Central banks attempt to calm concerns

Chris Scicluna
Emily Nicol

Overview:
As the coronavirus spreads and policymakers try to gauge an appropriate response, financial markets seem highly likely to remain volatile this week. For the time being, however, announcements from the Fed and BoJ, which bookended the weekend, as well as a statement from the BoE a little while ago, seem to have helped investors regain their poise. Indeed, most major Asian equity markets rose today (TOPIX up 1%, China’s CSI300 up more than 3%), most European stock indices have opened up about 1½% or more, US equity futures are also higher, and there is now somewhat greater uncertainty about the near-term trajectory of major government bonds.

The statement from BoJ Governor Kuroda shortly after Tokyo market opening focussed explicitly on financial stability concerns, stating that the central bank “will strive to provide ample liquidity and ensure stability in financial markets through appropriate market operations and asset purchases”. Shortly afterwards, the BoJ followed words with deeds, offering to buy ¥500mn of JGBs in a repurchase operation for the first time since 2016. But the emphasis on financial stability, and recourse to market operations to support that aim, underscores the reluctance of the BoJ to avoid having to cut rates further, unless perhaps the yen appreciates sharply once again (since the BoJ statement the yen has depreciated from ¥107/$ back down to ¥108.5).

In contrast to Kuroda’s announcement, Jay Powell’s statement on Friday evening emphasised “the evolving risks to economic activity” posed by the coronavirus. And noting that the Fed is “closely monitoring developments and their implications for the economic outlook…and will act as appropriate to support the economy” signalled that a cut in the fed funds rate target range is likely to be coming sooner rather than later.

So, shorter-dated USTs rallied further in Asian time, with 2Y yields about 13bps lower to 0.78%, almost 50bps lower than ago. In contrast, having dipped below 1.04% in early Asian trading, 10Y UST yields have reversed much of this move back to 1.12%, albeit still about 25bps below their level a week ago. In Japan, yields on JGBs are roughly 2-3 bps higher across the curve (10Y yields up close to -0.14%). But ahead of tomorrow’s RBA meeting, where a rate cut now seems more likely than not, ACGBs behaved like USTs, with the curve flattening markedly (2Y yields down more than 7bps to below 0.5%, but 10Y yields just 1bp lower at 0.80%). Euro govvies are somewhat mixed so far – Bunds little changed but BTPs benefiting from the improved risk appetite.

Indeed, in Europe, we also now expect central banks to provide additional monetary easing before the summer. But the Bank of England this morning announced that it “will ensure all necessary steps to protect financial and monetary stability”, suggesting a BoJ-style preference for market operations over rate cuts. The ECB might be expected to follow with a similar message in due course, ahead of its regular monetary policy next week, which might well come too soon to deliver new easing measures.

Indeed, before cutting rates, policymakers in Europe will likely wait first for the impact of the epidemic to show up in the economic data (which won’t be the case for a number of weeks to come) and also for an initial response of fiscal policy. The first substantive announcement on the fiscal front came on the weekend from Italy, although the planned package of support, which includes tax relief measures, will amount to little more than 0.2% of GDP – certainly insufficient to fully offset the impact on growth in a country where the number of coronavirus cases in Italy leapt above 1700, about fourteen times the level a week ago. Indeed, while policymakers in Europe won’t be able to take such draconian action as those in China, the weekend’s dire Chinese PMIs illustrated the toll that the epidemic could, in due course, take on other major economies (detail on these data, and what to expect in the coming week, below).

China:
Perhaps predictably given the widespread lockdown since the Lunar New Year, the Chinese PMIs for February were dire suggesting that activity in a large majority of companies was hit last month. Indeed, the government’s official manufacturing PMI slumped a whopping 14.3pts to 35.7, while the non-manufacturing PMI fell 24.5pts to 29.6, both easily the lowest on record. Within the detail of the manufacturing survey, the output component was down 24pts to 27.8, with the new orders index 22pts lower at 29.3, signalling sharp contraction and a likely greater hit to global supply chains than might even have been expected. Admittedly, this survey (26 January – 25 February) was conducted during the worst of the disruptions. With firms having been slowly resuming output – the National Statistics Bureau suggested that as of 25 February almost 80% of enterprises had gone back to work, although other sources suggest that the resumption rate for SMEs was just one third – we would expect the PMIs to signal that February marked the trough. This notwithstanding, Q1 GDP data will be terrible. And the disruption to supply chains seems bound to weigh on global output for many months to come.

