Kuroda talks JGBs as spending slumps

Chris Scicluna
Emily Nicol

Overview:
After yesterday’s substantive gains in most major global markets, Asian equities have ended the week on a somewhat less decisive (albeit still largely positive) note. Japanese markets were a case in point. While the yen yesterday depreciated to ¥107/$ for the first time in more than a month, the Topix gave up most of its initial gains, slipping back to close up just 0.2% on the day, with some decidedly weak consumer spending data perhaps justifying caution (see below). Chinese stock markets, however, made late gains to leave the CSI300 up 0.6% at the close and almost 4% over the week as a whole.

After yesterday’s extremely sharp bond market sell-off, which partly reflected the positive trade war news and some decent US economic data, yields on USTs have remained elevated today, with 2Y yields locking in yesterday’s increase of more than 10bps to remain close to 1.53% and 10Y yields close to 1.57%. In this context, all eyes today will be on the latest US labour market report as well as comments from Fed Chair Powell at the SNB in Zurich scheduled for 18.30 CET.

JGBs unsurprisingly followed yesterday’s moves in other major bond markets, with 10Y yields up almost 2bps to close to -0.25%. Most striking was the leap in 30Y yields, up 7bps to close to 0.20%, with the move exacerbated by comments from BoJ Governor Kuroda in an interview in the Nikkei newspaper that ultra-long yields had “fallen a bit too far”. He added that, as a result, “returns for life insurers and pension funds have declined significantly, and it has a negative impact on consumer sentiment”, and that the BoJ would “adjust the volume and timing of our ultra-long bond market operations as necessary”.

Of course, it was a judgement that ultra-long yields were excessively low that led the BoJ to introduce its yield curve control framework back in 2016. And flagging the possibility of new policy action at the BoJ’s next policy meeting, which concludes on 19 September, Kuroda stated that "We're considering a variety of possibilities, including combinations of [measures] and improved versions". Referring to the fact that 10Y yields have been languishing well below the BoJ’s stated target range for a while, he accepted that "If there's no limit at all, the interest rate target of 'around zero' will become meaningless" although he suggested some tolerance of recent developments in this respect. And, once again, he also flagged the possibility of a cut in the -0.10% policy rate.

Moving to Europe, despite another disappointing German industrial production report, Bund yields are also a touch higher this morning, at -0.59%, up 9bps from this time yesterday. And in the UK, with the opposition parties looking set on Monday again to reject PM Johnson’s call for a general election before an Article 50 extension has been activated, Gilt yields have also remained significantly higher again and sterling is stable close to $1.233, up about 2½ cents from Wednesday morning.

Japan:
Japan’s economy held up relatively well in the second quarter, supported not least by solid consumption growth as spending on durable goods ramped up ahead of next month’s consumption tax hike. But today’s monthly consumption-related figures suggested that this tax hike-associated boost might well have already started to fade, with a notable weakening in spending at the start of the third quarter. This was particularly evident in the BoJ’s consumption activity index, which declined for the second successive month in July and by 2½%M/M, the steepest drop since the post-2014 consumption tax hike slump. This left the year-on-year rate in negative territory (-0.8%Y/Y) for the first time since October 2016. Within the detail, there was another sizeable drop in the durable goods index (-6.7%M/M), while the non-durable goods index fell for the third consecutive month (-2.4%M/M), both the steepest declines since April 2014. But spending on services also posted the largest monthly fall (-1.6%M/M) since February 2014.

The household spending survey similarly implied a weak start to the third quarter, with total spending down 0.9%M/M in July following a near-3%M/M drop previously. And when excluding the more volatile items, core spending fell a steeper 1.9%M/M, with particularly notable declines in spending on household goods (-14.7%M/M) and clothing (-8.4%M/M). So, while the annual rate of growth remained positive (0.8%Y/Y) for the eighth consecutive month, it was by far the softest pace this year. And while some of the weakness in today’s figures was attributed to bad weather in July, underlying spending growth looks to have been more subdued at the start of the third quarter, raising questions as to how much support consumption will provide to GDP growth even ahead of October’s tax hike.

