Japan’s business conditions tank

Emily Nicol
Chris Scicluna

Overview:
It’s been a mixed start to the third quarter for Asian stock markets. With the latest BoJ Tankan offering a very downbeat view of the outlook in most respects (see below for the detail), consumers seemingly still very pessimistic too, and the yen firmer, the Topix fell 1.3%. In contrast, in China, where the latest Caixin PMIs tallied with yesterday’s government survey to point to further manufacturing sector growth last month, stocks made gains, with the CSI300 up 1.9%. Following yesterday’s end-quarter gains, US stock futures are down, however. And the tone in European markets is variable, despite an unmistakeable V-shaped rebound in German retail sales and further reports of plans for additional Italian fiscal stimulus. Major sovereign bonds, meanwhile, are weaker across the board amid steeper curves. 10Y JGB yields rose 2bps to 0.04% and 30Y Yields rose a further 4bps to 0.62%.And elsewhere, 10Y yields on USTs, Bunds and Gilts all similarly up a couple of bps or so today.

Japan:
The BoJ’s comprehensive Tankan survey predictably revealed widespread deterioration in business conditions over the second quarter, with assessments of profits, sales, employment and inflation having weakened significantly too. Large firms anticipate only limited recovery in the current quarter too with SMEs even more downbeat. Within the detail:

  • There were significant declines in both the headline manufacturing and non-manufacturing diffusion indices (DIs) for large firms in Q2, with the former down a massive 25pts to -34 and the latter 26pts to -17, the first negative reading for almost eleven years, and both the lowest since the global financial crisis.
  • Among the subsector detail, given the sharp decline in overseas visitor numbers, cancellation of major events and the closure of various tourist attractions, the hit to firms in hospitality was particularly large (the DI for large enterprises fell 32pts to -91), as well as for those offering services for individuals (down 64pts to -70). The Covid-related hit was severe for large auto manufacturers too (down 55pts to -72). Surprisingly, large retailers were somewhat more optimistic in Q2, although this followed considerable pessimism in the aftermath of October’s consumption tax hike. And overall, the relevant DIs for SMEs in these sectors saw greater declines.
  • Overall, when including SMEs, the all industry DI declined 27pts to -31, the weakest since 2009. And while large firms were a touch less pessimistic about the outlook for Q3, SMEs were anticipating even tougher times ahead. As such, the all industry DI was forecast to fall a further 3pts to -34.
  • With sales set to fall sharply, firms revised significantly lower their expectations for profits in the current fiscal year. Large firms expected a decline of more than 11%Y/Y following a drop of almost 12 ½%Y/Y in FY19. And with even weaker projections for SMEs, total profits were forecast to decline by almost 20%Y/Y in FY20, which would be the steepest drop since 2008.
  • Contrasting with the normal seasonal pattern, firms’ capex intentions were also revised markedly lower, forecasting a decline of 0.8%Y/Y in FY20 following a similar drop in the previous fiscal year. And despite the downwards revision, the forecast increase of more than 3%Y/Y among large firms looks too optimistic and seems highly likely to be again revised lower in due course.
  • Firms saw a substantial loosening in labour market conditions, with manufacturers signalling excess staffing levels for the first time since 2013. And with firms indicating ample spare production capacity too – the most since 2010 – the Tankan’s composite indicator of spare capacity fell sharply in Q2 to its lowest for seven years, suggesting significantly diminished pressure on wages and inflation.
  • The Tankan’s inflation indicators pointed to a much weaker pricing environment, with firms on aggregate reporting a decline in output prices last quarter – this was the first time large non-manufacturers cut prices since 2016. Firms were also more pessimistic about their ability to pass on costs to customers over the coming year, forecasting a decline of 0.3%Y/Y in their output prices over the coming year (compared with a rise of 0.2%Y/Y previously). 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 less than 1%Y/Y at the end of the projection horizon.

Meanwhile, although consumer confidence seemingly troughed in April, today’s monthly survey for June suggested the households remained relatively downbeat about conditions over the coming six months. The headline index rose 4.4pts to 28.4, still close to the lows seen during the global financial crisis, and still more than 10pts lower than the level at the end of last year. While there was a further improvement in households’ willingness to buy durable goods, the survey component still remained exceptionally weak compared with the long-run average. And so, while the decline was not as steep as May, new car registrations were still down a sizeable 26%Y/Y in June, the ninth consecutive annual decline.

