Article 50 extension ahead

Emily Nicol
Chris Scicluna

With no show-stopping news from the region or beyond to shift the mood one way or the other, Asian stocks largely lacked direction today, with China’s CSI300 a case in point, closing up just 0.2%. The Topix fared a touch better, closing up 0.4%, while the latest Japanese economic data (see below) suggested the likelihood of a positive contribution to GDP growth in Q3 from net exports despite significant ongoing weakness in overall trade. In the bond markets, JGBs were little changed (10Y yields still close to -0.15%).

But USTs have made losses this morning, with 10Y yields up about 2½bps to 1.78%, above Friday’s range. And yields on euro govvies and Gilts are also higher this morning (e.g. UK 10Y yields are up about 3bps to 0.73%), with sterling having reversed some of its losses in Asian time to be back closer to Friday’s close at $1.293. That seems appropriate after Saturday saw MPs in the House of Commons force UK PM Johnson to formally request an Article 50 extension beyond the end of the month. Despite the bluster from Johnson and his cabinet, there seems every reason for that extension eventually to be granted, all but removing the near-term risk of a no-deal Brexit. Indeed, while further twists and turns likely lie ahead in Parliament this week, events in the House of Commons over the coming couple of days should suffice to persuade the EU to grant an extension as formally requested in Johnson’s letter sent on Saturday night.

In particular, Johnson is unlikely to get his wish for another ‘meaningful vote’ today. But the Government is set to present its Withdrawal Agreement Bill (WAB) and will likely seek a ‘second reading’ vote on that draft legislation tomorrow. At the same time, opposition parties are set to table separate amendments that would call for a second referendum ahead of ratification, and compel the Government to seek a customs union with the EU during the transition phase. With the possible support of the Northern Irish DUP, who now feel betrayed by Johnson, and several ex-Conservative independents, the customs union amendment in particular would seem to have a strong chance of winning the day. And a defeat for the Government on such a vote could well see Johnson shelve the WAB, and instead seek a general election (with 5 or 12 December now the most likely dates).

Moreover, a vote on a so-called ‘programme motion’, proposing an unreasonably accelerated timetable to pass the WAB with negligible scrutiny by the end of the month, would seem doomed to failure. So, the outcome of either vote would seem to provide sufficient evidence for the EU to provide the Article 50 extension, most likely of three months in line with the request in ‘Johnson’s’ letter to the EU on Saturday night. Certainly, as has been the case for some time, we maintain our baseline scenario of an Article 50 extension and an early election before Christmas.

Beyond Brexit, the coming week will be notable for Draghi’s swansong at the ECB. But the final Governing Council meeting under his stewardship, to conclude on Thursday, will be inconsequential for policy. Data-wise, the highlights will be the euro area flash PMIs, also on Thursday, as well as the US durable goods report due the same day.

The latest Japanese trade report released earlier today provided mixed messages. Compared with a year earlier, the performance fell short of expectations, with the value of exports in September down more than 5%Y/Y, the tenth consecutive annual decline. Despite a softer pace of decline, shipments to China (up 5.3ppts to -6.7%Y/Y) remained the largest drag. And exports to South Korea (down 6.6ppts to -15.9%Y/Y) reported the largest annual decline in almost four years. There was also a steeper pace of decline in shipments to the US (-7.9%Y/Y), Thailand (-14.4%Y/Y) and UK (-13.6%Y/Y). However, overall exports to the EU were down a smaller -0.4%Y/Y. By type of good, exports of machinery (down 11.2%Y/Y) accounted for the largest share of the drop, weighed among other things by shipments of semiconductor manufacturing machinery (down 12.9%Y/Y overall and down more than 50%Y/Y(!) to Korea) while autos parts (down 14.7%Y/Y) were also particularly weak.

But adjusting for seasonal effects, the export performance was more encouraging. For example, the value of exports rose for the first month in three in September (1.4%M/M). And when also excluding price effects, the BoJ’s data showed export volumes increasing for the third month out of the past four (0.2%M/M) to leave them up a sizeable 1.7%3M/3M in Q3, the largest quarterly increase for two years. So, while import volumes rose 1.2%M/M in September, weakness in previous months left them broadly flat compared with Q2. Overall, therefore, today’s data suggests that net exports will provide a notable positive contribution to GDP growth in Q3, possibly reversing the 0.3ppt drag seen in Q2.

