Morning comment: A Brexit breakthrough, but Japanese and Aussie business sentiment softens

Chris Scicluna
Emily Nicol
Mantas Vanagas

Following the partial rebound in Chinese equities earlier in the day, Wall Street shrugged off an underwhelming January retail spending report – whereby significant downward revisions magnified the slump in December – with technology stocks leading the S&P500 to a strong 1.5% gain, the biggest since January, buoyed by merger activity. US credit spreads tightened but Treasury yields nudged only slightly higher.

Against that backdrop, strong gains have been seen across most equity markets in the Asian region today. In Japan the TOPIX rose 1.5% despite the latest MoF/Cabinet Office Business Outlook Survey confirming a sense of greater caution across the business sector (more on this below) while Hong Kong’s Hang Seng is also up around 1½%. And while China’s CSI300 gave up some of its early gains after lunch, it closed up 0.7%. A notable underperformer was Australia’s ASX200, which closed down 0.1% on a day which featured some weaker local data (more on this below too). UST yields have firmed further (10Y yield up to 2.66%) but JGB yields are little changed.

Of course, sentiment wasn’t harmed by last night’s Brexit deal reached between Theresa May and Jean-Claude Juncker, which pushed sterling above $1.32 and €1.17, the latter the strongest level since May 2017. The focus now shifts to the House of Commons for the long-awaited meaningful vote on the deal this evening, where success for the Prime Minister is still far from assured. In our view, it’s too close to call. Assuming that the UK Attorney General Geoffrey Cox later this morning revises his previous opinion that the UK risks being trapped ‘indefinitely’ within the backstop arrangements, much will depend on whether the Northern Irish DUP gives the revised package – which certainly falls short of meeting the party’s demands for a legally binding end-date to the Irish backstop and a unilateral exit mechanism – its backing, and hence whether most Conservative Brexiters also then feel able to come onside. Before the Brexit vote, the latest monthly UK GDP data and US CPI report will also be watched.

Yesterday evening’s Brexit deal saw Theresa May fall well short of securing the legally-binding unilateral exit mechanism and firm end-date to the Irish backstop which she had pledged to Parliament. Indeed, she achieved no changes whatsoever to the Withdrawal Agreement. Instead, however, she grudgingly earned ‘further interpretations of interpretations [and] reassurances of reassurances’ (as Juncker put it) that the UK will not be trapped in a customs union with the EU indefinitely. Whether these might prove sufficient to get her deal over the line today will only be clear as the day unfolds. Voting in the House of Commons will start at 7pm GMT this evening, and – with MPs to be given the chance to consider all amendments tabled by MPs (including no doubt one that would approve May’s deal subject to a second referendum) – could well drag on well into the evening.

The new assurances from the EU were packaged in the form of a four-page ‘joint instrument’ of ‘legal force and a binding character’, which provides clarification on the Withdrawal Agreement’s independent arbitration mechanism (with language inserted to please the UK side related to ‘good faith’ and ‘best endeavours’ of somewhat questionable legal value in EU law) that would determine how and when the UK might be able to secure ‘unilateral, proportionate’ suspension of parts of the backstop. Additional to that, a further unilateral declaration was issued by the UK Government, which might be considered of relatively limited value insofar as it relates to a bilateral agreement. Finally, with an eye on securing the support of certain Labour MPs from Leave-voting constituencies, the Political Declaration on the future relationship was amended to commit the UK to avoid regression from EU standards on workers’ rights and the environment.

Many Conservative Brexiter MPs who voted against May’s deal in January’s first meaningful vote have already indicated their willingness to support the package this time around. If amended significantly, the updated opinion – due mid-morning – of Attorney General Geoffrey Cox, who previously flagged the risks that the UK be trapped within the backstop indefinitely, could well persuade many others to fall into line. However, given the record 230 vote margin of defeat last time around, May still has a mountain to climb to get her deal approved this evening. Certain hard-core Brexiters have already reportedly expressed scepticism (e.g. with former Brexit minister Steve Baker saying that MPs should be wary of ‘entrapment’). Others (e.g. ERG Chair Jacob Rees-Mogg) have seemingly contracted out their view on the deal to the Northern Irish DUP, who could still have reason to vote against given the risk that a future UK Government would allow Great Britain to exit the backstop while leaving Northern Ireland trapped within (i.e. placing a new hard border down the Irish Sea). Little more than a dozen Labour MPs might be inclined to back the deal. So, this evening’s vote appears too close to call.