Euro area:
As far as such a thing is possible, Germany has had a very “good” pandemic in terms of controlling the spread of Covid-19 and suppressing the number of deaths, while also keeping the economy ticking over as best possible. And with the authorities having been able to allow the reopening of non-essential stores sooner than elsewhere, retail sales rebounded particularly vigorously in May. Indeed, data released this morning showed that pent up demand was more than satisfied, with sales leaping 13.9%M/M, the strongest growth rate on the 26-year series. And strikingly, that took the level of sales 3.6% above February’s pre-pandemic peak and 3.8% above the level a year earlier.

Within the detail, sales of food, beverages and tobacco were up 4.9%Y/Y while sales from non-food stores were up 3.5%Y/Y. While shoppers were able to return to the stores, online sales locked in their gains of past month to be up 28.7%Y/Y. Sales of furniture, household appliances and building supplies rebounded 8.6%Y/Y. But sales of clothes and textiles were still a long way below normal levels, being down 22.6%Y/Y. And pharmaceutical and cosmetic items were down 6.3%Y/Y.

We have also seen the first release of figures for new car registrations in June, with an improvement reported in France as sales rose 1.2%Y/Y, the first annual increase since 2019. Of course, given the substantial weakness seen over recent months, this left sales down 38.6%Y/Y in the first half of the year, by far the worst performance since the series began in the early 1990s. Italian numbers will follow later in the day.

This morning will also bring the publication of the final manufacturing PMIs for the euro area, Germany, France and Italy. Like the flash release and Monday’s Commission economic sentiment survey, these are expected to point towards a stabilisation of economic conditions following the initial deep contraction after the Covid outbreak rather than any vigorous expansion in June. Indeed, the flash euro area manufacturing PMI rose to 46.9, from 39.4 in May. And this morning’s Spanish figure, released for the first time, showed a rise of more than 10pts in the headline index to 49.0.

Elsewhere, Germany’s labour market figures – due shortly – are expected to report a further notable increase in the number of jobless workers to leave the unemployment rate rising to 6.5% in June, which would be the highest since H115. Meanwhile, ECB Executive Board member Panetta is due to speak publicly.

UK:
Like other major economies, the final UK manufacturing PMI survey for June is also due today. And similarly, this is expected to reveal that activity stabilised this month but without significant momentum, with the headline index rising to 50.1, from 40.7 in May.

The BRC shop price index, published earlier this morning, suggested that some of the downwards pressure on prices from the pandemic eased in the current month. The headline measure of prices rose 0.4%M/M to be down 1.6%Y/Y, representing a moderation of the pace of decline from -2.4%Y/Y in May. Food prices on this survey fell back for the second successive month, albeit by just 0.1%M/M to be up 1.5%Y/Y, the same annual rate as in May. But non-food prices rose for the first month since February, up 0.7%M/M to be down 3.4%Y/Y, following a drop of 4.6%Y/Y in May.

The Nationwide house price indices, however, suggested that residential property prices remain under downwards pressure. In particular, following a drop of 1.7%M/M in May – which was the steepest drop since 2009 – prices fell a further 1.4%M/M in June to be down 0.1%Y/Y, the first negative annual rate since 2012. Of course, the decline in prices coincides with a sharp drop in transactions, which were still down 50%Y/Y. And the sharp fall in mortgage approvals (down almost 90%Y/Y) in May points to a low level of activity ahead.

In other news, external MPC member Haskel will speak at an event while, in the markets, the DMO will auction 2028 and 2050 Gilts.

China:
The Caixin manufacturing PMIs for June, released today, broadly tallied with the official survey released yesterday, reporting a modest further improvement in activity. The headline PMI rose for the second successive month and by 0.5pt to 51.2, the highest since December. Today’s survey, which is concentrated on private sector and smaller firms than the official PMIs, signalled a rise in production for a fourth successive month, albeit at a softer pace than in May (the respective PMI dropped 1.2pts to 52.8). The new orders index, however, rose to 52.1, a six-month high and the first reading above 50 since January. But like the official survey, today’s release suggested that export orders continue to fall, albeit at a more moderate pace than in prior months (the respective PMI rose to 47.0). Likewise, employment reportedly fell in the sector for the sixth successive month (in this case, the PMI dropped slightly to 48.6).

US:
In the US, the latest FOMC minutes will be published, together with a number of top-tier economic data releases, including the ISM manufacturing index, vehicle sales numbers and the ADP employment report, all for June, as well as construction spending figures for May.

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