ECB and US payrolls on the docket

Chris Scicluna
Emily Nicol

Overview:
Despite the escalating unrest across the US over the weekend, Asian equities started the week on the front foot as Trump’s threats last week of retaliation stopped short of specific sanctions over China’s new national security law for Hong Kong. In particular, the Chinese CSI 300 was up more than 2½%, even as the government’s official PMIs indicated no material improvement in business conditions in May – indeed, with the manufacturing index having slipped back, while the non-manufacturing edged only slightly higher, the composite PMI (53.4) was unchanged on the month. Meanwhile, the Hang Seng was up almost 3½%, while the South Korean Kospi was up 1.8%. Japan’s Topix made more modest gains (0.3%) as the latest tranche of Japanese economic data offered a predictably gloomy assessment for the near-term outlook despite an upside surprise to the latest capital spending survey in Q1 (see below for details).

In government bond markets, with USTs trading marginally weaker during Asian time (10Y yields are 1bp higher at 0.66%), European govvies have similarly opened lower even as today’s data releases – final manufacturing PMIs for May – are likely to confirm that activity remains extremely weak despite the modest recovery from April. Indeed, this morning’s French car registrations figures showed a further decline of 50%Y/Y in May following a decline of 89%Y/Y in April.

Looking ahead, the main policy event this week will be the ECB’s Governing Council meeting on Thursday, where we expect a sizeable expansion of its PEPP programme. In contrast, the RBA’s meeting tomorrow seems bound to leave policy unchanged. Data-wise, euro area retail sales figures will emphasise the hit to demand in the face of lockdown measures across the region, while flash inflation numbers will see the headline rate fall closer to zero. But all eyes at the end of the week will be on the US payrolls report, with the unemployment rate expected to have jumped to 19%.

Japan:
Against the backdrop of a steady flow of downbeat economic data from the major economies, today’s release of Japan’s financial statistics of corporations, at face value at least, exceeded expectations. In particular, it suggested that capital spending jumped in Q1, by more than 7%Q/Q – the most for seven quarters – to leave it 3½% higher than a year earlier. But the MoF suggested that a lower response rate than usual to the survey (62.3%) may have swayed the data. Certainly, the message contrasted markedly with the preliminary release of Q1 GDP, which suggested that private sector investment (in nominal terms) declined 1.0%Q/Q. While the drop in the national accounts measure of capex in real terms was somewhat less pronounced (½%Q/Q), it remains highly uncertain as to whether this will be revised away in the updated Q1 GDP figures to be published a week today. Regardless of any upwards revision, having been estimated to have contracted by 0.9%Q/Q in the preliminary release, GDP is still likely to have declined for the second successive quarter in Q1.

The detail of the report supports our view that firms will reduce significantly further their capex intentions over the near term. While the survey suggested that sales posted a modest gain in Q1 (1.9%Q/Q) this followed four consecutive quarters of contraction to leave them still down 3½% compared with a year earlier. Moreover, profits declined for the fourth successive quarter and at a double-digit rate in Q1, leaving them down a whopping 32%Y/Y, the largest annual drop since the global financial crisis. And while the weakness was broad based, the transport equipment sector was one of the worst hit of the larger sectors – with profits down more than 50%Y/Y. The negative impact seems bound to be much worse in Q2 when production and demand has been significantly disrupted by the Covid-19 restrictions.

Certainly, today’s car sales figures for May were inevitably extremely weak, down more than 40%Y/Y, the most since the 2011-quake. And while the final manufacturing PMI survey showed no change to the headline index in May – which at 38.4 was 3½pts lower than April – the detail of the report was more downbeat. For example, the output component was revised down by a further 1.4pts in May to 30.3, a drop of 4.4pts from April, while the new orders PMI was revised by an additional 0.9pt to 25.0, a decline of more than 8pts on the month, with the respective indices at their lowest since March 2009.

Looking ahead to the remainder of the week, Wednesday will bring the final services and composite PMIs for May. But likely of more interest will be the April figures for household spending and consumption activity on Friday, which are expected to post double-digits declines that month. That day will also bring the Cabinet Office’s composite indicators of business conditions, which will no doubt be consistent with a sharp contraction in activity in Q2.

Euro area:
The main event in the euro area this week will be the ECB’s policy announcement on Thursday, where we fully expect the Governing Council to agree an increase in asset purchases. In particular, we expect the PEPP total to be increased by a further EUR500bn, with the programme extended into 2021, perhaps as far as September 2021 to match the timescale of the recent changes to collateral rules. The ECB might also announce that the principal payments from maturing PEPP bonds will be reinvested for an extended period of time. In light of the European Commission's proposal to issue EUR750bn of bonds to fund recovery, the ECB might also signal its readiness to increase the share of the PEPP programme taken by supra-national bonds. And the Governing Council could also signal a willingness to buy bonds of fallen angels within the context of its corporate bond purchase programme.

