Pain ahead

Emily Nicol
Chris Scicluna

Overview:
With Trump having last night warned of a ‘very very painful’ two weeks ahead, the mood is very gloomy again with equity markets down almost across the board and major bonds firmer.

Certainly, Asian stocks maintained the negative momentum from Wall Street, with most major indices lower today and S&P futures down too. Japanese markets led the way, with the Topix closing down 3.7% as the BoJ’s Tankan inevitably signalled a marked deterioration in business sentiment, with large manufacturers the most downbeat since 2013, and Covid-19 cases rising further in Tokyo. The Hang Seng’s currently down about 2½%, with HSBC weighed by yesterday evening’s announcements by the PRA that the major UK High Street banks will cancel their dividends and buybacks through to year-end. With China’s private sector Caixin manufacturing PMI having followed yesterday’s equivalent official indices by rising back above 50 (albeit only by 0.1pt), the CSI 300 fared better, closing down just 0.3%. But European stocks have followed the main trend, with most major indices currently down about 3% or more.

In the bond markets, USTs have made further gains, with 10Y yields dropping more than 7bps to below 0.60%, the bottom of the range of the past three weeks. Following yesterday’s announcement by the BoJ of an increase in the frequency of its purchases, JGBs made gains particularly at the short end of the curve, although 10Y yields were little changed close to zero percent. And even though there’s a deluge of new supply on its way, euro area core govvies and Gilts have followed USTs higher at the start of a day that will bring further downbeat economic survey data, not least from the manufacturing sector.

Japan:
The day’s flow of manufacturing PMIs from the major economies got underway today with the final Japanese indices, for which the headline index reported no change from the flash estimate of 44.8, 3pts lower than in January and the lowest since the global financial crisis in 2009. However, the detail was disappointing, with the output PMI revised down by a further 1pt from the flash to 41.1 – a drop of 6.3pts on the month and the lowest reading since the 2011-quake.

The BoJ’s quarterly Tankan survey, however, provided a far richer source of information and inevitably also signalled a marked deterioration in business conditions in Q1, as the impact of the coronavirus outbreak took its toll on an economy already struggling to recover from last October’s consumption tax hike. And, while a large share of survey responses might well have been returned before the Covid-19 crisis intensified in the final week of March (the survey was conducted between 25 February and 31 March), unsurprisingly there was a sizeable worsening of sentiment in firms across most sectors and sizes.

Given the sharp decline in overseas visitor numbers, cancellation of major events and the closure of various tourist attractions, the hit to the services sector was most notable with the headline non-manufacturing DI for large firms down 12pts – the largest quarterly drop since Q109 – to +8, the weakest reading for seven years. And the deterioration in the accommodation and hospitality sector was striking (albeit not surprising), with the DI for large firms down a whopping 70pts to -59, a record low. Large manufacturers were also notably more pessimistic, with the headline index down 8pts to -8, similarly the weakest for seven years. Sentiment among SMEs also fell its lowest since the start of Abenomics. Moreover, firms were decidedly more downbeat about the outlook for Q2, with the headline DI for all firms forecast to fall a further 14pts to -18, which would match the low seen after the 2011-quake.

Other detail of the report was predictably weaker, with firms of all sizes and manufacturers and non-manufacturers alike revising down their expectations for sales growth in FY19 – total enterprises on average predicted a drop of 0.7%Y/Y (compared with -0.1%Y/Y previously). But given the current backdrop, their expectations for modestly positive growth in FY20 seems too optimistic.

This notwithstanding, firms remained downbeat about their projected profits growth, forecasting a drop of 2½%Y/Y in FY20 following an anticipated drop of more than 7½%Y/Y in FY19 (with a double-digit decline in the manufacturing sector).

With this mind, the forecast increase in manufacturers capex plans was somewhat surprising, projecting growth of 2.4%Y/Y in FY20 following an increase of more than 4%Y/Y in FY19) Non-manufacturers were seemingly more upbeat about fixed investment intentions too – indeed, the forecast decline of 2%Y/Y was the softest for an April survey since FY07 (non-manufacturers in particular typically revise up their full-year forecasts as the year progresses).

