Japanese survey disappoints, Aussie employment exceeds expectations

Chris Scicluna
Emily Nicol

Overview:
While yesterday’s soft US inflation data further raised market expectations of a series of near-term Fed rate cuts, US equities declined once again (S&P500 closed down 0.2%). And with the Asian dataflow offering little cause for encouragement, and no good news on the trade war (indeed, Trump was again in a belligerent mood, threatening sanctions on Germany over its Nord Stream 2 gas pipeline with Russia), most major equity indices in the region fell again today. Japan’s Topix was among the worst performers (down 0.8%) as the yen appreciated and the Government’s latest quarterly business sentiment survey suggested a weakening in activity in the current quarter and a further chill to come after the consumption tax hike in October (see detail below). And the Hang Seng fell at a similar rate as the street protests continued to dominate attention. China’s CSI300, however, edged down just 0.2% after yesterday’s mixed bag of bank lending data.

In fixed income markets, USTs have made further gains (2Y yields now below 1.86% and 10Y yields down below 2.11%). JGBs made modest gains at the shorter end of the curve, with 2Y yields back below -0.20% and the probability of a cut in the BoJ’s IOER before year-end back above 50%. And ACGBs made further gains too, with 2Y yields down to a new record low of 1.01%, as Australia’s unemployment rate remained stubbornly unchanged despite stronger-than-expected job growth in May (more on this below too).

Looking ahead, US futures markets are pointing south today and European govvies have opened higher too. But in forex markets, sterling is stable, having yesterday taken a step down after Parliament rejected a motion with cross-party support to take action that might have ruled out a no-deal Brexit. While the shameless populist Boris Johnson is set to see his status as favourite to be the next UK Prime Minister highlighted by today’s first-round vote in the Conservative leadership election, we continue to see other Brexit outcomes as more likely than a no deal.

Japan:
Today’s Japanese releases provided mixed messages about the economic outlook. On the positive side, services firms appear to have had a stronger start to the second quarter, with tertiary activity rising for the first month in three in April and by a faster-than-expected 0.8%M/M, the largest increase since October. While the improvement was widespread, the pickup was principally driven by the ICT and living and amusement-related subsectors (up 2.6%M/M and 1.9%M/M respectively), with the latter underpinned by increased activity at travel agencies, hotels and ‘ceremonial-related services’ ahead of the extended Golden Week holiday. Retailers also saw increased activity, as did finance and energy services providers. Taken together with modest growth in manufacturing output (tomorrow’s revised figures are expected to confirm that production rose 0.6%M/M in April), today’s data suggest that all industry activity – due for release a week today – should also report a solid rebound at the start of Q2 following the 0.4%Q/Q contraction recorded in Q1.

Notwithstanding the improvement in activity at the start of Q2, today’s MoF/Cabinet Office Business Outlook Survey – often a good indicator of the direction of movement of the more comprehensive and closely-watched BoJ Tankan survey (due 1 July) – indicated that, on balance, firms perceive business conditions to have worsened in recent months. Amongst large firms, a net 3.7% of respondents judged business conditions to have weakened (the most for three years), driven by a marked deterioration in the manufacturing sector no doubt in part related to heightened downside risks associated with the global economic outlook. But they were also more downbeat about domestic conditions than their non-manufacturing counterparts. Admittedly, small- and medium-sized non-manufacturers assessed a more significant deterioration in domestic conditions. And overall, as usual, SMEs were more downbeat than their larger counterparts.

With the exception of smaller enterprises, Japanese firms were more optimistic about conditions in Q3. And perhaps surprisingly given the likely slump in domestic demand following the scheduled consumption tax hike in October, as well as ongoing uncertainties about the global outlook, large firms on balance just about anticipated business conditions to improve in Q4. But, perhaps inevitably, firms of all sizes and across both the manufacturing and non-manufacturing sectors alike forecasted a significant worsening of domestic conditions in Q4.

While firms were more upbeat about their expected sales growth in the current fiscal year (up 1.2ppts to 1.3%Y/Y), they were more pessimistic about their projected profits this year, with the anticipated decline revised to -3.3%Y/Y from -0.4%Y/Y just three months ago. Against this backdrop, it was perhaps somewhat surprising to see firms’ capex projections revised significantly higher from three months ago. In particular, firms estimated that spending on plant and machinery and software will grow 9.0%Y/Y in FY19, up from the 6.2%Y/Y decline forecast previously (admittedly not an usually large revision between the first and second survey estimates for a fiscal year).

Euro area:
This morning brought the final German inflation figures for May, which unsurprisingly aligned with preliminary release, confirming the 0.8ppt drop in the EU-harmonised rate to 1.3%Y/Y, a thirteen-month low. The national headline CPI rate also dropped 0.6ppt to 1.4%Y/Y. Within the detail, as expected, the most notable downward pressure related to prices of package holidays last month, with a drop of 9.0%Y/Y following the Easter-related surge in April (+11.2%Y/Y). As such, services inflation declined 0.9ppt to 1.2%Y/Y. So, while goods inflation moved sideways at 1.8%Y/Y, this left core CPI down 0.5ppt to 1.3%Y/Y.

