Following a month of extraordinary gains in USTs and notable losses in equity markets, the Fed’s leadership made clear yesterday that it would not stand idly by if the case for policy action becomes compelling. Referring to developments in “trade negotiations and other matters”, Chair Powell stated that the FOMC was “closely monitoring the implications … for the U.S. economic outlook and … will act as appropriate to sustain the expansion.” In a subsequent interview on CNBC, Vice Chair Clarida added that the Fed might choose to act “pre-emptively… depend[ing] on the context at the time”.
So, with a message that the Fed’s “patient” stance should not be interpreted as indifference or inertia, US equities had their best day in five months, with the S&P500 closing up 2.1%. And, despite some underwhelming services PMIs from Japan and China (see below), most of the main Asian equity indices today inevitably followed suit. Although the yen firmed slightly to move back close to 108/$, Japanese stocks led the way, with the Topix also closing up 2.1%. In contrast, however, a decline late in the day saw China’s CSI300 close effectively unchanged from yesterday.
Despite the positive mood around equity markets, fixed income markets were also largely firmer in Asian time, supported by that suggestion of a shift in Fed policy. USTs reversed some of yesterday’s losses (e.g. 2Y yields are back below 1.85% having peaked above 1.92% yesterday afternoon, and 10Y yields are back below 2.10%). And with rumours that the BoJ might eventually feel compelled to follow any Fed easing with a short-term rate cut of its own, JGBs made further gains too: 2Y yields fell 3bps to -0.23%, the lowest in more than two years, while 10Y yields fell 2bps to below -0.13% for the first time since August 2016. ACGBs also made gains too (3Y yields down more than 3bps to below 1.08% and 10Y yields down a similar amount to back below 1.48%), as Australia’s latest GDP data broadly met expectations reporting the weakest annual growth rate since 2009, supporting the case for further RBA rate cuts (detail on this below too).
The positive tone to sovereign bonds appears to have followed through to Europe this morning, with 10Y Bund yields down almost another 2bps to a new low close to -0.23%. And Gilts are firmer too, ahead of the release this morning of the UK (and final euro area) services PMIs for May, euro area retail sales data, and, later today, the US non-manufacturing ISM survey and ADP employment report.
While Japan’s manufacturing PMI published earlier in the week continued to signal marked contraction in the sector in May – the output index fell to 48.7 – today’s services PMI suggested that conditions in that sector were more stable. Admittedly, the headline index fell for the third consecutive month in May But the decline was negligible, just 0.1pt, leaving it at 51.7. This still marked the thirty-second consecutive above-50 reading and was broadly in line with the average of the past year. There also a modest pickup in the orders component for the first month in three to 53.0, similarly in line with the recent average. And while there was a notable drop in the services employment PMI, this followed a sharp increase in April to leave the index at its second-highest reading since the series began and consistent with ongoing steady job growth.
Taken together with the findings of the manufacturing survey, Japan’s composite PMI was therefore also little changed in May, dropping just 0.1pt to 50.7. And the composite new orders PMI nudged slightly higher to 51.6. Overall, with these indices aligning with the averages so far this year, the composite PMIs remain consistent with modest, rather than vigorous, growth in Q2, and we expect to see some moderation from the 0.5%Q/Q increase in GDP recorded in the first quarter of the year.
While last week’s official Chinese non-manufacturing PMI suggested that conditions in the sector remained stable in May, today’s private sector Caixin services PMI was more downbeat. In particular, the headline index declined 1.8pts to 52.7, a three-month low. And the weakness was widespread – i.e. the new orders PMI fell 0.8pt, the new export orders PMI declined 4.5pts and the employment PMI was down 0.9pt. But we would emphasise that this series is notoriously volatile. Indeed, on a three-month moving average, the headline index rose to 53.9, its highest reading since February 2018. And despite the weakness in Monday’s manufacturing survey (for which the output PMI fell 0.6pt to a four-month low 50.1), the composite Caixin PMI – despite falling 1.2pts in May – also rose on a three-month basis to 52.4, the highest reading August 2018.
Today’s Q1 GDP figures came in close to expectations, with growth of 0.4%Q/Q double the rate in Q418 and extending the period of unbroken positive growth to eight years. Nevertheless, the annual rate of growth slowed markedly in Q1, by 0.6ppt to just 1.8%Y/Y, the softest pace for almost a decade. Within the detail, the weakness principally reflected a decline in private investment (-1.0%Q/Q) as the housing market continued to drag on growth – indeed, transfer of ownership fell a whopping 13%Q/Q in Q1 the biggest drop since Q300 – to leave it down 24%Y/Y, while dwelling investment was down 2½%Q/Q, 3%Y/Y. Household consumption provided less support than of late too, with the increase of 0.3%Q/Q the softest for almost six years. So, government spending was the principal domestic contributor to growth in Q1, while net trade also provided a boost, both contributing 0.2ppt apiece.
With the ongoing housing market adjustment likely to continue to weigh on consumer spending and downside risks to the global (Chinese) economic outlook having intensified over recent months, there is a significant probability that Aussie GDP will slow further in the second quarter. So, after the RBA yesterday cut the cash rate by 25bps to 1.25%, and Governor Lowe stated that it’s “not unreasonable” to expect further easing ahead, the market is pricing a probability of greater than 60% of another rate cut by August.
Today will bring euro area retail sales data for April as well as the final services and composite PMIs for May. Having moved sideways in March to take the gain over Q1 as a whole to 0.7%Q/Q, euro area retail sales are expected to decline about ½%M/M at the start of Q2, not least as sales dropped a sharp 2.0%M/M in Germany. Meanwhile, the PMIs are highly likely to align closely with the preliminary estimates for which the euro area services PMI fell 0.3pt to 52.5, a five-month low, and the composite PMI inched up just 0.1pt to 51.6. (The final euro area manufacturing output PMI, released on Monday, was revised down just 0.1ppt to 48.9).
Today will round off the May PMIs with the services survey. Having reached a 2½-year low of 48.9 in March, the headlines services PMI rebounded to 50.4 in April. However, in light of the weakness reported in other sectors, we expect a decline back below 50 in May. And following a rare sub-50 reading for the manufacturing PMI earlier this week, that would leave the composite PMI similarly in contraction territory for the first time since July 2016. UK car registration numbers for May are also due this morning.
In the US, the non-manufacturing ISM survey for May will be released along with the Fed’s Beige Book, the final Markit services and composite PMIs, and – ahead of Friday’s official labour market report – the ADP employment numbers. Fed speakers include Vice Chair Richard Clarida.