Boost to Japanese sentiment likely to be short-lived

Emily Nicol
Chris Scicluna

Overview:
US stocks rallied towards the close yesterday to erase earlier losses (the S&P500 closed effectively unchanged on the day), and most major Asian markets have picked up the baton with further gains today. With the yen continuing to weaken, touching 107.8/$ for the first time since early August, Japan’s main indices were at the front of the pack (the Topix closed up 1.65%), as Abe reshuffled his cabinet and a business survey suggested that firms were broadly upbeat about conditions in the current quarter but unsurprisingly uneasy about the outlook for Q4.

Chinese markets, however, were the principal exception to the positive picture (with the CSI300 closing down 0.7%), as the trade-war news-flow remained somewhat mixed. While reports suggested the Trump administration was mulling an executive order to counter shipments of fentanyl and counterfeit goods from China, the Chinese authorities announced selected exemptions to apply to the first round of its tariffs imposed on US goods from July, which – counter to media rumour – failed to include key agricultural items.

In bond markets, meanwhile, after making significant further losses yesterday (10Y yields rose roughly 10bps on the day to briefly move above 1.74% for the first time in five weeks, USTs have made modest gains in Asian time. But major bonds in the Asia-Pacific region played catch up, with the 5Y JGB auction seeing the weakest take-up in more than two years, and 10Y JGB yields up a further 2bps to close to -0.21% for the first time since early August. ACGBs also made gains (10Y yields up more than 6bps to close to 1.14%) despite a weaker Aussie consumer confidence survey.

Finally, amid major uncertainty about quite what the ECB will announce tomorrow in terms of further policy easing, core euro area govvie yields are a touch higher again this morning (10Y Bund yields at a five-week high above -0.55%), but BTPs have opened higher (10Y yields back just below 1.00%) after Italian Prime Minister Conte last night won his second parliamentary confidence vote in two days (this time in the Senate) to confirm the establishment of the new centre-left coalition government.

Japan:
While the Cabinet Office’s composite index of business conditions last week indicated a further deterioration at the start of the third quarter, and JCER’s monthly GDP estimate, published today, suggested that the economy contracted as much as 0.5%M/M in July, today’s MoF/Cabinet Office Business Outlook Survey – often a good guide to the tone of the more comprehensive and closely-watched BoJ Tankan survey (due 1 October) – indicated that, on balance, firms perceive business conditions to have improved slightly in recent months. Amongst large firms, a net 1.1% of respondents judged business conditions to have strengthened in Q3, driven by an improvement in the non-manufacturing sector – perhaps reflecting increased demand ahead of October’s consumption tax hike. In contrast, however, small-sized non-manufacturers were significantly more downbeat about overall conditions. And, overall, as usual, SMEs were more downbeat than their larger counterparts.

But with the consumption tax set to increase at the start of Q4 and so domestic demand likely to fall back immediately afterwards, the MoF’s survey predictably reported that firms were on balance more uneasy about the outlook for that quarter. Indeed, a marked deterioration in domestic conditions is expected by large-, medium- and small-sized firms alike. A net 15.8% of large firms anticipate conditions to worsen in Q4, the most since after the last sales tax hike in Q214. And on balance, firms expect a further modest deterioration at the start of 2020 too.

Against this backdrop, firms were less upbeat about their expected sales growth in the current fiscal year (down 0.6ppt to 0.7%Y/Y), and notably more pessimistic about their projected profits this year, with the anticipated decline revised to -4.6%Y/Y, and manufacturers forecasting a decline of more than 9%Y/Y and non-manufacturers forecasting a drop of more than 2½%Y/Y. Against this backdrop, it was perhaps somewhat surprising to see firms’ capex projections revised only slightly lower, with firms estimating that spending on plant and machinery and software will grow a still-solid 8.3%Y/Y in FY19.

In politics, Prime Minister Abe’s first Cabinet reshuffle in almost a year today brought no major surprises, with key Cabinet positions unchanged, including Yoshihide Suga as Chief Cabinet Secretary and Taro Aso as Finance Minister. But former Economy Minister Toshimitsu Motegi – who was a key figure in the TPP negotiations – was reassigned to Foreign Minister, while Taro Kono will become the new Defence Minister. And rising political star and a potential candidate to become the next Prime Minister Shinjiro Koizumi will become the new Environment Minister, making him the youngest male Cabinet minister in post-war Japan.

UK:
Boris Johnson’s Brexit negotiator David Frost will return to Brussels today amid increased speculation that – hemmed in by Parliament’s legislation aimed at a blocking a no-deal Brexit – the Prime Minister is now minded to try for a deal. However, true to form, Johnson continues to tell different things to different audiences. Having earlier this week raised expectations that he might seek broadly to replace the all-UK backstop within Theresa May’s negotiated Withdrawal Agreement with a Northern Ireland-only backstop, yesterday he sought to downplay expectations in that regard in talks with the DUP, supposedly refusing to countenance any deal that would “break up the economic and constitutional integrity of the UK”.

We remain sceptical of the chances of success for any deal negotiated by Johnson. While he has seemingly accepted that agriculture and food in Northern Ireland would be treated as part as a so-called “all-Ireland economy”, that would be far from sufficient to meet the UK and EU commitments to avoiding border infrastructure on the island of Ireland. Indeed, reports, such as that in today’s Daily Telegraph, suggest that Johnson continues to reject a Northern Irish Customs Union with the EU, which would seem to be a necessary condition for a truly open border and hence a negotiable deal if the UK-wide backstop was to be replaced.

Moreover, even if he is able to reach a deal with the EU that ditched the UK-wide backstop with a NI-only backstop, it is very difficult to see how he would find a majority in the House of Commons for it. The DUP (and many right-wing Conservative MPs) would likely oppose Johnson’s proposals. And most Labour MPs who voted against Theresa May’s deal would consider Johnson’s proposals far less attractive than May’s, given that they would replace the implied customs union and level playing-field provisions advocated by the opposition with a commitment to an eventual highly protectionist “Canada-minus” trade deal. So – unless it was to be subject to a confirmatory referendum against the option to revoke and remain (as in the previously-rejected Kyle-Wilson amendment) – we would still expect any deal proposed by Johnson to be rejected by MPs, ensuring a further extension of the Article 50 deadline beyond end-October and a new general election in late November or December.

Australia:
The overnight release of Australia’s Westpac consumer confidence survey fell short of expectations in September, with the headline index falling 1.7%M/M to 98.2. While this likely reflected payback for the surge seen in August (+3.6%M/M), it nevertheless maintained the downward trend seen since the start of the year. While the weakness was widespread this month, households were notably more downbeat about their expected financial situation over the coming twelve months, with the relevant index falling to its lowest for four years. Today’s survey followed a more downbeat NAB business survey yesterday, which suggested that momentum in the business sector continued to weaken in August, with the headline confidence and conditions indices falling to +1, both well below the long-run average and the latter at its lowest since September 2014.

Euro area:
Ahead of tomorrow’s euro area IP release, this morning brought July production figures from Spain. In line with weaker showings from the largest three member states, Spain’s IP was down at the start of Q3, with output declining for the second successive month and by 0.4%M/M, to leave it ½% lower than the average in Q2. Like in Germany and Italy, the weakness in July principally reflected a decline in production of capital goods (-2.5%M/M), while output of consumer goods fell for the second successive month (-0.1%M/M) and production of intermediate goods was down for the third consecutive month (-0.3%M/M). As such, the euro area’s aggregate figures are likely to show a decline in IP (excluding construction) of a little more than ½%M/M.

US:
Ahead of Thursday’s CPI figures, the main US data release tomorrow will be August PPI data.

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