Services in the spotlight

Chris Scicluna
Emily Nicol

While yesterday saw Wall Street edge up to new highs, a notable drop in oil prices late yesterday saw Asian equities start today on the back foot. And against the backdrop of a weaker Caixin services PMI, Chinese equities were one of the worst performers, with the main CSI 300 index closing the day more than 1% lower. And while the Japanese services PMI continued to signal remarkably stable conditions in the sector, the Topix was also down around 0.7%. In contrast, the Aussie ASX 200 closed up 0.5%, perhaps taking support from some improved trade and housing market reports (see more on all the economic data below).

In bond markets, the rally continues as expectations for global monetary easing increased. Yesterday saw 10Y UST yields fall below 2% to its lowest level in more than two years, while BoE Governor Carney’s comments of increased downside risks to global and UK GDP growth triggered a marked drop in gilt yields and an increase in expectations for an interest cut in Bank Rate: markets are now pricing in a near-50% chance of a cut by the end of the year. So, while the BoJ reduced its purchases of intermediate and ultra-long bonds at its regular operation today, 10Y JGB yields also fell 1bp to -16bps. And euro area markets appear to have maintained this rally this morning after last night saw EU leaders’ nominate IMF MD Christine Lagarde to succeed Mario Draghi as ECB President in November, which should ensure a continuation of the pragmatic approach to policy-setting at the ECB favoured by Draghi.

There were no major surprises from the Japanese services PMI at the end of the second quarter, which suggested that conditions in the sector were little changed and remained remarkably stable. Admittedly, the headline business conditions index increased for the first month in three in June, with the 0.2pt rise to 51.9 marking the 33rd consecutive above-50 reading and leaving the level bang in line with the average so far this year. However, the survey’s new orders component (52.9) was a touch softer in June, albeit still pointing to expansion ahead, while the employment PMI fell for the second successive month to a four-month low (51.9).

Given the pickup in the headline services PMI, the composite PMI was also a touch firmer in June. Nevertheless, given the ongoing weakness implied by the manufacturing PMI, the composite output PMI stood at a more subdued 50.8 in June, in line with the average over the second quarter as a whole. While this is little changed from the average index in Q1, it is nevertheless well down on levels seen over the past 2½ years. And other components of the survey were weaker at the end of second quarter, with the new orders and employment PMIs falling to their lowest levels since January, while the output price PMI posted the largest monthly decline since February 2018 to leave the index at its lowest for thirteen months.

The message from the Chinese Caixin services PMIs was broadly consistent with that of the government’s official surveys published over the weekend. Admittedly, the monthly profile was weaker in the Caixin release, with the headline services index declining for the second successive month in June and by 0.8pt to 52.0, a four-month low. But this still left the average index in Q2 at a still-healthy 53.1, unchanged from the average in Q1. And while the composite PMI also posted the third consecutive monthly decline in June (down 0.9pt to 50.6, an eight-month low), the quarterly average moved broadly sideways at 51.6 in Q2. This notwithstanding, against the backdrop of the ongoing China-US trade dispute and softer global economic growth, the survey’s measure for future output fell to its lowest level since the measure was introduced to the survey in 2012.

Euro area:
Yesterday evening saw EU leaders finally agree on whom to nominate to lead the European institutions. As had been widely reported during the day, that package included German Defence Minister Ursula von der Leyen to succeed Jean-Claude Juncker at the Commission and French IMF Managing Director Christine Lagarde to succeed Mario Draghi at the ECB Presidency. While these nominations will need to be approved by the European Parliament, it should be considered a favourable decision from an economic perspective: while Lagarde is not an economist, she is internationally credible and a good communicator, she is wary of the existential risks that would threaten the euro if the ECB failed “to do whatever it takes”, and would likely adopt the pragmatic approach to policy-setting favoured by Mario Draghi. Certainly, we would not expect to see a significant step-change to policy making at the ECB when she takes the reins, although Chief Economist Philip Lane would play the pivotal role in determining future policy.

The main data focus in the euro area today will be 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. Given the modest downward revision on Monday to the euro area manufacturing output index (down 0.3ppt from the flash to 48.5), we might well see the headline composite PMI nudged slightly lower too. In the markets, Germany will sell 5Y Bunds.

The UK’s services PMI will also likely signal subdued conditions in the sector at the end of the second quarter, with the headline business conditions index expected to have moved sideways in June at a subdued 51.0. Of course, given the downside surprise to yesterday’s construction and Monday’s manufacturing surveys, risks to this forecast would appear skewed to the downside. Certainly, we wouldn’t be surprised to see the composite PMI slipping below the key-50 expansion level to add to evidence of negative GDP growth in Q2.

After comments yesterday by BoE Governor Carney of increased downside risks to global and UK GDP growth triggered a notable increase in market expectations that the MPC will cut rates by the end of the year, this morning’s BRC shop price index for June also attracted attention. In particular, this suggested that retail price inflation fell sharply in June, with the headline rate down 0.9ppt to -0.1%Y/Y, the first decline since October. With food price inflation unchanged at 1.8%Y/Y, the decline was fully accounted for by lower non-food inflation, which fell 1ppt to -1.2%Y/Y, the steepest drop for eleven months, as retailers attempt to offset weakening demand.

Elsewhere, speeches by BoE Deputy Governors Broadbent and Cunliffe will also likely attract attention.

It will be a busy day for top-tier US releases today, including the non-manufacturing ISM and services PMI surveys, weekly jobless claims numbers, ADP June employment figures, and final durable goods and trade reports for May.

After the RBA yesterday cut interest rates for the second successive month, the latest data published by the Australian Bureau of Statistics overnight were on the whole more positive. In particular, the trade surplus rose a stronger-than-expected AUD925mn to a record high AUD5.7bn in May, as a 3.6%M/M increase in the value of exports more than offset the 1.5%M/M increase in the value of imports. Within the detail, the increase in exports was once again underpinned by a rise in goods exports (more than 4%M/M) as shipments of metal ores increased 13.4%M/M to leave them more than 40% higher than a year earlier. So, while the improvement in exports no doubt reflects to some extent price effects, today’s data suggest that net trade is currently on track to provide another modest boost to GDP growth in Q2 – indeed, on average in April and May, the value of exports were 2.3% higher than the average in Q1, while the value of imports were up 2% on the same basis.

With respect to the housing market, the latest building approvals data were also less downbeat in May than of late. In particular, the number of dwelling approvals rose for the first month in three and by a stronger-than-expected 0.7%M/M. But this reflected a 1.2%M/M increase in the volatile ‘other dwellings’ category, while house approvals fell for the fourth consecutive month (0.3%MM). And while the pace of annual decline moderated slightly in May, they were still down by almost 20%Y/Y, the tenth consecutive double-digit decline. 

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