Widespread manufacturing weakness

Emily Nicol

Overview:
A slightly less dovish stance from the Fed yesterday – with the decision to cut the FFR target range by 25bps to 2.00-2.25% not unanimous and Chair Powell’s comment that yesterday’s policy easing amounted to a ‘mid-cycle adjustment’ rather than the beginning of an extended easing cycle – saw US equities weaken notably yesterday, with the S&P 500 closing 1.1% lower on the day. So, while the Fed clearly left the door open for additional rate cuts, noting in particular that it will “act as appropriate to sustain the expansion”, US government bonds fell.

As such, Asian equities on the whole made losses today. Indeed, with limited progress seemingly made during the trade talks between US and Chinese officials, China’s main CSI 300 closed the day 0.8% lower. But while the latest Korean trade figures highlighted ongoing export weakness, the Kospi’s losses were more limited at 0.4%. And despite a downwards revision to the Japanese manufacturing PMI (see details below), the Topix eked out a gain, rising 0.1% on the day.

Bond markets typically followed Treasuries lower, with a notable jump in 10Y JGB yields by 2½ bps to -0.14%. And with euro area govvies having risen ahead of the Fed announcement – with 10Y Bund yields at a record low – they have predictably opened lower this morning. While today’s BoE policy announcement with see policy left unchanged, we might well see a more dovish statement reflecting the increased downside risks to both the domestic and global outlooks. Certainly, today’s data focus with manufacturing PMIs due from across the major economies are likely to emphasise the challenging conditions facing firms in the sector.

Japan:
Japan’s final manufacturing PMI was certainly disappointing, suggesting that the sector continued to struggle aginast the backdrop of the more challenging global environment. In particular, the headline index was downwardly revised by 0.2pt from the preliminary release to 49.6, to leave it just 0.1pt higher than June and in contractionary territory for the third consecutive month. And the revision in the output component was larger still to leave it 0.3pt lower on the month at 48.1, a four-month low and the seventh successive sub-50 reading. But while the new orders PMI was revised a touch higher from the preliminary estimate, at 48.1 it still signalled a significant decline. This was also true for the survey’s price indices, which despite an upwards revision of 0.4pt were still down on the month. Indeed, the output price PMI was 0.6pt lower than June at 48.8, at a near-three-year low, while the input price PMI declined more than 1pt to 52.7, the lowest since the start of 2017.

China:
The Chinese Caixin manufacturing PMI echoed the message from the government’s official survey, which suggested that conditions in the sector had stabilised somewhat at the start of Q3 despite ongoing concerns about the China-US trade dispute. In particular, the headline manufacturing index rose 0.5pt in July to 49.9, with the output component increasing 1.1pt to 50.1. And the new orders component edged back above the key 50-expansion level too. But there was a notable drop in the output price index, down 2.4pts to 48.6, indicating deflationary pressures in the sector for the first time since January.

UK:
After the Fed’s announcement last night, the main policy event today will come from the UK, with the BoE’s latest monetary policy decision and publication of its August Inflation Report at midday. We expect no changes to policy, with Bank Rate set to be left at 0.75%. But with Carney having recently noted increased downside risks to global and UK GDP growth, we would expect the MPC to be more downbeat about the near-term outlook. And with Bank staff last month having revised down their Q2 GDP forecast from 0.2%Q/Q to 0.0%Q/Q, we expect the Inflation Report to reveal downward revisions to the Bank’s GDP growth forecasts and possibly its inflation projection too. Of course, with the appointment of Boris Johnson as Prime Minister increasing the risk of a no-deal Brexit on 31 October, the MPC’s assessment of the economic effects of Brexit uncertainty will be under the spotlight too. Given heightened downside risks, domestic and overseas alike, it would seem appropriate for the MPC to tweak its forward guidance that “were the economy to develop broadly in line with [the] May Inflation Report projections that included an assumption of a smooth Brexit, an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a limited extent, would be appropriate”.

This morning will also bring the UK’s most noteworthy data release of the week, with the July manufacturing PMI. In June, this survey was particularly disappointing, with the headline PMI declining for the third consecutive month and by 1.4pts to 48.0. The weakness in the output PMI was even more striking, down more than 3pts to 47.2. And we expect no improvement at the start of Q3, with the headline indices likely to signal ongoing marked contraction in the sector.

Euro area:
Today will also bring the final manufacturing PMIs for July from the euro area and various member states. The flash estimates were particularly disappointing, with notable declines in the headline figures for the euro area (down 1.2pts to 46.4), Germany (down 1.9pts to 43.1) and France (down 1.9pts to 50.0), suggesting ongoing weakness in the sector at the start of Q3. In the markets, France will sell fixed-rate and index-linked bonds with various maturities.

US:
In the US, as the dust settles on the Fed’s policy announcement (please see the comment from Mike Moran, Daiwa America’s Chief Economist), the data focus in the US today will be on the manufacturing sector, with July’s ISM and Markit PMI due to indicate a subdued start to the third quarter. Meanwhile, ahead of tomorrow’s payrolls report, today will also bring the latest Challenger job cuts figures for July and the weekly jobless claims numbers.

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