firms forecast an increase of 2.3%Y/Y. Admittedly, large manufactures are likely to revise down their forecast over coming quarters in line with the usual pattern. And overall, anticipated capex growth was below the equivalent forecasts in FY17 and FY18.

Of course, an increase in capex growth would be consistent with ongoing evidence that firms have insufficient capacity constraints. This notwithstanding, today’s Tankan suggested that they were not quite as tight as reported three months ago. For example, the survey’s employment conditions index rose 3pts to -32, its highest reading in a year a year, albeit still suggesting that labour shortages remain especially acute. And so, the Tankan’s composite indicator of spare capacity edged slightly lower in Q2, suggesting that (admittedly already weak) upward pressure on wages and inflation might be waning.

Certainly, the Tankan’s inflation indicators once again pointed to a weaker pricing environment, especially in the manufacturing sector. Indeed, large manufacturers reported a notable easing in input price pressures in Q2, with the DI down 6pts to +11. Moreover, large manufacturers on aggregate reported a decline in output prices last quarter for the first time in two years. Large non-manufacturers had a little more success in passing price rises through to customers, although the relevant DI was down for the second successive quarter to +6, its lowest for a year. And looking ahead, on balance large manufacturing firms indicated that they expect to face downward pressure on their output prices. Firms’ specific forecasts for inflation and their own output prices will be released tomorrow, alongside additional industry detail from the survey.

The latest monthly consumer confidence survey was hardly encouraging about conditions in the household sector at the end of Q2 either. In particular, the headline sentiment index declined for the ninth consecutive month in June and by 0.7pt to 38.7, its weakest level since November 2014. While the weakness was widespread, there was another notable deterioration in households’ willingness to buy durable goods, with the relevant index falling to its lowest reading since the previous consumption tax hike in April 2014. So, while we would expect to see a pickup in spending on big-ticket items ahead of the scheduled tax hike in October, today’s survey continued to suggest that underlying consumption growth will likely remain subdued.

Looking ahead, there are only a few further releases of note to come out of Japan this week. Wednesday will bring the services PMI along with the BoJ’s estimate of the output gap for Q1. And the back end of the week will bring the BoJ’s latest consumption activity release, as well as the Cabinet Office’s composite index of business conditions for May. In the markets, the MoF will conduct auctions of 10Y and 30Y JGBs tomorrow and on Thursday respectively.

Euro area:
Datawise, after last week’s top-tier sentiment surveys suggested that there was a further loss of economic momentum in the euro area at the end of Q2, the coming week brings a mixed bag of new data, none of which should be a show-stopper. The week kicks off with the final manufacturing PMIs for June, for which the headline flash euro area index remained very weak at just 47.8. Today also brings euro area May data for bank lending, which has been broadly steady if not particularly vigorous of late. Unemployment figures, which keep improving faster than expected (the headline rate dropped to a near-11-year low off 7.6% in April), are also due.

German retail sales figures for May are due tomorrow and should post a rise following a notable drop of 1.0%M/M in April. The following day brings the final services and composite PMIs for June, for which the flash euro area headline indices rose 0.5pt to 53.4 and 0.3pt to 52.1 respectively, principally due to a better showing in France. Thursday will bring euro area retail sales figures for May, which – as in Germany – should show a return to positive growth. And Friday will bring German factory orders for May and French trade data for the same month.

In the markets, Germany will sell 5Y Bunds on Wednesday, while the following day will bring French auctions of 10Y, 15Y and 30Y bonds and Spanish auctions of 5Y, 7Y, 10Y and 30Y bonds.

Politics are set to remain prominent in the UK in the coming week as the Conservative leadership contest continues with further hustings between the candidates. But Parliamentary machinations about Brexit will also be back in focus, as the House of Commons will vote on new legislative amendments tabled by MPs opposed to the UK leaving the EU without a deal. The proposals aim to reduce the incentives faced by the government to move to a no-deal Brexit by withholding public expenditure in such an event. But given that there still remains four months to go to the Article 50 deadline, we suspect that the amendments will not find a majority as many MPs will first want to give the next Prime Minister an opportunity to steer a policy course away from no deal before taking draconian legislative action.

Data-wise, the most notable new releases from the UK will be the June PMIs. The headline manufacturing PMI (due today) is expected to remain below the key 50.0 mark, having fallen to a near-three year low of 49.4 in May. The construction PMI (tomorrow) is also expected to remain below 50.0, while the services PMI (Wednesday) is expected to move broadly sideways from May’s sluggish reading of 51.0. Other data releases in due in the coming week including the BoE’s May bank lending figures (Monday), new car registrations for June (Thursday) and Q1 unit labour cost data (Friday). In the bond market, the DMO will sell 6Y and 30Y Gilts tomorrow. 

A busy week for US economic news will kick off today with the June ISM manufacturing survey on Monday, with the equivalent non-manufacturing survey coming on Wednesday. With the following day bringing the Independence Day holiday, Wednesday will also bring several other releases, including the weekly jobless claims numbers, the ADP June employment figures, and final durable goods and trade reports for May. Most attention will be on Friday’s labour market report for June, with nonfarm payroll growth expected to take a step up from 75k in June close to the average for the year to-date (164k). The unemployment rate, meanwhile, is expected to remain unchanged at 3.6%, while average earnings data will be closely watched too. Beyond the data, Fed Vice Chair Clarida will speak on monetary policy on Monday with NY Fed President John Williams speaking the following day along with Cleveland Fed President Loretta Mester. No UST auctions are currently scheduled.

Perhaps unsurprisingly given May’s US tariff hike, today’s Caixin manufacturing PMIs – which covers largely smaller private firms – suggested that June was the worst month for Chinese industry since January. Certainly, the headline PMI dropped the most (0.8pt) to the lowest level (49.4) since the start of the year. And the detail was decidedly weak too, with a drop of 1.1pt in the output index to 49.0, and a fall of 1.9pt in the new orders index to just 48.8, both similarly the respective steepest declines and lowest levels since January. Employment was also reportedly down last month. So, curiously, the only notable upwards pressure on the survey indices was registered in terms of prices, with the input price PMI up 0.5pt to a seven-month high of 51.0, and the output price PMI up 1pt to the same level, the highest in three months.

The weekend’s official manufacturing PMIs – which has a better coverage of larger firms and SoEs – told a similar story. But starting from a lower base, the headline index was merely unchanged at 49.4, matching January’s level, while the declines in the output and new orders indices were more modest (down 0.4pt and 0.2pt respectively to 49.6 and 46.3), both the lowest since February.

The Caixin non-manufacturing PMIs will come on Wednesday after the official indices suggested little change from May: the headline activity index fell just 0.1pt to 54.2 (still, admittedly, a seven-month low) while the new orders index rose 0.8pt to a three-month high of 51.5.

All eyes tomorrow will be on the RBA. While this is certainly not a done deal, on balance we expect the Board to cut its main cash rate by a further 25bps to 1.00%. Data-wise, the May trade report comes the following day while retail sales and job vacancy data for the same month will come on Friday.

Categories : 

Back to research list


This research report is produced by Daiwa Securities Co. Ltd., and/or its affiliates and is distributed by Daiwa Capital Markets Europe Limited in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Conduct Authority and is a member of the London Stock Exchange and Eurex Exchange. Daiwa Capital Markets Europe Limited and its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.

This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.

Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at  /about-us/corporate-governance-regulatory. Regulatory disclosures of investment banking relationships are available at https://daiwa3.bluematrix.com/sellside/Disclosures.action.