BoJ gives banks tentative thumbs-up

Emily Nicol
Chris Scicluna

Overview:
After yesterday’s extraordinary events in the crude market, which saw WTI for May delivery trade sharply negatively (as low as -$40 at one stage), global markets are inevitably showing signs of unease today. Although June WTI contracts are still trading above $20, other factors including conflicting reports surrounding the health of Kim Jong-Un have injected additional unease. So, Asian-Pacific stock markets were down across the board (the Topix closed down 1.2%, with Korea’s KOSPI down 1.0% but the Hang Seng currently down more than 2.0%). And European stock markets are all weaker too, with the Stoxx Europe is down for the first time in four days, currently by about 1½%.

In the bond markets, however, moves are somewhat less pronounced, with USTs currently little different to yesterday’s US close (10Y yields close to 0.60%). Likewise, JGBs were little changed with 10Y yields remaining well anchored close to zero percent as the BoJ gave its financial sector a cautious seal of approval in its latest Financial System Report. ACGBs made modest losses despite a very downbeat assessment of the Australian economy by RBA Governor Lowe. And in Europe, BTPs are a touch weaker (10Y yields back close to 1.96%, their highs for the month) despite an announcement by Italian PM Conte that he intends to start relaxing gradually the country’s strict lockdown restrictions from 4 May. Gilts are firmer, with this morning’s labour market data having failed to give a true picture of the large-scale rise in joblessness (temporary and permanent) currently underway (see below).

Japan:
The BoJ’s latest semi-annual Financial System Report released today gave the sector tentative thumbs up. Despite being stressed significantly by the coronavirus crisis, the BoJ concluded that Japan’s financial system had remained broadly stable and continued to provide the necessary funding to support the economy. That reflected a combination of supportive factors – most notably, the exceptional support provided by the BoJ (including its expanded liquidity facilities and increased purchases of corporate bonds) and the government, financial institutions’ ample capital and liquidity, and firms’ elevated levels of retained earnings and cash stockpiles.

To date, the BoJ noted that pressures on liquidity faced by Japanese borrowers had largely been limited to small and micro services firms in hospitality and retail. And average interest rates on new loans had remained around historically low levels. But it recognised the importance that the government’s credit guarantee and interest subsidy schemes be implemented smoothly.

The BoJ also inevitably cautioned that Japanese banks needed to be prepared for rising bad loans and investment losses. And it warned that, in a worse-case scenario, vulnerabilities in the system still risked triggering a negative feedback loop between the real economy and the financial sector. Indeed, should the current economic weakness at home and abroad become protracted, the BoJ flagged that problems stemming from tightened liquidity could yet become solvency problems for an increasing number of firms.

Among other things, the BoJ cautioned that lending had increased over recent years to domestic ‘middle risk firms’, rental real estate businesses, and high-leverage projects including large-scale M&A activity. Indeed, it noted that the deviation of the trend in real estate loans relative to GDP recently reached a record high for the post-bubble period. And for the first time since 1991, the BoJ’s warning indicator for the total credit-to-GDP ratio had turned “red”, suggesting signs of overheating.

Moreover, in terms of overseas activity, the BoJ warned that Japanese financial institutions had increased loans to firms with relatively low creditworthiness including – of particular concern in light of the most recent events – in energy-related sectors. And despite recent action by the Fed to alleviate strains in global USD demand through its special swap lines, the BoJ flagged persistent concerns with respect to foreign currency funding risks given Japanese institutions’ large-scale dollar needs. Of course, it also recognised that losses on securities investments could increase significantly if adjustments in financial markets became more abrupt.

UK:
Yesterday finally saw the UK’s Coronavirus Job Retention Scheme – whereby firms can have 80% of the monthly wages of furloughed employees, up to a cap of £2.5k, paid by the government – go live. HMRC initially indicated that applications had been made by 140k firms on behalf of roughly 1mn workers. But surveys, such as the ONS’s special coronavirus business survey, suggest that take-up could eventually reach more than 40% of firms and in excess of 8 million workers, more than double the level originally envisaged by HM Treasury but consistent with the levels of take-up of similar schemes in France and Germany.

