Kuroda casts eye on the short end

Chris Scicluna
Emily Nicol

While US stocks yesterday moved broadly sideways for a second successive day (like on Friday, the S&P again closed effectively unchanged), many Asian markets today have had a better day. With Japan’s flash PMIs (see below) reporting only a modest weakening (in contrast with yesterday’s dire euro area indices), the Topix returned from yesterday’s holiday with a rise of 0.4% on the day. And while Governor Yi Gang stated that the PBoC would be in no rush to cut rates aggressively or introduce QE, China’s main indices also moved higher (the CSI300 closed up 0.3%), after US Treasury Secretary Mnuchin stated that Vice Premier Liu He will visit Washington DC in the w/c 7 October.

Meanwhile, JGBs unsurprisingly followed yesterday’s rally in other major bond markets with gains across the curve – 10Y yields are back down about 3bps to around -0.25%, with 2Y yields touching new three-year lows and currently about 2bps lower near -0.33%. In a speech in Osaka, Governor Kuroda noted the relevance to BoJ thinking of the latest policy easing by the Fed and ECB in the face of heightened geopolitical risks and the rising threat of protectionism. And – in a hint that a cut in the -0.1% policy rate might be under discussion at next month’s Policy Board meeting – he emphasised that the “there is no change in our recognition regarding the impact on economic activity and prices of the term structure of interest rates, in that short- and medium-term interest rates have a larger impact than longer-term rates”. He also repeated his preference for a steeper yield curve, reiterating that “an excessive decline in super-long-term interest rates could lower the rates of return such as on insurance and pension products, and this may exert a negative impact on economic activity through a deterioration in people's sentiment”.

In other major bond markets, USTs have moved back from their highs yesterday, with 10Y yields currently at 1.71%. And with equities in the region opening higher, euro area govvies have given up a fraction of yesterday’s gains too, perhaps not helped by Bank of France Governor Villeroy confirming that he saw no need to restart QE right now. The latest French INSEE business survey, released this morning, was also somewhat supportive of sentiment, particularly in light of yesterday’s PMIs. But there is trepidation about quite how bad the German ifo indices will be when they are released later this morning.

Meanwhile, in forex markets, sterling is broadly steady ahead of this morning’s announcement of the UK Supreme Court judgement on whether PM Johnson’s shutdown of Parliament was lawful. Among other things, a judgement against Johnson would be expected to prompt calls for his resignation for misleading the Queen.

There were no major surprises one way or the other from Japan’s flash September PMIs overnight. These maintained the recent trend, with manufacturers evidently continuing to struggle with the more challenging external environment, but conditions in the services sector remaining broadly stable. In particular, the headline manufacturing PMI declined for the fourth month out of the past five to 48.9, matching the 2½-year low hit in February. And the output component remained in contractionary territory for the ninth consecutive month, to leave the quarterly average little changed from Q2 at 48.6. But despite a modest increase in September, the new orders PMI still signalled a steeper pace of decline over the quarter as a whole, while the employment index fell to its weakest for more than three years.

Admittedly, the headline services PMI slipped back from August’s 22-month high, down 0.5pt to 52.8, still the second-highest reading since October 2017 and consistent with ongoing expansion in the sector. Indeed, the quarterly index in Q3 was 0.8pt higher than Q2 at 52.6, the strongest such reading since Q217. While the new orders PMI edged slightly higher in September, this followed three consecutive monthly declines to leave the quarterly index a full point below the average in Q2 and its lowest for three years. And the employment component fell for the fifth consecutive month to 49.7, the first sub-50 reading since late-2016.

Overall, the headline composite PMI fell 0.4pt in September to 51.5, nevertheless still the second-firmest reading this year following the striking 1.3pts increase in August. As such, the average index for Q3 stood at 51.3, 0.6pt higher than Q2 and consistent with ongoing expansion in the current quarter ahead of the consumption tax hike. While the retail sector is not captured by the survey, judging from the PMIS the outlook for the post tax-hike period looks weaker for many sectors – the composite new orders component fell 0.8pt in Q3 to its lowest quarterly reading (50.6) for three years, while the employment PMI declined more than 2pts in Q3 to 50.5. Finally, with respect to inflation, the output price PMI fell to just 50.6 in Q3, the lowest since Q117.

Euro area:
After yesterday’s dire flash PMIs suggested a further loss of momentum in the euro area and the two largest member states at the end of the third quarter, today’s German ifo business survey is similarly expected to imply ongoing weakening of momentum and flag the risks of technical recession in the largest member state.

However, in contrast to the downbeat French PMI in September, the INSEE business survey today suggested that conditions remained broadly stable at the end of Q3, with the headline business composite indicator rising 1pt to 106. While the headline manufacturing index slipped back 1pt in September, at 102 it still remained above the long-run average, with firms in the sector on the whole a touch more upbeat about their order books and therefore more optimistic about the near-term production expectations.

Services firms were reportedly more optimistic too, with the headline index rising 1pt to 106, while retailers suggested a marked bounce-back in the business climate in September, with the relevant index up 4pts to 104. And construction firms were reportedly their most upbeat since May 2008. Overall, like the PMIs – which saw the quarterly index rise above the averages in Q2 and Q1 – today’s survey further supports our forecast of another of solid French GDP growth, of 0.3%Q/Q in Q3.

Separately, ECB Governing Council members Guindos and Hernandez de Cos will speak publicly later today. In the bond markets, Germany will sell 2Y Schatz.

This morning will bring the judgement of the UK Supreme Court on whether PM Johnson’s shutdown of Parliament was lawful. While the judgement cannot be predicted with confidence, on balance we think the greater likelihood is that Johnson’s action will be considered unlawful. If so, Parliament could be reconvened, giving cross-party MPs greater time to scrutinize the Government’s Brexit policy and perhaps act again to ward off a no-deal Brexit. The ability of Johnson to prorogue Parliament once again next month in a deliberate attempt to force through a no-deal Brexit could be curtailed. And it would also no doubt prompt calls for his resignation for misleading the Queen.

After a quiet start to the week for UK economic data, meanwhile, today will bring the September CBI industrial trends survey, which seems bound to indicate subdued conditions in the manufacturing sector despite some additional Brexit-related stock-building activity. August public finances data are also due and seem bound to report a significant increase in net borrowing compared to the same month a year ago not least due to increased public expenditure on Brexit preparations. In the bond markets, the DMO will sell 30Y Linkers.

In the US, the data-flow will include the September Conference Board consumer confidence survey results, as well as July house price data. The Treasury will sell 2Y USTs, while FOMC members Evans and George will speak publicly.

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