Services PMIs provide mixed messages

Emily Nicol
Chris Scicluna

Overview:
Investors continue to ignore the ugly scenes in the US, with the rally in stock markets largely extended in Asia today and oil prices again higher too (Brent crude is above $40bbl for the first time since early March) on continued optimism that the worst of the pandemic (at least in the major economies) is behind us. With risk appetite firm, in FX markets the dollar maintained its downtrend, with DXY sliding further to its lowest level since March.

While the latest PMI updates on services activity in Japan and China (details below) provided conflicting signals, with the former remaining extremely weak but the latter suggesting growth for the first time since January, the Topix closed up a further 0.7% but the CSI300 closed little changed from yesterday’s close. Australia’s main ASX index shrugged off confirmation of a drop in GDP in the first quarter with a solid 1.8% gain. And US stock futures are higher too while European equities are opening up this morning.

In the bond markets, USTs are somewhat weaker, with yields back to the top end of the range of the past week (10Y yields are up a couple of bps to back above 0.70%). JGBs were slightly weaker after the BoJ reduced its purchase amount for 3-5Y bonds at today’s regular operation, having increased the frequency of such operations (from 5 to 6 times) this month. And ahead of tomorrow’s ECB policy announcement, when news on the PEPP purchase programme is widely expected, euro area government bond yields are a couple of bps higher across the board this morning.

China:
Like the equivalent official non-manufacturing PMI (which rose a further 0.4pt to 53.6, the highest since January), today’s equivalent Caixin services PMI signalled an improvement in activity in May. However, the pace of improvement suggested by this survey was far more striking, with the headline PMI leaping more than 10pts to 55.0, suggesting the first growth in the sector since January and the strongest since 2010. Within the survey detail, the resumption of economic activity and firmer domestic demand was reflected in the first rise in new orders in the sector since January (the respective PMI jumped more than 7pts to 55.8, also a near 10-year high). But – as implied by the official survey – external demand for Chinese services remains weak, with the new export orders PMI still firmly in contractionary territory (44.4). And while firms appear to remain upbeat about the outlook, today’s survey added to evidence that jobs continue to be shed, with the services employment PMI below 50 for a fourth successive month.

When combined with the findings of the manufacturing survey, the Caixin composite PMI jumped almost 7pts to 54.5, similarly marking the first expansion in total activity since January. However, while overall orders were also stronger (up almost 5pts to 52.9), the other composite PMIs similarly suggested that employment continues to be cut and that downwards pressure on prices persist too.

Japan:
There were no major surprises from the final Japanese services PMI. Admittedly, the headline index was pushed higher from the flash release, by 1.2pts to 26.5, leaving it 5pts higher than April. Nevertheless, the index still marked the second-lowest reading on record (by a considerable margin). And the new business component similarly indicated ongoing sharp contraction in the sector, albeit to a less extent than in April. With the manufacturing output PMI having been revised lower in May (down 1.4pts from the flash estimate), the recovery in the composite PMI was more modest, up just 2pts on the month to 27.8, implying a contraction in output at an unprecedented pace so far in Q2.

Australia:
National accounts data published by the ABS today showed that, like all other major economies, Australia’s GDP contracted in Q1 as the country battled the bushfire crisis and then the impact of the Covid-19 outbreak. Indeed, despite an increase in government support in response to the natural disasters and virus crisis, output fell 0.3%Q/Q in Q1 – the first negative reading since the global financial crisis – to leave it up just 1.4% compared with a year earlier, the softest annual growth since Q309.

Within the detail, despite a notable increase in disposable income in the first quarter as some households received government support, there was significant weakness in household consumption, which fell (-1.1%Q/Q, to subtract 0.6ppt from growth) for the first time since Q408 and the most since Q186. This reflected an unprecedented drop in spending on services (-2.4%Q/Q), while spending on goods (+1%Q/Q) was driven by food, alcohol, pharmaceutical products and home office equipment. Private investment also fell for the fifth quarter out of the past six, knocking a further 0.2ppt off quarterly GDP growth, with residential investment down for the sixth consecutive quarter and spending on machinery and equipment down for the third consecutive quarter. Meanwhile, public sector investment also contracted for the first quarter since 2018.

