Japan consumers increasingly downbeat

Emily Nicol
Chris Scicluna

After yesterday’s very weak manufacturing ISM survey flagged increasing industrial sector weakness, US stocks inevitably went firmly into reverse, with the S&P500 closing down 1.2%. And, of course, USTs rallied. At one point 10Y yields were down 14bps from their intra-day peak of 1.75%, but have edged gradually back up to 1.66%.2Y yields, however, also dropped about 14bps from their peak and have failed to regain the lost ground, currently languishing down at 1.55%. And the market-implied probability of a rate cut at the end-October FOMC meeting, based on fed funds futures, has moved back above 50%.

Markets in Asian time have unsurprisingly taken their cue from the US, with stocks down across the board (with the exception of China, which remain closed for holidays). The Topix closed down 0.5%, perhaps a more measured decline than might have been expected in the aftermath of yesterday’s strengthening of the yen (currently around 107.8/$) and following a further weakening of Japanese consumer confidence and reaffirmation of subdued business inflation expectations (see below). Meanwhile, markets in Hong Kong reopened well down after yesterday’s holiday, but have clawed back most losses, with the Hang Seng currently down just 0.2% from Monday’s close.

In the bond markets, JGBs made gains across the curve, with yields down most from the 5 to 10Y maturity range (e.g. 10Y yields down almost 3bps to -0.17%). In Australia, in contrast, having already rallied yesterday, gains in ACGBs were modest and largely concentrated at the short end as the AUD strengthened a touch.

Elsewhere, in the FX market, after a modest bounce yesterday afternoon, sterling is weakening again (close to 0.89/€) ahead of Boris Johnson’s speech to the Conservative Party conference which, amid the jingoism, will see him preach to the converted about his imminent Brexit proposals. It remains to be seen, however, how much (honest) detail about those plans – extraordinarily, the first he’ll have made since the referendum more than three years ago – will actually be made available today. However, the substance reported in the press (see below) suggests proposals that have minimal chance of being agreed by the EU, and seem designed principally to allow Johnson to blame the Europeans for any failure to reach a deal before the end of October. Of course, our baseline forecast is still that the Article 50 deadline will be extended we still expect an extension.

Today the BoJ released further details from its latest Tankan survey, most notably with information on firms’ inflation expectations. And consistent with the message from yesterday’s survey – that showed the number of firms reporting declining output prices completely offsetting those reporting increases for the first time in two years – today’s Tankan summary confirmed that firms remain unconvinced that the BoJ will achieve its 2% inflation target, even within a 5-year horizon. Given the further deterioration in business conditions last quarter, however, today’s results were arguably not quite as bad as might have been expected, with little change in expectations from three months ago.

For example, for all firms, the average expectation of inflation was unchanged across the horizon, at 0.9%Y/Y one year ahead, 1.0%Y/Y at the three-year horizon and 1.1%Y/Y five years ahead – at the five-year horizon this has remained unchanged at this rate for eleven of the past twelve quarters, hardly consistent with the BoJ’s suggestion that inflation expectations will be supportive of a gradual upward trend in underlying inflation. Indeed, large firms remained more sceptical about the inflation outlook across the horizon, with manufacturers and non-manufacturers alike expecting inflation of just 0.7%Y/Y five years ahead.

As usual firms’ expectations regarding their own output prices were even weaker, and down compared with three months ago. In particular, firms were on average forecasting a rise in prices over the coming year of just 0.6%Y/Y, down 0.1ppt from the previous survey and the lowest for almost three years. And manufacturers were even more downbeat, forecasting a rise of just 0.3%Y/Y with auto companies continuing to forecast a decline in the coming year. Non-manufacturers were also less optimistic with their projected 0.8%Y/Y increase down 0.1ppt from three months ago.

The outlook further ahead was even more downbeat, with firms forecasting a cumulative increase of just 1.0% and 1.3% over the next three and five years respectively, both downwardly revised by 0.2ppt over the past three months. Larger firms were also more pessimistic about prices than three months ago, forecasting a cumulative decline in prices over the coming five years of just 0.3%. And while small firms were significantly more optimistic than their larger counterparts, they too revised down their price expectations over the coming five years, projecting a cumulative increase of 1.8%, the lowest for two years.

