Following yesterday’s steep declines in major markets (the S&P500 closed down 1.8% following drops of 3.0% or more in certain leading European bourses), the main Asian indices have followed the pack lower today. Japan’s Topix led the way with a drop of 1.7% but, once again, Hong Kong’s Hang Seng was more restrained currently down a little more than ½%. With little major economic news from the region to change the market tone, fears about global growth in the aftermath of Tuesday’s poor US ISM manufacturing survey were compounded after the WTO gave the US green light to retaliate for illegal state aid to Airbus – the USTR subsequently confirmed its intention, in a fortnight’s time, to impose a new 10% tariff on aircraft imported from the EU and a 25% rate on certain other goods, including wine, cheese, butter, selected pork products and whisky. The EU side has pledged to “respond firmly”.
Against that backdrop, and expectations of a further cut in the fed funds rate this month rising, sovereign bonds have inevitably fared well, with USTs having rallied notably: 2Y yields are currently close to 1.46%, down about 9bps from this time yesterday, while 10Y yields are down a similar amount close to 1.58%. JGBs have also made gains, this time with the curve flattening, with 10Y yields down about 2½bps to close to -0.20% and 30Y yields down about 3½bps to just below 0.35%. Yields on ACGBs moved back closer to their record lows, with 10Y yields about 4bps lower at 0.92%, as the latest Australian trade data disappointed expectations (see below).
In forex markets, the yen has locked in yesterday’s appreciation, currently close to 107.2/$, while sterling is stable even as Boris Johnson’s Brexit plans received a cool reception from the EU. Those plans will come under greater scrutiny today, ahead of more substantive negotiations over coming days. Meanwhile, the data focus today will be on services, with PMIs for the sector out of the EU and UK this morning and the ISM survey due in the US later on.
It was a fairly quiet day for Japanese economic releases, with just the final services and composite PMIs for September. And these provided no surprises, with the headline indices unrevised from the preliminary estimates signalling ongoing moderate expansion at the end of the third quarter. In particular, the headline services PMI was confirmed at 52.8, a decline of ½pt from August, still the second-highest reading for almost two years. While the new orders component was nudged down slightly from the flash release, this was still 0.2pt higher on the month at 52.0, a three-month high. A notable upwards revision to the business expectations index left it 1pt higher than August, similarly at a three-month high. And contrary to the implied cutback in employment in the sector reported in the initial survey, today’s release signalled a continued modest increase in September. There was, however, a sizeable downwards revision to the output price PMI, by 1.3pts to 50.2 to leave it 0.6pt lower on the month at its weakest reading since 2016.
So, with no substantive revisions to the manufacturing survey earlier this week – with the headline index unchanged from the flash release at 48.9, nevertheless matching the more-than 2½-year low reached in February – the composite PMI was unrevised at 51.5, a decline of 0.4pt from August but still second-highest reading this year. This left the index on average in Q3 at 51.3, 0.6pt higher than the average in Q2 and consistent with steady expansion last quarter. Of course, not least given the anticipated drop in demand in the aftermath of the consumption tax hike, the survey’s new orders component fell a sizeable 0.9pt in Q3 to just 50.5, the lowest quarterly reading for three years. The composite employment PMI also implied a much softer pace of growth, down 1.9pts in Q3 to just 50.8. And the output price PMI further illustrated the persistently subdued inflationary environment, down more than 1pt in Q3 to 50.4.
After the RBA in its post-meeting statement earlier this week continued to flag the downside risks emanating from the challenging external environment, today’s trade figures for August, published by the ABS, were weaker. In particular, the value of exports fell 3.4%M/M that month, the steepest drop since April 2017. While this left exports up more than 10%Y/Y, this was the softest annual pace since May 2018. And with the value of imports down just 0.4%M/M, this saw the trade surplus narrow for the second successive month in August to AUD5.9bn, albeit from a record high AUD7.9bn in June.
Within the detail, the weakness in August principally reflected a fall in iron ore prices – indeed, the value of such exports was down more than 10%M/M and largely accounted for the total drop in exports. In contrast, exports of rural goods rose for the first month in five (1.4%M/M), while services exports were up 0.6%M/M. Overall, with the decline in August coming on the back of four consecutive increases, today’s release still suggested that so far in Q3, the value of exports was on average 0.7% higher than the average in Q2. So with imports down 0.2% on a similar basis, today’s release also implied that net trade is on track to again provide modest support to GDP growth in Q3 for the third consecutive quarter.
Today’s euro area dataflow will bring the retail sales report for August and final services PMIs for September. After the more upbeat German retail figures at the start of the week, euro area retail sales are expected to have reversed some of the 0.6%M/M decline recorded at the start of Q3. And if the German release is anything to go by, July’s decline will be significantly smaller than initially estimated too. But the final September services and composite indices are expected to closely align with the preliminary readings, which reported a notable deterioration in conditions in services. As such, the euro area composite PMI will likely confirm a sizeable decline to around 50.5, the lowest since June 2013 and a level suggesting that economic growth has all but come to a halt.
