Morning comment: Japan PMI, China trade, German IP & UK politics

Chris Scicluna
Emily Nicol
Mantas Vanagas

Overview:
With concerns about Trump’s threat to hike tariffs on Chinese imports continuing to resonate, yesterday saw major government bonds rally (10Y Bund yields back down to -0.04% as 10Y UST yields fell back to 2.45%) and stocks suffer a torrid day, with the main euro area equity indices and the S&P500 closing down more than 1½%. Despite a better morning session, the negative tone has persisted across Asian markets today ahead of the resumption of US-China trade talks in Washington DC tomorrow. While the latest Chinese trade data, which reported weak exports but firmer imports, provided some distraction, China’s CSI is currently down almost 1½%. And with the yen stronger (briefly below ¥110/$ a short time ago) on increased risk aversion, Japan’s Topix closed down 1.7% as the latest services PMI survey also disappointed. Elsewhere in the Pacific, as was largely expected, New Zealand's Reserve Bank became the first central bank from the industrialised economies to cut rates this cycle, with the Official Cash Rate reduced by 25bps to 1.5%.

In Europe, however, a better-than-expected German IP report this morning might have offered a little comfort. But despite a stronger retail survey overnight, political dysfunction will continue in the UK as leading Tory backbenchers meet again to discuss a possible timetable for the Prime Minister’s resignation. Detail on all this below:

Japan:
After yesterday’s slightly more upbeat manufacturing PMI (up 1.8pts to an admittedly still-weak 48.9), today’s equivalent services survey was somewhat disappointing. In particular, the headline business conditions fell for the second successive month in April and by 0.2pt to 51.8, a three-month low. Nevertheless, this was bang in line with the average of the past 2½ years and still consistent with moderate expansion in the sector. And while there was a further notable drop in the new orders component, at 52.8 it also pointed to ongoing growth. Furthermore, there was a marked increase in the employment PMI in the sector, by 2.6pts – the largest monthly increase for almost six years – to 54.7, its highest reading since the series began in 2007.

Given the pickup in the manufacturing output PMI the composite PMI posted the first increase in six months at the start of Q2, although the 0.4pt rise left it at a still-subdued 50.8, a touch firmer than the average in Q1 but well below the average since the start of 2017. And the new orders component fell for the fifth month out of the past six, by 0.5pt to 51.3. So, with the first estimate of Q1 GDP on 20 May likely to report a contraction, today’s survey indicated ongoing subdued economic momentum at the start of Q2 too. And the news on the inflation front remained disappointing too, with the output price index down 0.6pt to 51.7, a ten-month low.

China:
While unease over the China-US trade talks remained elevated ahead of Vice Premier Liu He’s trip to Washington DC, the main economic focus in China today was on April’s trade report. And this added to survey evidence suggesting that the pickup in economic momentum at the end of Q1 was likely a temporary distortion due to the timing to the Lunar New Year holiday rather than the start of a more sustained recovery. In particular, the value of exports fell a steeper-than-expected 2.7%Y/Y in April, to leave the increase in the year-to-date at just 0.2%Y/Y, comparing unfavourably with the double-digit increase this time last year. In contrast, perhaps hinting at firmer domestic demand, the value of imports rose a stronger-than-expected 4%Y/Y. And so, China’s trade surplus narrowed to $13.8bn.

Within the detail, the weakness in exports was driven by a drop of more than 13%Y/Y in shipments to the US, while exports to Japan also fell at the steepest annual pace (>16%Y/Y) since mid-2009 (when excluding the New Year distortions). With respect to imports, there was a notable rise from Brazil (>20%Y/Y) and Australia (>16%Y/Y), while those from Japan rose 1.4%Y/Y following a drop of 14.1%Y/Y the previous month, and imports from South Korea fell 2.4%Y/Y, the least since October. But imports from the US continued to decline at a double-digit annual rate for the sixth consecutive month.