In terms of trade, exports fell sharply in Q1 (-3.5%Q/Q – the most for nine years) as services exports slumped almost 13%Q/Q on the back of the impact on restrictions associated with education- and tourism-related travel. But services imports were similarly significantly impacted (-13½%Q/Q). And with goods imports disrupted by supply constraints, total imports fell a steeper 6.2%Q/Q in Q1, to leave net trade contributing 0.5ppt to GDP growth.

Looking ahead, with the economy having largely remained closed to non-essential business for much of April and travel bans still in place, the contraction in output in Q2 will undoubtedly be significantly larger and therefore confirm the first technical recession in Australia for three decades. Having escaped the worst of the coronavirus, however, the pace of decline in GDP should be more moderate than the double-digit percentage declines anticipated in much of Europe and the US.

Among today’s other Australian data, the number of dwellings approvals remained remarkably resilient in April, down just 1.8%M/M compared with the forecast drop of 11%M/M, with approvals for private sector houses rising 2.7%M/M. However, new vehicle sales continued to decline sharply in May, with the 59.9k units sold that month down 35.3% from a year earlier, the largest decline for the month of May since the series began in 1991, following a record-49%Y/Y fall in April.

Euro area:
In terms of data, likely of most interest in the euro area today will be the latest German labour market figures for May, as well as the aggregate euro area and Italian numbers for April. The more timely German figures are expected to report a further increase of 190k in unemployment, albeit less than the 373k rise recorded in April. The smaller increase will reflect the easing of economic restrictions as well as continued support provided by the government’s short-time work ‘kurzabeit’ scheme, which the ifo institute yesterday subsidizing the wages of 7.3mn workers in May (this compares with 1½mn workers on the scheme at the height of the global financial crisis). Overall, with tens of millions of workers on government-supported furlough schemes across Europe, the full labour market impact of the crisis will not be fully reflected in the euro area’s unemployment figures too. 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.

Elsewhere, the final release of the service sector and composite PMIs for May is likely to highlight that economic conditions remain extremely weak. Indeed, like Monday’s manufacturing PMI, these are expected to confirm the main findings of the flash surveys showing that economic activity improved slightly in May, albeit remaining well below the pre-crisis level. The headline euro area composite index is expected to match the flash estimate of 30.5, up from a record low of 13.6 in April but still the second-lowest reading on record by a considerable margin and firmly below the key 50 level. The Spanish indices, published for the first time this morning, saw the services PMI rise more than 20pts from April’s extreme low to 27.9, a level still consistent with substantive contraction. And that left Spain’s composite PMI up 20pts on the month at a still very low 29.2.

UK:
Like elsewhere, this morning will also see the release of the final UK services and composite PMIs for May. The preliminary services PMI increased to 27.8 in May 2020 from an all-time low of 13.4 the previous month. And together with the improvement in the manufacturing PMI, the composite output PMI is expected to have risen by at least the 15pts seen in the flash release to 28.9. But this would still mark the second-lowest reading on the series, leaving it still almost 10pts below the trough during the global financial crisis, pointing to an extremely deep contraction at an unprecedented pace.

Meanwhile, the negative effect on inflation of the slump in demand last month was again evident in today’s release of the BRC shop price survey. In particular, the survey measure of non-food prices was down 4.6%Y/Y in May – the steepest annual drop since the series began in 2006 – following a drop of 3.7%Y/Y previously, as retailers cut prices further to try to attract consumers. And with food prices having eased back slightly too, the BRC’s measure of overall shop price inflation fell considerably further in May, down 0.7ppt to -2.4%Y/Y, the steepest drop since the series began.

US:
In the US, the non-manufacturing ISM and final services PMI for May will be published later today alongside final factory orders data for April. And ahead of Friday’s payroll figures, today’s release of the ADP employment report will also be watched for signs of life in the labour market.

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