Today’s all industry activity figures for August, however, suggested that economic output was on track for a modest decline over the third quarter as a whole. These suggested that total output moved sideways that month following only modest growth in July. And so, following a sharp decline in June, this left output on average in the first two months of Q3 0.2% lower than the Q2 average. Data previously released showed that industrial output fell a steep 1.2%M/M in August. And today’s figures confirmed another weak showing in construction activity, down for the third consecutive month and by 0.6%M/M, with declines in private and public sector construction output alike. Indeed, this left the level of private sector construction at its lowest for almost 2½ years. Of course, the weakness in the construction and industrial sectors was offset by stronger tertiary activity in August (0.4%M/M). And we would expect a further pickup in demand in September ahead of October’s consumption tax hike. Overall, we would need to see a notable rise in all industry activity in September (circa ½%M/M) to avoid a contraction over the third quarter as a whole.

Looking ahead, Wednesday will bring the BoJ’s latest Senior Loan Officer Opinion survey which will provide an update on lending demand and supply over the past three months. Thursday will bring the flash PMIs for October along with the Cabinet Offices coincident and leading indicators for August. The same day will also see the publication of the BoJ’s semi-annual Financial System Report, which will be watched closely for any signs of greater concern about developments in its dashboard of financial stability indicators and any associated impact on the risks to the economic outlook, with the analysis no doubt likely have some bearing on the Policy Board’s monetary policy decision the following week. In the markets, the MoF will sell 20Y JGBs on Thursday.

Euro area:
The main event in the euro area in the coming week will be the conclusion of the ECB’s Governing Council meeting on Thursday. The meeting will be most notable for being the final one to be chaired by Mario Draghi before Christine Lagarde takes over as ECB President at the start of next month. Policy-wise, however, the meeting will be a non-event. After the Governing Council last month agreed a package of new measures – including a 10bps cut in the deposit rate, an open-ended programme of net asset purchases to start on 1 November, a tiered rate framework to start on 30 October, and more generous conditions on the TLTRO-III operations – the outlook for policy seems unlikely to be discussed at the meeting. However, the much-publicised differences of opinion on the Governing Council will no doubt be a focus of the press conference. Moreover, Draghi might also be questioned on the desirability of the upwards shift in yields across the curve since the September meeting, which is in part likely related to the planned tiering framework. In terms of the economic outlook, meanwhile, there seems to be no good reason for the ECB to view its current forecasts as either too pessimistic or too optimistic.

Data-wise, the most notable new releases will be October survey results, including the flash PMIs on Thursday. The September PMIs suggested a further loss of momentum in the euro area at the end of the third quarter with declines in all key indicators and weakness most acute in manufacturing, for which the headline euro area PMI fell to 45.7, the lowest in more than seven years and the output and new orders indices down again likewise to the lowest since 2012. Other business climate indicators due include the German ifo and French INSEE indices on Friday and Wednesday respectively. And the Commission’s preliminary consumer confidence index for October will also be released on Wednesday with the German GfK consumer survey results due Friday. The ECB’s latest quarterly bank lending survey will be published tomorrow. In the markets, Germany will sell 10Y Bunds on Wednesday and Italy will sell a range of bonds on Friday.

In the US, the coming week will get off to a quiet start with no top-tier data due today and existing home sales figures for September the most notable release tomorrow. Other housing market data due include the FHFA house price figures for August on Wednesday and new home sales figures for September on Thursday. That day will also bring preliminary durable goods figures for September – which will likely be closely watched by the Fed – as well as the flash Markit PMIs for October and usual weekly claims numbers. And Friday will bring the final University of Michigan consumer survey for the current month. In the markets, the Treasury will sell 2Y Notes tomorrow, 5Y Notes and 2Y FRNs on Wednesday and 7Y Notes on Thursday. There will be no Fed-speak due to the purdah period ahead of the FOMC meeting the following week.

UK data:
Brexit will completely dominate the week in the UK, with few economic data of note. Public finances figures due tomorrow will show that net borrowing in September continued to trend higher than its level a year earlier on a trajectory incompatible with the Government’s fiscal rules. And the CBI industrial trends survey due the same day will suggest that manufacturing activity remained weak this month with orders in retreat following renewed Brexit-related inventory accumulation. UK Finance bank loan data for September, due Thursday, represent the only other UK release of note in the coming week. In the bond market, meanwhile, the DMO will sell 2025 Gilts tomorrow.

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