The justification for increasing and extending the programme further will be provided by the ECB’s latest set of staff forecasts. Following the April Governing Council meeting, the ECB published three illustrative scenarios, whereby GDP would drop by around 5%, 8% and 12% respectively under the “mild”, “medium” and “severe” assumptions. The account of that meeting, however, suggested that even last month the Governing Council members judged the “mild” scenario to be unrealistic. And, according to recent comments by ECB President Christine Lagarde, the ECB’s updated forecast is likely to show a path for output somewhere between the “medium” and the “severe” scenario, which would also be broadly in line with our own baseline projection. Even assuming no second wave of pandemic and lockdowns, it would also imply that GDP would not be expected to return to the pre-pandemic level before end-2022 or beyond. So, underlying inflation would remain weak over the full forecast horizon.

Datawise, the final manufacturing and service sector PMIs for Germany, France and the euro area are due today and Wednesday respectively, with the equivalent survey results for Italy and Spain to be released for the first time. The headline euro area composite measure, which will published alongside the service sector figures on Wednesday, is expected to match the flash estimate of 30.5, up from a record low of 13.6 in April, but still firmly below the key 50 level. And the equivalent construction PMIs will be released on Thursday.

The labour market also features at the start of the week with Spanish May jobless claims figures out tomorrow, followed by German data for the same month and the aggregate euro area unemployment numbers for April on Wednesday. But with tens of millions of workers on government-supported furlough schemes, the full labour market impact of the crisis will not be fully reflected in the unemployment figures. Indeed, the euro area unemployment rate is expected to rise less than 1ppt from the March level of 7.4%, and thus remain well down on the high of 12.1% reached in 2013.

In terms of the latest activity data, national car production and registration data for May will be released through the week, kicking off this morning with the French figures (down 50%Y/Y, following a decline of 88.8%Y/Y in April), with the Italian registrations figures later today. This week will also bring the release of euro area retail sales figures for April on Thursday. Consumer spending figures out of the worst affected member states, such as those from France last Friday, have been dire and this will be reflected in the aggregate euro area measure, which is expected to show a further fall of more than 12%M/M following the drop of 11.2%M/M in March. And on Friday, German factory orders data for April are expected to show a further decline of about 20%M/M reflecting widespread factory closures as well as slumping demand both at home and from abroad.

UK:
In the UK, the economic data likely of most note this week will be tomorrow’s lending figures from the Bank of England which are expected to show a further surge in bank loans to business to meet emergency liquidity needs but a continued reduction in net borrowing by consumers in April as households refrained from spending during the lockdown. The final PMIs for the manufacturing and services sectors will be published today and Wednesday respectively, with the construction PMI following on Thursday. Like in the euro area, the UK’s preliminary PMIs suggested that the pace of decline in economic activity eased somewhat this month as social distancing rules were relaxed very gradually. In particular, the composite output PMI rose 13.8pts to 28.9. But this was still the second-lowest reading on the series and almost 10pts below the trough during the GFC to suggest ongoing extremely deep contraction at an unprecedented pace. Thursday will also bring new car registrations figures for May, which seem bound to have remained extremely weak as car dealerships remained closed. On Friday, the final GfK consumer confidence survey for May will be published.

US:
In the US, this week’s data calendar kicks off today with the release of the final manufacturing PMI and ISM manufacturing indices for May, which will be followed by the release of the non-manufacturing indices on Wednesday. Tomorrow will bring May vehicle sales figures. Also published on Wednesday will be final factory orders data for April as well as the ADP employment report for May. The usual weekly initial claims figures will be published on Thursday, alongside trade figures for April and final productivity and costs data for Q1. But the main event of the week will come on Friday with the release of the May employment report, which is expected to show a jump in the unemployment rate close to 20%, while nonfarm payrolls are expected to drop by several millions following the decline of more than 20mn in April.

Australia:
In Australia, tomorrow will bring the conclusion of the latest RBA policy meeting, where the key policy parameters – in terms of both the cash rate and 3Y yield target – are widely expected to remain unchanged at 0.25%. And while Lowe’s statement might well imply that Australia has now passed the trough of the crisis, it will also suggest that risks remain skewed to the downside. Moreover, it will likely note that GDP is expected to remain well below the pre-Covid-19 level for several years to come, with unemployment set to jump, and inflation to remain well below target for the foreseeable future too. 

Turning to the data, tomorrow will also see the release of net exports and inventories figures for Q1, which will provide further insight into the pace of contraction in GDP at the start of the year. Indeed, GDP figures due the following day are expected to report a drop of almost ½%Q/Q, the first quarterly decline for nine years and fully reversing the increase in Q4. Wednesday will also bring April building approvals figures, followed on Thursday by final retail sales and trade data for the same month.

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