Tankan no game-changer for BoJ

Chris Scicluna
Emily Nicol

Overview:
After a better day for US stocks (the S&P500 closed up 0.5%), with the exception of China and Hong Kong which are on holiday, the main Asian indices have also started the new month on the rise. With the yen weaker (currently close to ¥108.25/$) and the all-important BoJ Tankan survey not quite as downbeat as was feared (see below), Japan’s Topix closed up 1.0%. And strikingly, in the bond markets, after yesterday’s late announcement of the BoJ’s reduced purchase intentions, JGBs sold off across the curve. 2Y yields rose more than 3bps to -0.30% while 5Y yields rose more than 6bps also close to -0.30%. And after the weakest demand at auction since 2016, 10Y yields leapt more than 5bps to close to -0.17%, back within the BoJ’s preferred target range of +/-0.2%.

Elsewhere, UST yields have shifted higher throughout Asian time (10Y yields are up about 6bps to 1.73%). In marked contrast, however, ACGBs more than reversed yesterday’s losses (2Y yields down 8bps to 0.67% and 10Y yields back down 4½% to below 0.97%) as the RBA cut its cash rate by 25bps to 0.75% (more on this below too). The decision also helped Aussie stocks to rise (the ASX 200 gained 0.8%), while the AUD weakened close to $0.67.

Meanwhile, sterling is broadly stable as reports suggest that the UK Government is set to present new Brexit proposals after Boris Johnson’s Tory Party conference speech tomorrow. Johnson has just denied reports by Irish broadcaster RTE that he will propose "customs clearance zones" involving "a string of customs posts perhaps five to ten miles away from the frontier", something that would be a non-starter for the Irish Government and thus, most probably, the EU too. However, some of the proposals – which seem likely to involve wheezes previously conjured up by Theresa May and rejected long ago by the EU – are likely to require infrastructure and will effectively represent a hard border. Other elements might also be considered by the EU side to be unworkable. So, despite Johnson’s denials, we continue to expect that, once they are formally presented, the EU will reject the UK’s proposals.

Japan:
While the consumption tax rate was finally raised today by 2ppts to 10%, the data focus in Japan overnight was on the BoJ’s Tankan survey, which is expected to play a key role in the BoJ’s decision-making process later this month when the Policy Board is due to ‘re-examine economic and price developments’. But while this implied a further deterioration in business conditions in Q3 and signalled an inevitable worsening in Q4, today’s survey was not as bad as some had feared and therefore need not be a game-changer for the BoJ.

The Tankan, nevertheless, suggested a widespread deterioration in business conditions last quarter. Perhaps unsurprisingly given ongoing concerns about the more challenging external environment, the headline DI for large manufacturers fell for the third consecutive quarter in Q3, by 2pts to +5, a more than six-year low. The most significant worsening of sentiment in Q3 was seen in the petroleum and nonferrous metals sectors (with the DIs down 30pts and 18pts respectively). But certain key export-oriented sectors also reported notable falls in Q3 – i.e. the general purpose machinery DI was down 8pts to +15, the production machinery DI was down 6pts to +11, and the autos DI was down 3pts to +2, all the lowest since 2016. In contrast, there was a modest improvement in the business-oriented and electrical machinery subsectors. As is often the case, medium- and small-sized manufacturers were more downbeat than their large counterparts, with the respective indices down 3pts apiece to +2 and -4. As such, the overall manufacturing DI suggested that pessimists in the sector outweighed optimists for the first time in three years. And manufacturers of all sizes forecast a further modest deterioration in Q4 too.

The headline DI for large non-manufacturers also slipped back in Q3, by 2pts to +21. But this suggested that conditions remained much more favourable than in the manufacturing sector, and well above the long-run average. And medium- and small-sized firms in the sector reported no change in conditions last quarter. Of course, given the anticipated hit to demand in the aftermath of the tax hike, firms in the sector were notably more downbeat about the near-term outlook. For example, large non-manufacturers forecast a drop of 6pts in Q4 – which would mark the largest drop since Q314 – to +15, with the retailers DI projected to decline 5pts to -1, which would be the first negative reading for almost five years. And the anticipated worsening of conditions for SMEs in the sector was even greater, with the indices forecast to fall 9pts to +9 and +1 respectively.

Against this backdrop, the Tankan suggested that firms are generally less optimistic about their sales growth projections this year and even more downbeat about their expected profits growth. Indeed, large- and small-sized manufacturers are now forecasting double-digit declines in FY19, with overall profits expected to fall 6.7%Y/Y this year, compared with a modest increase in FY18. But while large firms were a touch less optimistic about their investment intentions over the year as a whole, they were still forecasting growth of almost 12%Y/Y (admittedly well down on the equivalent forecast of 17.5%Y/Y in FY18). And overall, firms actually nudged up slightly their full-forecast by 0.1ppt to 2.4%Y/Y, albeit this would still mark the softest growth for three years.

