Japanese sentiment slumps

Emily Nicol

While US equities moved broadly sideways yesterday, Asian markets on the whole had a slightly better day despite earlier reports suggesting that the signing of the preliminary US-China trade agreement might well be pushed back into December, with China’s main CSI 300 closed 0.2% on the day. And the subsequent reports suggesting that China and US had agreed to gradually roll back tariffs should provide a further boost when markets reopen tomorrow. Japan’s TOPIX also closed 0.2% higher today, despite a disappointingly, albeit not unsurprisingly, weak Reuters Tankan survey, which suggested sentiment among Japanese manufacturers and non-manufacturers alike was at multi-year lows. And the news on the China-US tariff agreement saw the yen reverse much of today’s gains to leave it back around ¥109/$. Meanwhile, the Aussie S&P 200 was much stronger today, perhaps taking a boost the release of some positive trade figures (see more details on today’s data releases below).

In bond markets, while Aussie government bonds had followed the global trend higher overnight (10Y ACGB yields were down 6bps to 1.21%), European markets have seen yields rise since opening on the back of the reported progress in the trade talks. Indeed, despite a weak German industrial production release this morning, which confirmed the fifth consecutive quarterly contraction in Q3, 10Y Bund yields are currently trading 2bps higher at -0.32%. Looking ahead, the main event today will be the BoE’s latest policy announcement at midday, which will be accompanied by updated economic forecasts in its newly rebranded quarterly Monetary Policy Report.

Japanese sentiment surveys have painted a mixed picture of economic conditions in the immediate aftermath of the consumption tax hike last month. For example, contrasting with yesterday’s downbeat services PMI in October – which implied contraction in the sector for the first time in three years – the Reuters Tankan for that month provided a surprisingly upbeat assessment from non-manufacturers, with retailers in particular seemingly benefiting from the influx of visitors during the Rugby World Cup. This optimism, however, appears to have been short-lived.

Certainly, the latest Reuters Tankan published today signalled a marked deterioration in conditions in the non-manufacturing sector in November, with the headline diffusion index (DI) down 13pts on the month to +12, a three-year low. And while the weakness was broad based, the equivalent retailing DI reported the most significant decline, down a whopping 45pts on the month – the most since the series began in 1998 – to -15. Construction firms were also notably less upbeat too, with the relevant DI down 8pts to +18, the second-lowest reading since early 2013, and expected to fall significantly further over the coming three months too. Admittedly, when smoothing out monthly volatility, the headline non-manufacturing index on a three-month moving average basis moved sideways in November (+19) for the third consecutive month, nevertheless still well below the levels seen at the start of the year and a sizeable 18pts lower than the peak in mid-2018. And if the forward-looking DI is to be believed, the downward trend looks set to resume heading into the New Year.

Sentiment among Japanese manufacturers has been on a steady downward trend over the past year or so. And against the backdrop of a still challenging external environment, this fell further in November, with the headline manufacturing DI down 4pts at -9, the lowest for more than 6½ years. And the survey showed a drop in confidence among the key export-oriented sectors, with the electrical machinery DI down 4pts, general machinery DI down 6pts, autos DI down 17pts and precision machinery DI down 18pts. And while manufacturers were forecasting a modest improvement over the coming three months, pessimists in the sector were still anticipated to outweigh the optimists.

Euro area:
Attention in the euro area today was firmly on the latest German IP release. But while yesterday’s factory orders provided a rare upside surprise, today’s output figures broadly aligned with the downbeat expectations. In particular, total production fell 0.6%M/M in September, more than reversing the upwardly revised increase in August and marked the third monthly drop out of the past four. As such, output was still almost 4½% lower than a year earlier. Moreover, when excluding construction – the measure that aligns with the euro area IP data – the decline was even steeper at 1.0%M/M, -5.3%Y/Y.

Within the detail, like construction (1.8%M/M), energy production provided a modest boost in September (2.0%M/M) for only the second month out of the past eight. In marked contrast, the weakness in manufacturing in September (-1.3%M/M) was broad based – e.g. production of capital goods fell by 1½%M/M, intermediate goods by 1.3%M/M and consumer goods by ½%M/M. So over the third quarter as a whole, total manufacturing production declined 1%Q/Q, while total industrial output was down 1.1%Q/Q, admittedly smaller than the drop seen in Q2, but still the fifth consecutive quarterly contraction. And although yesterday’s manufacturing orders improved at the end of Q3 they still remained on a downward trend, while the latest manufacturing PMI implies ongoing declines at the start of Q4, suggesting therefore that the outlook for production in the sector will remain weak heading into year-end.

This morning will bring Germany’s construction PMI for October, which is also expected to imply weak conditions in that sector at the start of the fourth quarter. And Italy’s retail sales figures are likely to report a modest pickup in September following notable weakness in the previous two months. Elsewhere, the European Commission will also publish updated economic forecasts, while in the markets, France and Spain will sell bonds with various maturities.

The main event in the UK today will be the BoE’s latest monetary policy announcement, which will be accompanied by updated economic forecasts in its newly rebranded quarterly Monetary Policy Report. We expect no changes to policy, with Bank Rate set to be left at 0.75%. September’s policy statement implied a further loss of confidence on the MPC about the Brexit process, and also acknowledged the more challenging external environment. Since then of course PM Johnson signed up to a draft Brexit Withdrawal Agreement with the EU. But with that having not been ratified by Parliament and a new general election next month, there remains significant uncertainty about the outlook for Brexit. Therefore, we would expect the MPC to remain relatively downbeat about the near-term outlook, with possible further downward revisions to both its GDP growth and inflation forecasts.

Of course, in August, the MPC downplayed the value of its economic projections, emphasising the inconsistencies between the Bank’s assumption of a smooth Brexit and the conditions underpinning moves in market asset prices, which at the time had reflected the increasing probability of a no-deal. And so, Carney seems likely to reiterate that downside risks not least associated with political uncertainty remain to the fore and therefore restate that the MPC will “take all appropriate measures to support jobs and activity, consistent with achieving the 2% inflation target commitment”.

In the US, today’s data calendar will include monthly consumer credit figures for September, as well as the weekly jobless claims numbers. In the markets, the US Treasury will sell 30Y bonds, while the Fed’s Kaplan will speak in Dallas.

In Australia, meanwhile, today’s trade report published by the ABS came in ahead of expectations in September, with the trade surplus rising AUD0.6bn to AUD7.2bn, the third-highest on record. This in part reflected a pickup in exports values, by 3.5%M/M to leave them almost 15% higher than a year earlier. Meanwhile, the value of imports were up 2.5%M/M, 1.3%Y/Y. Over the third quarter as a whole, export values were more than 2½% higher than Q2, the eighth consecutive quarterly increase. Meanwhile, import values were up just 0.8%Q/Q. As such, price moves notwithstanding, today’s report suggests a positive contribution from net trade to Q3 GDP growth for the third consecutive quarter.

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