While today’s survey continued to signal insufficient capacity at firms it again suggested that the constraints were not as acute as three months ago. For example, the overall production capacity index rose 2pts to -1, the highest for more than three years, while the equivalent employment index increased 3pts to -28, the highest for 2½ years (and this seems likely to increase further over the coming quarter). And so the Tankan’s composite indicator of spare capacity fell in Q1 to its lowest since Q217, suggesting diminished pressure on wages and inflation.

Certainly, the Tankan’s inflation indicators pointed to a weaker pricing environment, with large manufacturers on aggregate again reporting a steeper decline in output prices last quarter. Large non-manufacturers also reported the fifth consecutive drop in its equivalent DI to +2, suggesting that they were still passing on input costs but by the least amount since 2016.

Against this backdrop firms were more pessimistic about their ability to pass on costs over the coming year, forecasting a decline of 0.3%Y/Y in their output prices over the coming year. And they were equally downbeat about their ability to increase prices over coming years too. Large and small non-manufacturers were more optimistic in this respect than their manufacturing counterparts, but were less upbeat than three months ago. So, firms on average were forecasting a cumulative increase in prices of less than 1½% over the five years ahead. And so, they also remained unsurprisingly unconvinced that the BoJ’s 2% inflation target could be hit at any point over the coming five years. Indeed, firms forecast core CPI of just 1%Y/Y at the end of the projection horizon.

Euro area:
Today kicked off with some surprisingly strong German economic data with retail sales up 1.2%M/M in February following a rise of 1.0%M/M in January to be up a whopping 6.4%Y/Y, the strongest annual rate in fourteen months. That figure was likely flattered by the extra trading day in February this year compared to in 2019. And, more notably, the stock-building by households due to the coronavirus outbreak appears to have been the main driver, with sales of food and tobacco up 5.2%M/M and those of pharmaceuticals and cosmetics up 1.7%M/M, but other main categories down.

Nevertheless, the overall tone of today’s euro area dataflow will be downbeat, being dominated by the final March manufacturing PMIs. Indeed, these have got off to a weak start with the Spanish figures released for the first time a little while ago. In particular, Spain’s manufacturing PMI fell almost 5pts in March to 45.7, the lowest in almost seven years. The survey detail reported the steepest drop in output since the peak of the euro crisis in mid-2012, while new orders fell the most in more than seven years and export orders fell the most since the global financial crisis in 2009.

Looking ahead, we expect to see downwards revisions from the flash PMIs for the euro area, Germany and France. Among other things, the preliminary figures reported a record drop of 9pts in the euro area manufacturing output PMI to 39.5, suggesting the steepest fall in production since April 2009. The headline manufacturing PMI, however, fell a more a more moderate 4.4pts to 44.8, inappropriately boosted by the increase in supplier delivery times reflecting severe supply-chain disruption. At the national level, the March manufacturing PMIs for Italy were also just published, with the drop in the headline index particularly sharp (down 8.4pts to 40.3. March Italian new car registrations numbers are also out, and will be similarly weak. February figures due include euro area unemployment.

Separately, in the bond markets, Germany will sell 5Y Bunds.

UK:
Like in the euro area, the UK’s final manufacturing PMIs are on the docket today. According to the flash estimate, the output PMI fell 8pts to 44.3, the lowest since 2012, with a similarly marked deterioration in the component for new orders. But, as in the euro area, due to the impact of lengthening delivery times the fall in the headline PMI was less striking, dropping 3.7pts to 48.0, merely a three-month low. The BRC’s shop price index for March is also due tomorrow.

Meanwhile, in the markets, the DMO will sell £3bn of 8Y Gilts, the first auction of a month when it intends to raise £45bn, roughly one third the size of last year’s total gross issuance and 60% more than the highest previous monthly issuance in mid-2009.

US:
In the US, the ISM manufacturing survey for March is due along with the equivalent final PMIs. In addition, the ADP employment report and vehicle sales figures, both for March, are due along with February construction spending data.

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