Record drop in German IP

Chris Scicluna
Emily Nicol

Overview:
Following Friday’s big upside surprise to the latest US jobs figures, most Asian stock markets have started the week on the front foot. In Japan – where the latest economic data provided a broadly expected upwards revision to Q1 GDP, confirmed a further surge in bank lending last month, but also suggested that business sentiment remains very downbeat (see detail below) – the Topix closed up 1.1%. But despite some stronger-than-expected Chinese exports data released over the weekend, most mainland indices rose less than half that rate.

Elsewhere, US stock futures are higher, as are oil prices (Brent close to $43bbl) after OPEC+ agreed on Saturday to extend the group’s production cuts through to end-July. But European stocks have opened roughly 1% lower in the aftermath of some extremely weak German production data, which posted a record fall (more on this below too).

In the bond markets, having risen sharply on Friday, yields on USTs are slightly higher again this morning (10Y yields up more than 1bp to close to about 0.91%). But JGBs saw only modest gains and losses across the curve, a pattern largely matched by euro govvies this morning, while FX markets are also steady.

Looking ahead, after last week’s easing of euro area monetary policy from the ECB, this week the Fed takes the spotlight, although the main planks of policy (rates, asset purchases) seem highly likely to remain unchanged. Clearer guidance on the future path of policy might well be forthcoming, however, particularly as the FOMC members will be updating their economic projections. Tweaks to the Fed’s range of special credit facilities might also be discussed. The US economic dataflow, which includes May inflation figures (Wednesday), will be most notable too, although UK monthly GDP (Friday) will also be watched.

Japan:
While the second estimate of Japanese national accounts figures for Q1 predictably brought an upwards revision to GDP, today’s release nevertheless confirmed a technical recession at the turn of the year. In particular, overall economic output declined 0.6%Q/Q (from the initial estimated drop of -0.9%Q/Q) following the 1.9%Q/Q slump seen in Q4 to leave output down 1.7% compared with a year earlier, the steepest annual drop since Q309.

The upwards revision was more than fully accounted for by private sector capex, which saw the initial estimated decline of 0.5%Q/Q more than reversed to an increase of 1.9%Q/Q. But this followed payback for the near-5%Q/Q drop seen in Q4. And so, non-residential investment was still almost 2% lower than a year earlier. And the other expenditure components still suggested considerable weakness at the start of 2020, with the declines marginally larger than in the initial estimate.

For example, private consumption was down 0.8%Q/Q, government consumption flat, public sector investment down 0.6%Q/Q and private inventories subtracted 0.1ppt from growth having previously made a negligible contribution. So, overall, domestic demand still subtracted 0.4ppt from GDP growth. Meanwhile, the negative contribution from net trade (0.2ppt) was unrevised, with the 6%Q/Q drop in exports more than offsetting the 4.9%Q/Q decline in imports.

Of course, Japan’s economy took a marked turn for the worse at the start of Q2, as pandemic containment measures impacted spending and output to a much greater extent than in Q1. And while surveys suggest that April might well mark the trough, today’s economy watchers survey signalled only modest recovery in economic conditions in May. For example, while the headline current conditions balance rose 7.6pts to 15.5, this still represented the third-lowest reading in the survey’s history and remained well below the key-50-mark representing an ‘improving’ situation.

The survey indicators for both household- and corporate-related demand remained close to historically low levels too, with economy watchers judging that the situation remained extremely severe due to the coronavirus. They were, however, somewhat less pessimistic about the outlook for the coming three months, with the expectations balance rising for the first month in six and by almost 20pts to 36.5.

Today’s other release, bank lending figures for May, illustrated the hit to corporate cash flow from the hit to demand. Indeed, bank lending jumped 1.8%M/M – the most since the series started in the early 1990s – to leave the annual rate up 2ppts to 5.1%Y/Y, similarly the strongest growth since the monthly series began and more than 1ppt higher than the peak during the global financial crisis.

Looking ahead to the remainder of the week, Wednesday’s machine orders data seem bound to reveal a sharp drop and point to much weaker capex over coming months. And this will likely tally with a downbeat message from the MoF’s business sentiment survey (due the following day), which will provide an update on conditions in Q2 and report expectations for the second half of the year too. Tomorrow’s labour earnings figures for April are expected to be extremely weak, while Wednesday’s goods PPI release will continue to flag that pipeline pressures remain skewed to the downside.

Euro area:
This morning’s release of German IP data kicked off the steady flow of manufacturing sector releases due out of the euro area this week. And these were predictably extremely weak. German industrial production plunged a record 17.9%M/M in April. That followed a slightly revised drop of 8.9%M/M in March, and left it down a whopping 25.3%Y/Y at the lowest level since 1997. Within the detail, output of manufacturing and mining fell more than one fifth (-22.1%M/M), with production of capital goods down more than one third (-35.3%M/M) to be little better than half the level a year earlier and the lowest since reunification. With factories in the sector all but shut, production of autos dropped by three quarters similarly to a post-reunification low.