While the Brexit votes will get most attention, this morning will also bring the most notable new UK data of the week with the ONS set to release its latest short-term output indicators, including the monthly GDP figures for January. UK economic activity dropped in December by 0.4%M/M, which represented the joint steepest fall in the last six years, and a small recovery, of about 0.2%M/M, is expected for the start of the year. Of course, the magnitude of the rebound will depend most of all on services activity, which accounts for around 80% of the economy, and growth of 0.2%M/M is similarly anticipated in this sector. Industrial production, meanwhile, looks set to remain unimpressive, perhaps declining for a sixth consecutive month. And the trade deficit looks set to widen back to about £3.5bn, a little above the average of the past three months and well above the average of the past year.

The domestic focus in Japan today was on the MoF/Cabinet Office Business Outlook Survey for Q1, which cast some further light on the expectations of the business sector. In keeping with other recent business surveys, the Business Outlook Survey indicated that, on balance, firms perceive business conditions to have weakened somewhat in recent months, especially in the manufacturing sector. Moreover, in fewer numbers, on balance firms indicated that they expect a further weakening in business conditions over the next quarter before some improvement takes hold in Q3 – no doubt reflecting an anticipated boost to spending ahead of October’s scheduled consumption tax hike. The Business Outlook Survey often provides a good indicator of the direction of movement travelled by the key indicators in the more widely-followed and comprehensive BoJ Tankan survey, so today’s results suggest that a decline can be expected in the Tankan survey indices on 1 April – albeit from levels that are very elevated by historical standards.

Turning to some of the detail, amongst large firms, a net 1.7% of respondents reported a deterioration in overall business conditions in Q1, the weakest reading since Q218 – a result driven by the net 7.3% of manufacturers that reported weaker conditions, the most since Q216 – with similar proportions reporting weaker domestic conditions too. Indeed, domestic conditions for large-, medium- and small-sized firms in the sector were considered to be the weakest since 2016.

Looking ahead, on balance, large firms indicated that they expected little change in business overall conditions next quarter and only a small net proportion foresaw an improvement in domestic conditions. However, about a net 6% of large firms indicated an expected improvement in overall business conditions in Q3, with optimism shared equally amongst manufacturing and non-manufacturing firms. As usual the expectations of medium-sized firms were slightly less optimistic than their larger counterparts. And as is also typically the case, small firms did not share the optimism of their larger counterparts at all, with these firms reporting an expectation that both overall and domestic economic conditions would deteriorate further over the coming two quarters following a very widely reported deterioration in Q1. Firms of all sizes continued to report worsening labour shortages in Q1 and an expectation that shortages would continue to get more acute over the next two quarters, albeit at a slower pace.

Elsewhere in the survey, respondents also provided their fifth estimate of sales, profits and capex for the almost-completed FY18, as well as their first estimates for FY19 (the latter obviously very tentative). Firms now forecast growth in business sales of 2.4%Y/Y in FY18, down from 2.8%Y/Y in the prior survey. Further growth of just 0.1%Y/Y is forecast to occur in FY19. Ordinary profits are now forecast to decline 1.7%Y/Y in FY18, which represents a deterioration relative to the 0.4%Y/Y increase that had been forecast previously. This largely reflects the performance of manufacturers, with profits now expected to fall 5.8%Y/Y compared to the 2.8%Y/Y decline forecast previously. In FY19 profits are forecast to fall 0.4%Y/Y again led by a 1.8%Y/Y decline at manufacturing firms.

