Trade-talk noise dominates as machine orders wilt

Emily Nicol
Chris Scicluna

Ahead of the resumption today of high-level trade talks between the US and China, the latest media reports have offered differing perspectives on the chances of an interim deal. For example, the SCMP suggested that lower-level talks had had failed to make any advances on Chinese forced technology transfers and state aid, issues which US Commerce Secretary Ross suggested had “gotten worse”. But the New York Times reported that the US administration was ready to offer licences to allow some US companies to supply “non-sensitive” goods to Huawei, Bloomberg suggested the US side might incorporate (essentially meaningless) Chinese commitments to maintain a stable currency in a new deal that would see the planned future tariff increases taken off the table, and the FT yesterday reported that China had offered to increase purchases of certain US agricultural products.

Against that uncertain backdrop, the main Asian stock markets have been mixed, although China’s main indices have followed yesterday’s gain in the US by similarly advancing (the CSI300 rose 0.8%). In Japan, however, as the latest machine orders numbers disappointed somewhat but a business survey suggested that the hit from the consumption tax hike might not be as severe as some firms feared (see below), the Topix closed little changed on the day.

In the bond markets, meanwhile, yesterday’s FOMC minutes appeared to validate expectations of an October rate cut (see note from Mike Moran, Daiwa US chief economist), so, ahead of this afternoon’s US CPI data, UST yields are currently little changed from just before their release (2Y yields close to 1.45%, 10Y yields near 1.57%). JGB yields are little changed on the day too (10Y yields close to -0.215%). But despite some disappointing German and French economic data (more on these below too), euro govvie yields are a touch higher, tallying with the higher opening for regional equities. In the forex market, sterling is again weaker against the euro (now above £0.90/€) ahead of today’s meeting between UK PM Johnson and Irish Taoiseach Varadkar at an undisclosed ‘neutral’ (lol) location in the North West of England, which seems highly unlikely to provide the breakthrough required to achieve a Brexit deal at next week’s Summit. UK monthly GDP data will also be watched this morning for indications of the likelihood of near-term BoE easing.

There were a number of economic releases out of Japan overnight, which again provided mixed messages about conditions at the turn of the quarter. The latest machine orders data certainly had a more downbeat tone to them, with core orders recording the second successive decline in August (-2.4%M/M) to leave them down a whopping 14½%Y/Y, the largest annual drop for almost five years. Orders placed by non-manufacturers fell for the second successive month too, with the 8%M/M decline principally reflecting a drop in orders from the electricity sector. Meanwhile, manufacturing orders declined 1.0%M/M, with a notable drop in the non-ferrous metals sub-sector.

Of course, orders data are notoriously volatile. And the recent weakness to some extent likely reflects payback for the double-digit monthly increase in June, which was the strongest for 16½ years. Nevertheless, on average in the first two months of Q3, orders were down a little more than 2% from the Q2 average – admittedly on track for a better performance than initially estimated by the Cabinet Office (-6.1%Q/Q in Q3) following the 7½%Q/Q increase in Q2 – with an equivalent near-7% decline in orders placed by non-manufacturers. So, with core orders typically providing a guide to non-residential investment three months ahead, today’s release further suggests a subdued quarter for private capex growth in Q4, following a likely tax-hike-related boost in Q3.

Other details of today’s release were more positive, with government orders up for the second successive month (and by a sizeable 36.8%M/M) to leave them almost 38% higher than a year earlier, and on average so far in Q3 9% higher than the average in Q2. And there was a somewhat surprising pickup in overseas orders in August, to leave them trending in the first two months of Q3 more than 8% above the Q2 average.

Today’s Reuters Tankan survey for October – the first monthly release to capture the initial impact of the 2ppt consumption tax hike – suggested that business conditions were better than some had feared at the start of Q4. For example, the headline manufacturing DI rose for the first month in five to -5, possibly reflecting some improved optimism on the back of the US-Japan trade agreement. Indeed, car manufacturers were notably more upbeat this month, with the relevant index rising 25pts to a seven-month high. But there was also a surprising boost to retailers’ confidence in October, with the Rugby World Cup perhaps offsetting to some extent the impact of the consumption tax hike, with the relevant DI rising 20pts to +30, its highest since June 2015. So overall, the headline non-manufacturing DI increased 6pts in October to +25, a three-month high.

When smoothing out monthly volatility, however, the message from today’s survey was less upbeat. For example, the manufacturing DI remained on a downward trend at the start of the fourth quarter, with the headline index on a three-month basis falling to its lowest level since early 2013. And the equivalent non-manufacturing DI was unchanged at its lowest level since 2016. Moreover, firms across both sectors forecast a further deterioration in conditions over the coming three months.