Euro area:
The data focus in the euro area today has remained on the German manufacturing sector, with industrial production figures for March released a little while ago. The headline figure beat expectations, with total IP up for the second successive month, rising 0.5%M/M, albeit following downwardly revised growth of 0.4%M/M in February. Within the detail, manufacturing and mining output rose 0.4%M/M in March, similarly representing a second monthly increase in a row. Output of consumer goods rose 1.1%M/M while output of intermediate goods rose for the first time this year, up 0.4%M/M. But production of capital goods was flat. Meanwhile, tallying with the elevated level of confidence in the sector, construction output increased for a fifth successive month, up 1.0%M/M following (downwardly revised but still highly vigorous) growth of 4.0%M/M to leave it up almost 10%Y/Y. In contrast, despite the increase on the month, total IP was still down 0.8%Y/Y in March, with manufacturing and mining output down 2.2%Y/Y.

Looking at the first quarter as a whole, total IP was up 0.5%Q/Q in Q1, a sharp turnaround from the declines of 1.0%Q/Q in Q3 and Q4. Manufacturing and mining output, however, was down 0.1%Q/Q, nevertheless still an improvement from the declines of more than 1.0%Q/Q in each of the previous two quarters. Construction activity, meanwhile, rose a whopping 3.9%Q/Q to mark the best quarter for the sector since Q116. Of course, such a rate seems impossible to sustain, and so we expect negative payback in construction in Q2. And, given the drop of 4.1%Q/Q in factory orders in Q1 including further declines in orders in key sub-sectors such as autos and chemicals, and continued extreme weakness in survey indicators from the sector – e.g. April’s manufacturing PMI of 44.4 and new orders PMI of just 40.8 – we would not be surprised to see manufacturing production decline once again in Q2 too.

Beyond the economic data, ECB President Draghi will speak publicly at a “Youth Dialogue” today. In the markets, Germany will sell 5Y Bunds.

UK:
Politics remains centre-stage in the UK once again today. Following a meeting yesterday evening between Theresa May and Sir Graham Brady, Chair of the 1922 Committee of backbench Tory MPs, to discuss demands for the PM to set a date to resign, the 1922’s Executive will today meet to decide whether to amend the Conservative Party’s rules to allow a binding no-confidence vote in May’s leadership in June. Certainly, there is dissatisfaction at the suggestion that the PM might not confirm her departure before the summer recess in the second half of July, which would probably not give sufficient time for the Party to select a new leader before MPs’ return to Parliament in September.

Meanwhile, the Brexit negotiations between the Government and Labour party leadership should continue today. But comments from the opposition team last night reaffirm our central view that these remain a charade, with little prospect of tangible progress towards a compromise that is unlikely to appeal to either side. If, as we expect, these talks eventually break down, a further set of indicative votes in the House of Commons on various Brexit options would be the likely next step, although momentum now appears to be increasing for a second referendum

On the data front, the overnight release of the BRC Retail Sales Monitor suggested that UK retailers had a decent month in April. Warm weather over the Easter weekend helped to lift overall spending. But while food, children’s toys and furniture got a boost, some categories such as clothing and footwear, and various

items from department stores suffered as shoppers turned their attention to outside activities. Overall spending in nominal terms rose by 4.1%Y/Y on the survey’s measure. And on a like-for-like basis, growth was a touch lower at 3.7%Y/Y, similarly the strongest in two years. Both these rates, however, were distorted by the timing of Easter and therefore do not reflect true momentum in the retail sector. Indeed, the three-month growth rate of total sales of 1.2%3M/Y, which was broadly in line with its longer-term average, might be a more useful indicator in this case. However, it is worth noting that this survey has diverged significantly from the official ONS data in recent months. Indeed, the ONS figures showed a steep increase in retail sales volumes in Q1 in March leaving them 6.7% higher compared to a year ago. But with consumer sentiment remaining subdued, and housing market indicators showing few signs of a recovery, we think the underlying growth on the High Street is likely to moderate to levels more consistent with the BRC data.

US:
In the US, today is set to be uneventful for new economic data, although Fed Governor Brainard will speak publicly and the Treasury will sell 10Y Notes.

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