Elsewhere, today will see ECB Vice President de Guindos speak in Madrid, while Governing Council member Hernández de Cos will give a speech in Barcelona and dovish Finnish Governor Rehn will speak in Helsinki. In the markets, France and Spain will sell bonds with various maturities.
Given the weakness in Tuesday’s manufacturing figures, today’s non-manufacturing ISM is likely to be closely watched for signs of a loss of momentum in the sector at the end of the third quarter. Today will also bring factory orders figures for August, Challenger job cuts data for September and the weekly jobless claims numbers. In terms of Fed-speak, voting FOMC members Clarida, Evans and Quarles, as well as non-voting members Kaplan and Mester, are set to be in action.
Boris Johnson will today present his new Brexit proposals to the House of Commons, where there might well be a majority of support in favour. But the European Parliament’s Brexit Committee is set later today to publish its own response, which seems highly likely to be critical. Certainly, in their current form, there seems every reason to expect Johnson’s proposals to fail to win the EU’s consent.
Among many criticisms, the plans were lacking in detail, with much left to be ironed out only if and when the Withdrawal Treaty comes into force during the transition period. There was also no published legal text. And crucially, like much that Johnson comes up with, the measures simply appear not to be fit for purpose. For a start, they would add significantly to burdens for businesses, particularly in Northern Ireland. And, most seriousy, they clearly go beyond well-known EU redlines. It’s no surprise, therefore, that the proposals received cool receptions from Commission President Juncker and Irish Taoiseach Varadkar.
The heart of Johnson’s plan, which centres on replacing Theresa May’s Irish border backstop, would see Northern Ireland remain aligned with the EU’s single market rules for all goods, including food, in an “all-Ireland regulatory zone”. But there is plenty of important detail absent on how this might work in practice. And the arrangements would throw up plenty of oddities. For example, on the EU’s behalf, regulatory checks would have to be conducted on goods moving within the UK from Great Britain to Northern Ireland. But at the same time, there would be no checks on goods moving in the opposite direction, from Northern Ireland to England, Scotland or Wales.
Most problematically with respect to Johnson’s proposal for “all-Ireland regulatory zone”, the arrangements would have to be endorsed by the Northern Ireland Executive and Assembly during the transition period before they go into force, and then every four years thereafter. That would effectively give the Democratic Unionist Party a regular veto over the nature of the Irish border, i.e. raising the prospect of a much harder border at its whim. That is surely something that won’t be accepted in Dublin, Brussels or among the other half of Northern Ireland’s community.
In terms of customs arrangements, meanwhile, Northern Ireland would remain fully part of UK arrangements, which – contrary to one option that had been left open by Theresa May’s proposed Political Declaration – would be wholly distinct from the EU’s arrangements at the end of the transition period. Among other things, that would imply the need for tariffs to apply to goods exported from the whole of the UK including Northern Ireland to the Irish Republic. More importantly, these proposals would require checks to ensure compliance with the different customs (and VAT) regimes as goods move between the two countries.
Johnson claims that these physical checks could be minimal and “conducted at traders’ premises or other points in the supply chain”. But the technology is lacking. And the arrangements are unlikely to suffice for effective enforcement along a border that in the past was a focal point for smuggling and paramilitary activity. Of course, however light touch the enforcement, surveillance in the border communities will be resented. And so, the EU side will understandably judge that Johnson’s proposals raise profound issues about compatibility with the Northern Ireland agreement as well as serious questions about the integrity of the single market and customs union.
Despite the obvious flaws, the public response of Commission President Juncker was predictably polite, noting some “positive advances” but also judging that there were “some problematic points”. Likewise, Irish Taoiseach Varadkar noted that the proposals “do not fully meet the agreed objectives of the backstop” but also that he “would study them in further detail”. In private, however, EU leaders, particularly in Dublin and Brussels, will be much more critical.
Of course, the EU does not wish to be blamed for the failure to reach a deal. So, negotiations between the UK and EU will take place over coming days. But even if there are sudden shifts in position behind the scenes, it seems impossible to believe that the differences can be bridged and necessary detail completed in time for agreement to be reached at the EU Summit on 17-18 October to allow the UK to leave the EU with a deal at end-October. While that means that Johnson is highly likely in due course to try to pivot towards a no-deal Brexit, given the Benn-Burt anti-no-deal legislation, we continue to attach a high probability to our baseline assumption of an extension of the Article 50 deadline. That, however, might well require further recourse to the UK’s Supreme Court in the back end of the month.