Looking ahead, the latest Chinese trade figures for January and February are currently scheduled to be published on Saturday. But the PMIs suggest that these are bound to be extremely weak on both sides of the ledger, with significant double-digit declines in both exports and imports alike.

Japan:
While all eyes were on the BoJ, like in China, today brought the final Japanese manufacturing PMI for February. But while this (perhaps surprisingly) reported a modest upwards revision from the flash estimate (+0.2pt), the headline index was still down 1pt from January at 47.8, the lowest reading since mid-2016. And the weakness was broad based across the survey, with the output PMI downwardly revised to 47.4, an eleven-month low and firmly in contractionary territory, while the new orders index down 3.7pts to 43.4, the lowest for more than seven years. Meanwhile, the final services PMI (due Wednesday) is likely to report a more marked deterioration in sentiment due to hit to tourism. Indeed, the flash headline index fell more than 4pts to 46.7, its lowest level since the April consumption tax rate hike in 2014. The latest consumer confidence survey (due tomorrow) is likely to show a less sanguine outlook for domestic consumption over the near-term too.

So Japan’s economy seems set for a very difficult first quarter of 2020. But the overnight release of the MoF’s capital spending survey suggested a weaker performance in private sector investment than originally thought in the final quarter of 2019 too. Indeed, this suggested that private capex declined 5.0%Q/Q in Q4, to leave it down 3½%Y/Y, the first year-on-year drop since Q316 and the steepest since the start of Abenomics. And the weakness was broad based, with investment in the manufacturing sector down 5½%Q/Q (-9.0%Y/Y) and non-manufacturing sector down 4.7%Q/Q (-0.1%Y/Y). In terms of the second estimate of Q4 GDP (due a week today), today’s release suggests a slightly steeper pace of decline from the 3.9%Q/Q drop in real non-residential investment than reported in the preliminary national accounts figures. But with private sector inventories expected to provide a slightly larger contribution, overall we expected GDP growth to be little changed from the initial reading of -1.6%Q/Q. But another disappointing outturn for sales (down 2.9%Q/Q, the most since Q212) and profits (down for the third consecutive quarter and by 6.7%Q/Q) suggests ongoing weakness in capex ahead.

The back end of the week will bring the latest household spending and BoJ consumption activity figures for January, which like last week’s retail sales, are likely to point to modest recovery in spending habits at the start of the year. Friday will also bring January labour earnings figures and the Cabinet Office’s composite indicator of business conditions for the same month. In the markets, the MoF will sell 10Y JGBs tomorrow and 30Y JGBs on Thursday.

Euro area:
News on the spread of the COVID-19 coronavirus and the responses, if any, of policymakers will continue to dominate attention in this week. Nevertheless, several euro area economic releases of note are due, kicking off with the final manufacturing PMIs this morning. The flash estimates showed the headline index rising 1.2pts to a twelve-month high of 49.1, implying further stabilisation in the sector. But this in part reflected increased supplier delivery times as the initial impact of the coronavirus on availability of components started to take its toll, a development which should be judged to be negative. And the majority (if not all) of the survey responses were collected before the virus outbreak escalated in Italy. So, we would expect to see only minimal amendments made to the various PMIs in the final manufacturing survey for this month. The equivalent final services PMI survey (due Wednesday) typically has a slightly longer collection period and therefore might have seen a modest share of firms respond after the surge in Italian cases. But overall, we expect to see only modest downward revisions to the services and composite indices, from the four-month high of 52.8 and six-month high of 51.6 reported in the respective flash estimates.

Wednesday will also bring euro area retail sales figures for January, which seem bound to have picked up at the start of the year following weakness at the end of 2019. However, the 1.6%M/M decline in euro area sales reported in December is likely to be revised given that the drop in Germany is now estimated to have been 2.0%M/M rather than the steeper plunge of 3.3%MM originally published. Separately, tomorrow will bring the euro area’s flash CPI estimate for February. Not least given the downwards shift in the oil price over the past month we expect headline inflation to have fallen back slightly, by 0.1ppt to 1.3%Y/Y. But Friday’s national data also suggest that core inflation might well have edged back up to 1.2%Y/Y. Tuesday will also bring the euro area’s latest labour market figures, which are expected to show the unemployment rate unchanged at 7.4% in January, the joint-lowest reading since mid-2008 but still only 0.1ppt lower than in June. Meanwhile, at the country level, German factory orders data, Spanish IP figures and Italian retail sales numbers, all for January, are due to be published on Friday. In the markets, Germany will sell inflation-linked bonds tomorrow, while France and Spain will sell bonds with various maturities on Thursday.