Turning to inflation, the latest goods producer price data provided further evidence of more acute deflationary pressures down the pipeline. In particular, the annual headline PPI rate fell further into negative territory in September, down 0.2ppt to -1.1%Y/Y, the largest such drop since 2016. And the impact of previous yen strengthening was again evident – indeed, import prices in yen terms were down more than 9%Y/Y, while the annual decline in contract currency terms was more modest at 6.4%Y/Y. Given the significant declines in the price of raw materials and intermediate goods, there was further downward pressure on final corporate prices for consumer goods too, with annual inflation on this measure falling further into negative territory in September at -2.2%Y/Y, the lowest since 2016. And while prices of imported consumer items were down a hefty 5.6%Y/Y, there was a further weakening in domestic inflationary pressures too.

Euro area:
This morning’s data from the two largest member states have disappointed expectations, with downside surprise to German exports and French industrial production. In particular, the value of German export values dropped 1.8%M/M in August, the most since April, to reach a four-month low. In contrast, imports 0.5%M/M following a steep 2.4%M/M the prior month. Looking through the monthly volatility, however, exports in the first two months of Q3 were still on average 0.2% higher than in Q2, while imports were trending 1.4% below their Q2 average, suggesting that net goods trade might well have provided a positive contribution to GPD growth in Q3 for only the second quarter in six.

In France, contrary to the expected increase, manufacturing output fell 0.8%M/M in August, weighed notably by autos production (down for a third successive month and by 1.0%M/M) and consumer durables (down 3.2%M/M). With utility and energy output down but construction up slightly, total IP dropped 0.9%M/M. As a result, manufacturing output and IP were down 1.6%Y/Y and 1.4%Y/Y respectively, and were both trending about 1.0% below the Q2 average over the first two months of Q3 strongly suggesting a non-negligible negative contribution to GDP growth over the third quarter as a whole.

Italian IP figures, due later this morning, are expected to report a modest increase in August, although this would still leave output down more than 1½%Y/Y.

Today will also bring the account from the ECB’s September Governing Council meeting, which will be of interest not least given the well-publicised split in opinions of various members on last month’s stimulus package.

With the EU Summit set to commence a week today and the Brexit talks seemingly tinkering on the verge of collapse, all eyes today will be on the outcome the lunchtime tête-à-tête between UK Prime Minister Boris Johnson and his Irish counterpart Leo Varadkar. The meeting looks set to be a make-or-break occasion to see whether Johnson will offer any flexibility on his proposals for the Northern Irish Assembly to be granted a veto on regulatory arrangements, and half-baked plans for customs checks between Northern Ireland and the Irish Republic, both issues being clearly unacceptable to the EU in current form. If there is explicit willingness to compromise on the UK side, further talks could continue between UK government and Commission officials tomorrow, although a Brexit deal at next week’s Summit still seems highly unlikely.

It will be a busy day for top-tier UK data releases too with the August production figures, including monthly GDP, due. With some car plants missing their usual maintenance shutdowns that month, manufacturing output might post a second monthly gain. However, we expect output in services and construction to decline, and so also expect a small drop of 0.1%M/M in GDP. Given the rise of 0.3%M/M in July, however, that would still leave overall economic output on track for a modest gain in Q3 following the fall of 0.2%Q/Q in Q2. The August trade data, however, seem likely to show a widening in the deficit and ongoing weakness in exports.

The impact of persistent political uncertainty on the housing market was further evident in today’s RICS house price survey. Admittedly, the headline price balance exceeded expectations in September, rising 2pts to -2. But this still signalled a slight decline in national prices compared with a year earlier. And the detail of the survey was more downbeat. For example, the survey suggested that the number of new instructions fell to the lowest in three years, with a drop in new buyer enquiries too. Against this backdrop, the surveys newly agreed sales component fell sharply in September, with expectations for near-term sales also weaker last month.

In Australia, meanwhile, there was some tentative evidence that recent monetary policy easing was helping to boost demand for loans. According to the ABS, new lending to households rose for the third consecutive month in August and by a stronger-than-expected 3.2%M/M. Once again, this was boosted by housing-related lending, with the value of lending for owner occupier dwellings almost 2% higher on the month, while lending for investment dwellings was up 5.7%M/M. In contrast, however, consumer credit continued to decline (to leave it a hefty 17.8% lower than a year earlier), while lending to business also maintained a downward trend.

The US data highlight today will likely be September’s CPI figures. While food prices will likely remain subdued, given the jump in the oil price earlier in the month headline inflation is expected to edge slightly higher to 1.8%Y/Y. Meanwhile, core CPI is forecast to move sideways at 2.4%Y/Y. Elsewhere, the US and Chinese trade delegations are set to meet today, while in the markets, the Treasury will sell 30Y bonds.

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