Of course, an increase in capex growth would be consistent with ongoing evidence that firms have insufficient capacity. This notwithstanding, today’s Tankan suggested that the constraints were little changed from three months ago, and not quite so acute for manufacturers. Indeed, the survey’s manufacturing production capacity index rose 1pt to 0, while the equivalent employment index increased 2pts to -20, both the highest for two years.

Admittedly, today’s monthly labour market figures were a touch more upbeat. For example, the number of people in employment rose for the third consecutive month in August (190k) to a new record high 67.35mn, to leave the unemployment rate at just 2.2%. And while the job-to-applicant ratio was unchanged at 1.59, the lowest since 2017, there was a modest pickup in the number of jobs on offer. Overall, however, the Tankan’s composite indicator of spare capacity was unchanged in Q3, suggesting a lack of fresh upward pressure on wages and inflation.

Certainly, the Tankan’s inflation indicators once again pointed to a weaker pricing environment. Indeed, large manufacturers and non-manufacturers reported a notable easing in input price pressures in Q3, with the respective DIs down 6pts to +5, a near-three-year low and 5pts to +12, a two-year low. Moreover, large manufacturers on aggregate reported a steeper decline in output prices last quarter. Large non-manufacturers had a little more success in passing price rises through to customers, although the relevant DI was down for the third consecutive quarter to +5, a five-quarter low. And looking ahead, on balance large manufacturing firms indicated that they expect to face further downward pressure on their output prices.

Australia:
As was widely anticipated, the RBA today cut its cash by a further 25bps to a new record low of 0.75%. That took its cumulative easing so far this year to 75bps. The post-meeting statement reiterated that “it is reasonable to expect that an extended period of low interest rates will be required in Australia”. And in a new form of wording, the Board stated that it is “prepared” to ease monetary policy further if needed. As far as we’re concerned, it seems far more likely than not that, in due course, it will have to put those preparations into action. Indeed, the statement flagged developments both at home and abroad that mean it’s surely only a matter of time before it has to deliver that additional monetary easing.

As far as external developments are concerned, the Board recognised again the downside skew to risks to the outlook for the global economy. And, tallying with recent comments by Governor Lowe, it drew attention to “the forces leading to the trend to lower interest rates globally and the effects this trend is having on the Australian economy and inflation outcomes”. Like in the other major economies, RBA easing has become less effective at boosting inflation in the current environment of heightened global uncertainty, flat-lining international trade, excess global savings, and interest rates very close to the lower bound.

In terms of domestic developments, having failed to anticipate the extent of the weakening in Australian economic growth over the second half of last year, the RBA appears somewhat more optimistic, with the statement also echoing comments made by Governor Lowe in his Armidale speech last week that “a gentle turning-point… appears to have been reached with [Australian] economic growth a little higher” in H119. However, perhaps most significantly for the inflation outlook, the Board also noted ominously that “forward-looking indicators of labour demand indicate that employment growth is likely to slow” against a backdrop where the labour market, and economy as a whole, still has spare capacity. And in a nod to the ongoing steady rise in labour force participation, it underscored the ongoing efforts required to reach full employment as a precondition for achieving the inflation target.

On balance, market pricing suggests that a further rate cut is more likely than not in December. That might prove too soon. But a cut no later than the Australian autumn seems highly likely. And once the cash rate has indeed been cut to 0.5% but further easing is required – which, given our downbeat view of the global economic outlook in 2020 and ongoing labour market slack, seems likely to be the case – QE will be firmly on the RBA’s agenda.

Euro area:
The main economic focus in the euro area today will be the flash estimate of CPI for September. Despite the recent pickup in the oil price, headline CPI is expected to have fallen below 1%Y/Y, possibly by 0.2ppt to 0.8%Y/Y, for the first time since November 2016. Meanwhile, core inflation might well tick higher to 1.0%Y/Y. This morning also brings the final manufacturing PMIs for September, which despite some revisions seem highly likely to echo the extremely disappointing flash release that showed the headline euro area index declining 1.4pts to 45.6, the lowest in more than seven years. Indeed, the Italian and Spanish figures published for the first time this morning suggested a further notable deterioration in September, with the respective headline indices down 0.9pt to 47.8, a six-month low, and 1.1pts to 47.7 respectively, the lowest since April 2013.

Elsewhere, Bundesbank President Weidmann is due to speak in Vienna later today.

UK:
While speculation surrounding the Government’s aforementioned Brexit proposals will dominate the news flow, today’s UK manufacturing PMI will also be closely watched. Having declined to the lowest level for more than six years in August (47.4) the headline manufacturing index is expected to fall further into contractionary territory in September as downside risks – domestic and external alike – intensified. In the markets, the DMO will sell 18Y Gilts.

US:
In the US, today will bring the manufacturing ISM for September, which is expected to show that the headline index remained consistent with stagnation in the sector. The final manufacturing PMI from Markit, which is less closely watched than the ISM survey, is likely to give a slightly more positive signal, aligning with the flash estimate which reported a modest recovery at the end of Q3. Construction spending figures for August and vehicle sales numbers for September are also due. Elsewhere, the Fed’s Evans is due to speak in Frankfurt, while Governors Clarida and Bowman will speak in the US.

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