UK:
The start of the week will bring the launch of the first round of negotiations between the UK and EU on their future relationship. There appears to be a significant gap between the positions of the two sides. And the UK government has soured the relationship with its threat of walking away from the talks if there is insufficient progress in line with its wishes by June, and also by suggesting that it might backtrack on its earlier commitments (e.g. indicating an unwillingness to implement fully the Northern Ireland Protocol of the Withdrawal Agreement). Nevertheless, we still see scope for an eventual deal, albeit perhaps not until October. As such, the talks seem likely to generate far more heat than light for several months, a process that might thus be expected to fuel uncertainty and, given the risks that the EU and UK will be trading on WTO rules from the start of 2021 if there is no deal, undermine business confidence and harm investment expenditure too.

Turning to the data, the final UK PMI surveys for February will be the main focus at the start of the week, with the manufacturing, construction and services indices due today, tomorrow and Wednesday respectively. But similar to the euro area releases, responses to these surveys are likely to have been largely collected before the acceleration of coronavirus cases in Italy. And given the arithmetic calculation of the manufacturing PMI – that an undesirable lengthening of supplier delivery times adds positively to the headline index – we wouldn’t expect to see a significant downwards revision to the preliminary estimate (which had risen 1.9pts to a ten-month high of 51.9). However, the longer survey collection period might trigger a modest downwards revision to the services PMI (which already fell 0.6pt in the flash estimate to 53.3) on heightened coronavirus concerns. Other releases due in the coming week include the BoE’s latest lending figures (today), new car registrations numbers (Thursday) and the REC/KPMG Report on UK Jobs (Friday). In the markets, the DMO will sell 5Y Gilts on Wednesday and 8Y inflation-linked Gilts on Thursday.

US:
It will be a busy week for US top-tier releases, with the first half dominated by February sentiment surveys, including the manufacturing ISM and final Markit manufacturing PMI (today) and the non-manufacturing ISM and final Markit services PMI (Wednesday). The flash PMIs showed signs of a notable weakening in conditions in both the manufacturing and non-manufacturing sectors – indeed, the flash composite PMI fell a sizeable 3.7pts in February to 49.6, the first contractionary reading since October 2013, with the new orders PMI reporting the first sub-50 reading since the series began more than a decade ago. The ISM indices, however, are expected to remain consistent with steady expansion. Wednesday will also bring the ADP employment report ahead of Friday’s more closely watched BLS payrolls report. The latter is expected to show another strong increase in non-farm payrolls in February (below the 225k increase seen in January but above the 175k average of 2019), to leave the unemployment rate unchanged at 3.6%. Friday will also see the release of the full trade report for January, as well as consumer credit figures for the same month. Other releases include February vehicle sales numbers (tomorrow), January factory orders and revised productivity figures for Q4 (Thursday). Meanwhile, politics-wise, ‘Super Tuesday’ will determine the results of the Democrat primaries in 14 states and about one third of delegates to the National Convention in July.

Australia:
The coming week will also be an eventful one for Aussie economic news, with the conclusion of the RBA’s latest policy-setting meeting tomorrow and release of Q4 GDP data on Wednesday. RBA Governor Lowe had recently cautioned against the potential side effects of further monetary easing, flagging in particular concerns that additional cuts might exacerbate the current strong upswing in house prices which could cause problems further down the track. And today’s CoreLogic house price figures might have supported this view, reporting the eighth consecutive monthly increase (1.2%M/M) to leave prices up more than 7%Y/Y, with double-digit year-on-year increases in Sydney and Melbourne. But given the significant downside risks to global demand and the likely hit to Australia’s GDP growth associated with the coronavirus, credible reports at the end of the week suggested that the RBA is now prepared to ease policy imminently. As such, with markets now fully pricing in a rate cut this week, we now expect the Cash Rate to be cut by 25bps to a record low 0.50% tomorrow.

Even before the coronavirus outbreak, Q4 GDP data were expected to illustrate subdued economic activity at the end of last year, with growth expected to be no stronger than the 0.4%Q/Q recorded in Q3. While this would see annual growth rise to 2.0%Y/Y, bang in line with the RBA’s forecast and the strongest pace for a year, this would still remain well below the average rate seen since the Global Financial Crisis. Today’s inventories figures did however come in on the upside, suggesting positive contribution of 0.2ppt to quarterly GDP growth. Meanwhile, tomorrow’s net exports data for Q4 will also be closely watched. The back end of the week will also provide insight into economic developments at the start of Q1, with January’s trade report (Thursday) and retail sales figures (Friday) due. 

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