Moreover, on top of those furloughed, the OBR last week projected that, if the lockdown continues for three months, unemployment could rise by more than 2mn workers by end-Q2. That would push the unemployment rate to 10%, 1½ppts above the global financial crisis peak. So, the Resolution Foundation estimates that 11.7mn could be either unemployed or furloughed this quarter. 

Therefore, the official ONS labour market data reported this morning are already well out of date. The jobless claims data – which reported an increase of 12.2k claims in March, to take the claimant count unemployment rate just 0.1ppt higher to 3.5% from a downwardly revised rate the prior month – were collected in the second week of the month, well before the coronavirus lockdown was announced and enforced. The headline data, which reported a rise of 0.1ppt in the ILO unemployment rate to 4.0% and a 172k rise in employment, related to the three months to February and were thus very much distant history.

Nevertheless, even these figures suggested that underlying conditions in the labour market were already softening over that period. Vacancies in the first week of March were down on a year-on-year basis for the tenth consecutive month, falling 52k 3M/Y albeit just 6k 3M/3M. And average labour earnings growth moderated 0.3ppt to an 18-month low of 2.8%3M/Y in February, with the ex-bonus figure dropping 0.2ppt to 2.9%3M/Y, the lowest since July 2018.

Since then, average household incomes have taken a kicking. The government reported that by the first week of April, the number of new claimants for Universal Credit (UC) – who can be either in or out of work – since the start of lockdown had reached 1.4mn. And yesterday’s publication of Markit’s household finance survey reported that about one third of UK households reported a decline in income from employment this month. And the survey’s headline index of financial wellbeing posted a record drop of 7.6pts to 34.9, its lowest since November 2011. Unsurprisingly, Markit’s survey also suggested that job security perceptions had fallen sharply, with the relevant index similarly plummeting to its weakest on record.

Euro area:
In its latest monthly report, the Bundesbank yesterday estimated that the loss of consumer spending on various services – including catering, travel and leisure activities – and clothing in the second half of March would on its own knock a full 1ppt off the level of GDP over Q1 as whole. Indeed, reflecting the sharp drop in spending, Germany’s Ministry of Finance stated this morning that VAT receipts in March were down more than 10%Y/Y, the steepest drop in 25 years. And with the lockdown having only seen a very modest relaxation yesterday via the opening of small shops under still-strict social distancing conditions, the drop in spending and overall economic activity in Q2 will be several times more severe – most likely in double-digit percentage terms from Q1.

So, today’s German ZEW survey of financial market professionals for April is expected to report a record monthly deterioration in the headline current conditions sentiment indicator at the start of Q2. Given the tentative steps towards an easing of the lockdown, however, the expectations index is anticipated to post an improvement from March’s eight-year low (-49.5).

Australia:
One focus in Australia today was RBA Governor Lowe’s Sydney speech, in which he acknowledged that the economy faced the sharpest contraction since the 1930s. In particular, while Lowe cautioned against the difficulties of economic forecasting at the current time, the RBA’s current assessment is that in the first half of 2020, output will contract by around 10%, the number of hours worked will decline by 20%, and the unemployment rate is likely to reach around 10% by June (almost twice the current rate).

Against this backdrop, and given the plunge in the oil price, headline inflation is likely to fall significantly, possibly into negative territory by the middle of the year. And with growth likely to remain subdued in Q3 as certain restrictions on activity are likely to remain in place, before a pickup towards year-end, the RBA expects the unemployment rate to remain above 6% and well above its estimate of NAIRU over the coming couple of years. As such, headline and underlying inflation is expected to remain below the RBA’s target for the foreseeable future too. And so the RBA’s current policy measures – including its new yield curve control framework – seem bound to remain in place for a significant time even if its purchases of ACGBs need not remain as elevated as at the outset of the scheme.

Indeed, with market conditions having improved over recent week, Lowe today confirmed that the Reserve Bank has deliberately scaled back its daily bond purchases over recent days and would now schedule any bond purchase operations on Mondays, Wednesdays and Thursdays. While he noted that the RBA would not necessarily buy at each of these auctions, he implied that he expected the Bank to continue buying on a weekly basis for the foreseeable future. Moreover, he reiterated that if conditions warrant it, the RBA will return to daily bond purchases.

US:
In the US, today will bring existing home sales figures for March. While certain contracts signed in January and February might well have still completed last month, today’s release is still expected to show a sizeable decline on the month.

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