Later this morning, April’s industrial production data will suggest a soft start to Q2. Despite growth in France and Spain, significant weakness in Germany and Italy will likely see aggregate production (excluding construction) fall for the second successive month and by a slightly steeper pace than the 0.3%M/M drop in March. Meanwhile, in the bond markets, Italy will sell 3Y, 7Y and 15Y BTPs.

UK:
Sterling took a step down back below $1.27 yesterday afternoon as the House of Commons failed to back a cross-party motion that might have prevented a no-deal Brexit at end-October. We were not surprised by the defeat, however. And contrary to some commentary, we did not view that as the last chance for MPs to block such a destructive outcome, with the timing (more than three months ahead of the next Article 50 cliff-edge) and vagueness of the proposals contributing to yesterday’s negative outcome. Indeed, if and when procedural options are exhausted and the next Prime Minister chooses to head for a no-deal Brexit, the Speaker would seem likely to allow MPs to take the nuclear option of rejecting the Government in a vote of no confidence. And we continue to see a majority in Parliament willing to take that action to trigger an early General Election in the autumn if that is the only path left available to block no deal.

Of course, much will depend on the identity and intentions of the next Prime Minister. In that respect, today will bring the first elimination ballot for the Conservative Party leadership contest. The ten candidates will each require the backing of 17 MPs to stay in the race – should that threshold be achieved by all candidates, the one with the least votes will be eliminated. Further votes among Conservative MPs will then be held on Tuesday, Wednesday and Thursday next week in order to identify the two candidates to be subject to a vote of all party members. The winner of the contest to become Conservative leader, and hence Prime Minister, will then be announced in the second half of July.

Populist gaffe-prone Brexiteer and former Foreign Secretary Boris Johnson – who, among other things, twice in the past lost his job for lying and is viewed with significant mistrust by many EU leaders – is the clear favourite to reach the final vote among party members, probably already having the backing of one thirds or more of the 313 Conservative MPs. And given his evident popularity among the rank-and-file membership, it’s no surprise that he’s odds-on to become the next Prime Minister. (Current Foreign Secretary Jeremy Hunt, who has also recently offended many EU leaders, and Environment Secretary Michael Gove whose campaign has been significantly set back by admissions of cocaine use, seem to be ahead of the rest of the pack in the race to join Johnson on the final vote.)

Johnson’s utterances on Brexit suggest that – assuming he wins the Conservative leadership contest – he would initially try to renegotiate Theresa May’s Brexit deal. Given the lack of principal evident in his flip-flopping in previous votes on May’s Withdrawal Agreement, we do not rule out the probability that he would accept minimal cosmetic changes before resubmitting the deal for a vote in Parliament. It would remain to be seen whether that, coupled with threat of an early General Election in the event of a defeat, would suffice for the deal to be finally endorsed. But we see the probabilities of an Article 50 extension and new election (or even second referendum), or adoption of a Johnson deal, as greater than the probability of a no-deal Brexit.

Data-wise, the latest RICS house price survey suggested a slightly more stable residential property market in May, probably supported by the avoidance of a no-deal Brexit the previous month. For the first time in ten months, there was only a minimal drop in new buyer enquiries, although agreed sales reportedly continued to decline significantly and expectations are for a further fall over the coming three months. New sales instructions also declined for an eleventh successive month. While the survey’s headline national house price balance remained in negative territory, at -10.2% it was the best since October. The regional detail suggested a fourth consecutive monthly softening of downwards pressure in London, where price declines have been steepest, with the South East now the primary source of weakness. Looking ahead, national price expectations remain slightly negative for the coming three months (net balance of -14%), but positive for the coming year (+22%).

Australia:
All eyes in Australia today were on the latest labour market report as the RBA has made clear that such data would be pivotal in determining future adjustments in monetary policy. Overall, today’s report exceeded expectations, with the number of people employed rising a stronger-than-expected, and an above-trend, 42.3k in May, to push annual growth up 0.4ppt to 2.9%Y/Y (360k), the strongest rate in fourteen months. Admittedly, the rise once again reflected stronger growth in part-time employment (up 39.8k), with full-time employment up just 2.4k in May following a drop in April. But this still left full-time employment up a whopping 266k on a year earlier, significantly outpacing growth in employment of part-timers. Meanwhile, the labour force participation rate rose 0.1ppt to a new series high of 66.0%.

The number of people unemployed fell for the first month in three in May, albeit by just 2.4k. And so that left unemployment down just 6.8k compared with a year earlier, the smallest annual drop for a year. As such, the unemployment rate moved sideways at 5.2%, 0.1ppt above the trend rate and still significantly higher than the RBA’s central estimate of the equilibrium rate, which Assistant Governor Luci Ellis yesterday suggested is now a little below 4.5%. The underemployment rate also edged higher in May, by 0.1ppt to 8.6%. Overall, therefore, today’s report suggests that spare capacity in the labour market will likely continue to weigh on wage growth over the near term, maintaining downside risks to the inflation outlook.

US:
After yesterday’s soft CPI readings further boosted expectations of an imminent easing cycle (with fed funds futures now price a probability of greater than 50% that we will see two cuts in the FFR by September) today will bring the usual US weekly jobless claims figures, as well as the latest monthly import and export price indices. In the markets, the US Treasury will sell 30Y bonds.

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