Today’s labour earnings figures will have offered little cause for optimism about the near-term spending outlook too. In particular, headline wage growth fell back into negative territory in July, down 0.7ppt to -0.3%Y/Y, with a notable drop in summer bonus payments, down more than 2%Y/Y that month. Admittedly, underlying wage growth was more positive, with scheduled earnings up 0.6%Y/Y, from a decline of 0.1%Y/Y previously and the first positive reading this year. And data based on a common sample suggests that regular wage growth accelerated to 0.9%Y/Y in July. While this is above the average of the past two years, it still remains below levels that would be consistent with shifting inflation onto a higher path. And based on this common sample series, the drop in bonus payments was larger too. As such, headline wage growth was also more negative at -1.0%Y/Y, the first decline on this basis for two years.

On the whole, the recent data flow imply a subdued economic performance at the start of the third quarter, an assessment also reflected in the Cabinet Office’s latest composite indices of business conditions today. In particular, the coincident index fell for the second successive month in July, to 99.8, the lowest level since September 2016. But while the leading index edged slightly higher in July, at 99.6 it was still the second-lowest since early 2010 at a level consistent with significantly lower GDP growth.

Euro area:
Germany’s industrial production data disappointed expectations once again, with another drop in July, down 0.6%M/M to leave it down 4.2%Y/Y and 2.0%3M/3M. Manufacturing and mining output was down 0.8%M/M and 1.6%3M/3M, with production of capital goods (down 1.2%M/M) and intermediate items (down 0.7%M/M) offset only slightly by increased production of consumer goods (up 0.6%M/M, with durables up 2.2%M/M). Construction output rose for the second month, albeit up just 0.2%M/M and down 2.4%3M/3M. And energy production fell for a sixth successive month, down 1.3%M/M and 6.8%3M/3M. Looking ahead, while car output looks to have picked up in August to give a modicum of support, downbeat survey indices and shrinking order books would suggest that further declines in manufacturing output, and overall IP, are likely to be forthcoming.

More positively for the ECB, Germany’s latest labour cost data, also released this morning, were stronger. Indeed, while the quarterly increase moderated slightly in Q2 by 0.3ppt to 0.8%Q/Q, this still marked the fourth consecutive quarterly rise, with costs of gross earnings and non-wage costs rising at the same pace. So, on an annual basis, overall labour cost growth picked up 0.7ppt to 3.2%Y/Y, matching the 2½-year high seen two years ago, with wage and non-wage costs rising at a similar rate, hinting at a modest inflationary impulse from the tight labour market.

It will be a busy end to the week for top-tier euro area releases, including the euro area’s updated national accounts for Q2. While we expect GDP growth to align with the previous estimate of 0.2%Q/Q, this release will provide the first official expenditure breakdown, in which the weakness of exports will be striking. Today will also see revised euro area employment data for Q2, which are similarly expected to confirm that growth moderated 0.2ppt to 0.2%Q/Q, with the accompanying country breakdown likely to show softer growth across the member states.

UK:
In the UK, the anti-no-deal Brexit legislation is set to conclude its passage through the House of Lords today, to allow MPs on Monday to consider their amendments and allow the bill to receive royal assent before next week’s planned prorogation of Parliament. All indications, however, are that opposition MPs will reject the subsequent Government motion seeking a general election on 15 October, preferring instead to wait for the formal request for an Article 50 extension to be activated before the UK goes back to the ballot box.

Data-wise, the end of the week brought the KPMG/REC report on UK jobs, which provided an update from recruitment consultancies on labour market conditions in August. And against the backdrop of heightened political uncertainty, this perhaps unsurprisingly suggested a further drop in hiring, with the number of people placed in permanent roles declining at the fastest rate for over three years, while temporary placements continued to rise only marginally. While the supply of candidates also fell sharply in August, the number of vacancies also increased at the slowest pace since the start of 2012, with reduced demand for both permanent and temporary staff alike.

US:
All eyes in the US, meanwhile, will be on the August labour market report. While non-farm payrolls are expected to have increased at a similar rate to the 164k seen in July, weaker manufacturing and non-manufacturing employment ISM indices this week suggest risks to this forecast might be skewed to the downside. Nevertheless, the unemployment rate is expected to have moved sideways at 3.7%. But average hourly wage growth is expected to have moderated in August to 3.0%Y/Y, which would be the softest rate for eleven months. And later in the day, Fed Chair Powell will discuss the economic outlook and monetary policy at an event in Zurich.

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