Among other items, output of intermediate goods was down a hefty 13.8%M/M, with consumer goods down a somewhat more moderate 8.7%M/M (merely the lowest level since 2009). Energy output fell 7.2%M/M. And, in marked contrast to the other large euro area member states, construction output remained relatively resilient to the pandemic, dropping just 4.1%M/M to merely its lowest level since December.

With factories better able to resume ‘normal’ activity last month, production will have rebounded. However, orders were down by more than one third in April, and surveys suggest that they remained very weak in May. So, while the government’s stimulus measures, including a cut in VAT to last throughout the second half of the year, will support domestic demand, the level of output in German manufacturing seems bound to remain well down on the pre-Covid level for a long time to come.

Looking ahead, French and Italian IP data will follow tomorrow and Wednesday respectively, and the week will conclude with the aggregate euro area numbers on Friday. Following a record 11%M/M fall in March, euro area output is forecast to have declined about 20%M/M, leaving it down almost 30% compared with a year earlier. Supply constraints as well as the weakness in demand will be evident in the latest German and French trade data, due to be published tomorrow. Tuesday will also bring the Bank of France’s business sentiment survey for May, which is expected to report only a moderate improvement in the overall confidence indicator as firms progressively returned to work.

Final euro area Q1 GDP data, also due to be published tomorrow, are expected to confirm that output contracted at a record rate close to the preliminary estimate of 3.8%Q/Q (-3.3%Y/Y) in Q1 as lockdowns introduced in March took their toll. This release will provide the first official expenditure breakdown, with private consumption and investment set to have declined sharply, while net trade likely provided some support as a fall in imports offset weaker exports. It will also report employment data for Q1 for the first time, although these will fail to adequately reflect the labour market impact of the drop in economic output. Meanwhile, on Friday, final May CPI data for France and Spain are expected to confirm that inflation fell further on the back of lower energy prices.

As far as monetary policy commentary is concerned, ECB President Lagarde is due to speak at a European Parliamentary hearing on economic and monetary affairs this morning, while the ECB’s Vice President de Guindos will speak at an online event on Wednesday.

UK:
The most noteworthy UK data this week will be the April GDP report on Friday. These figures are bound to show a massive hit to activity across the services, manufacturing and construction sectors alike, as the country remained in lockdown. Following a drop of 5.8%M/M in March, GDP might well have fallen by four times that rate in April. The gradual lifting of containment measures over recent weeks means that April will prove to be the trough. Nevertheless, we think that it will be 2023 before activity returns to the pre-coronavirus level. April’s trade figures, also due on Friday, will flag the significant negative impact of the on domestic and external demand and supply chains. Ahead of this will be will be quiet for data – the BRC retail sales monitor for May is out tomorrow, followed by the RICS house price balance for the same month on Thursday. In terms of policy communication, BoE Chief Economist Haldane will speak today, while Deputy Governor Cunliffe will speak tomorrow.

US:
In the US, the key economic focus this week will be on Wednesday’s FOMC rate decision, the publication of the Committee’s updated economic projections, and Fed Chair Powell’s accompanying press conference. No amendments to policy are expected, but insights into the Fed’s assessment of economic conditions and possible next steps should be informative. Meanwhile, the US data calendar kicks off tomorrow with the release of the NFIB small business survey for May as well as JOLTS job openings and final wholesale inventories data for April. Not least given the record monthly drop in the core measure in April, more interesting for the markets will be CPI inflation figures for May, due to be published on Wednesday. The Federal budget statement for May will also be published that day. Producer price data are due Thursday along with the latest weekly jobless claims numbers. And on Friday, import and export price data will be released as well as the University of Michigan’s preliminary consumer confidence survey for June.

China:
While the weekend’s Chinese trade figures showed a record surplus in May ($69.9bn), the underlying detail of the report disappointed, at least for those who were hoping that China would play its part in supporting post-Covid global economic recovery. The decline in the value of exports was certainly less than had been expected, although it was still down more than 3%Y/Y (-7.7%YTD/Y), with shipments to Europe and the US continuing to fall as lockdown measures impeded demand. And there was a notable deterioration to major emerging markets such as India, South Africa and Brazil where the pandemic escalated. But the main surprise (and disappointment) from the weekend’s data was the significant weakness in imports, which were down a much-steeper-than-expected 13.3%Y/Y, reflecting ongoing subdued demand as well as supply-side constraints. The near-term trade outlook remains highly uncertain, of course, with global demand set to remain very subdued and supply chains likely disrupted on top of renewed tensions between the US and China (the Chinese authorities halted the purchase of some US farm goods from 1 June).

Australia:
A relatively quiet week for Australian economics releases brings the NAB business confidence survey for May (tomorrow) and Westpac consumer confidence survey for June (Wednesday), both of which are expected to point to a modest recovery in sentiment as containment measures started to ease. Tomorrow will also bring job advertisements figures for May.

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