Reflecting widespread skill shortages and current high absolute levels of profitability, firms forecast that spending on plant and machinery and software will grow 7.4%Y/Y in FY18, although this was down somewhat from the forecast increase of 9.1%Y/Y made in the previous survey. This growth remains mostly due to the manufacturing sector, where spending is forecast to rise 17.2%Y/Y. Spending amongst non-manufacturers is forecast to increase just 2.1%Y/Y, albeit up marginally from the 1.9%Y/Y growth forecast in the prior survey. As usual the opening forecast for FY19 was very cautious, with spending expected to be down 6.2%Y/Y due to sharply lower spending in the non-manufacturing survey. That said, this still marks one of the weakest opening forecasts for capex of the past decade – a result that probably reflects the high level of investment that is already currently taking place and increased uncertainty regarding the economic outlook. Tonight’s machine orders data for January will provide further insight into the near-term capex outlook, and these are expected to be soft, with core orders expected to drop about 1½%M/M to leave them down more than 2.0%Y/Y. 

In the US, focus today will be on February CPI figures, with prices expected to have risen by 0.2% on the month to leave annual inflation unchanged at 1.6%Y/Y. Core CPI is also expected to have risen by 0.2%M/M to leave the annual rate also unchanged, at 2.2%Y/Y. Tuesday will also bring the NFIB small business optimism survey for February. In the markets, the US Treasury will sell 10Y notes.

Euro area:
It should be a fairly quiet day for euro area data today with the day’s most notable release – the final French payrolls figures for Q4 – already released. These data reported another modest net increase in total payrolls of 53.6k (0.2%Q/Q), again underpinned by private sector employment growth (50.7k, 0.3%Q/Q). So, compared with a year earlier, total payrolls were up 150k (0.6%Y/Y, the softest annual rate since Q415), with private sector payrolls rising 160k (0.8%Y/Y). Within the detail, there were solid increases in payroll employment in the industrial and construction sectors, with the latter reporting an annual increase of 25.6k. And while the decline in temporary employment in the services sector continued, payrolls in the sector were up 32.7k, to leave them up 114.5k over the year. Turning to the public sector, although payrolls stabilised at the end of last year, they were still down 11.8k (-0.2%Y/Y) from a year earlier.

The domestic focus in Australia today was on the release the NAB Business Survey for February. After strengthening in January, the closely-watched business conditions index fell 3pts to +4 in February – a level that is fractionally below the long-run average for this series. The headline business confidence index also fell 2pts to +2, so also remained slightly below its long-run average. Within the detail, this month respondents were slightly less positive about trading conditions, forward orders, capex and especially profitability. However, given the RBA’s strong focus on developments in the labour market, it was notable that the employment index was steady at +5 – a level that remains slightly above its long-run average. On the pricing side, firms indicated a 0.8% lift in labour costs over three past three months – slightly above last month’s outcome. However, they reported that their output prices rose just 0.3% over that period – the weakest outcome since July 2017. This suggests that CPI inflation will continue to track well below the midpoint of the RBA’s 2-3% target range in the near term at least. 

In other news, more evidence of weakness in the housing market was provided by the latest report on housing finance. The value of home loan approvals fell a further 2.4%M/M in January following a 3.6%M/M decline in December. Again the greatest source of weakness was the investor segment, where new lending (i.e. net of refinancing) fell 4.1%M/M and almost 29%Y/Y. The value of new lending for owner-occupied dwellings fell 1.3%M/M and 17.1%Y/Y. Finally, ahead of tomorrow’s monthly Westpac consumer confidence reading, the weekly ANZ-Roy Morgan index fell a sharp 5.3pts to 109.5 last week, marking the weakest outcome since August 2017. All components of the survey moved lower, but with the largest deterioration occurring in indicators relating to the economic and financial outlook – an outcome that may reflect reaction to last week’s disappointing GDP report.

New Zealand:
The ANZ ‘Truckometer’– a measure of traffic flows that is correlated with overall economic activity – reported a slight increase in February. Specifically, after rising strongly in January – rebounding from a soft end to last year – the heavy traffic index nudged up 0.4%M/M to lift annual growth to a very solid 6.3%Y/Y (the 3-month average rose 3.5%Y/Y).

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