While yesterday’s Tankan suggested that the deterioration in business conditions was less than had been feared, it still maintained the steady downward trend in sentiment seen over the past year or so and indicated a further hit to conditions in the current quarter from reduced demand in the aftermath of yesterday’s 2ppt tax hike. Certainly the latest consumer confidence survey – which assesses conditions over the coming six months – implied a further significant weakening in domestic demand over coming quarters. In particular, the headline index fell for the twelfth consecutive month in September (and has now failed to rise in any month since 2017) by 1.5pts to 35.6, the lowest level since mid-2011 in the aftermath of the Great East Japan Earthquake.

The weakness was broad based, with increased concerns about the employment outlook and prospects for income growth sending the respective indices to their lowest since Abe took office at the end of 2012 and the start of 2015. But once again, the largest drop in confidence related to households’ willingness to buy durable goods, with the relevant index falling 3.6pts (the most since just the before the 2014 consumption tax hike) to 28.1, the lowest since the height of the Global Financial Crisis (when adjusting for methodological changes). Over the third quarter as a whole, this index was down a whopping 6pts compared with Q2, admittedly a more modest drop compared with the decline immediately before the 2014 tax hike but still consistent with very weak underlying consumption growth.

All eyes today in the UK will be on the final day of the Conservative party conference, with PM Boris Johnson supposedly to set out his ‘take it or leave it’ offer to the EU on Brexit. Of course, given Johnson’s habit of being economical with the truth, it’s difficult to know quite how much of what he’ll say today at face value. And his detailed proposals might not be available until tomorrow, when he is set to present them to the House of Commons.

However, media reports imply a highly problematic set off proposals. In particular, the Daily Telegraph suggests that they would be tantamount to a deal that would wholeheartedly trash the notion of frictionless trade between the EU and UK. Among other things, the Irish border backstop would be replaced with convoluted mechanisms leaving Northern Ireland aligned to EU rules for agricultural and industrial goods for four years (extendable only by a decision of the Northern Ireland Assembly, which would be contentious in the extreme), but leaves it squarely in UK customs territory. So, Northern Ireland would face two borders, one with the EU and another with the rest of Great Britain – just the thing to stir up animosities between communities in the Province, and add significant burdens to business too.

Moreover, the proposals blatantly trash the EU’s red lines of a fully open border on the island of Ireland, and the protection of the integrity of the single market. So, while the EU will of course be willing to discuss the proposals in more detail to see if common ground can be reached, if the Telegraph is right we should assume minimal probability that agreement will be reached with the EU in time for the UK to leave at end-October. And that would leave a further extension of Article 50 (forced by opposition MPs, which is our baseline assumption) or a no-deal Brexit (if MPs are unable legally to force the implementation of the Benn-Burt Act that would demand the PM formally requests an extension on 19 October) as the only possible outcomes at the end of the month.

Data-wise, today will bring the latest construction PMI for September. Yesterday’s manufacturing PMIoffered a pretty bleak outlook for the sector, and the headline construction PMI similarly is expected to imply continued contraction in the sector at the end of the third quarter, with the headline index forecast to be unchanged at 45.0.

Yesterday’s manufacturing survey indicated diminishing inflationary pressures in the sector, with the output price PMI falling to its lowest in three years. And the overnight release of the BRC shop price index suggested that retail price inflation maintained a steady downward trend in September. In particular, the headline rate fell a further 0.2ppt to -0.6%Y/Y, the lowest for eighteen months. While this in part reflected lower food inflation (down 0.5ppt to 1.1%Y.Y), there was a steeper pace of decline in non-food inflation, down 0.2ppt to -1.7%Y/Y, the lowest since May 2018. Not least due to intense competition on the High Street, retail price inflation has been significantly weaker than overall consumer price inflation over recent years. Nevertheless, with underlying inflationary pressures subdued, we continue to expect headline CPI to remain below the BoE’s 2% inflation target over coming months.

Euro area:
A quieter day for euro area data releases will bring just the Spanish labour market figures for September. In August, the number of people in registered unemployment rose for the third consecutive month, although this still left them almost 120k lower compared with a year earlier. And while this morning’s non-seasonally adjusted figures suggested another rise in unemployment in September (adjusted figures will be published later today), employment maintained its steady upward trend of recent years rising in further 33k in September to 19.3mn, the highest level since April 2008 and just 100k below the previous peak.

In the US, today will bring just the ADP employment report for September, while voting member Williams and non-voting member Harker are due to speak publicly.

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