China's demand shock persists

Chris Scicluna
Emily Nicol

Overview:
After yesterday’s rebound on Wall Street (the S&P500 closed up 1.15% with banks up more than 4%), today brought a mixture of modest gains and losses in Asian bourses, which nevertheless left all in negative territory for the week.

China’s main stock market indices were little troubled either way by the country’s latest activity data – which highlighted that the demand-side hit from Covid-19 is proving far harder to shake off than the supply-side impact. Meanwhile, ahead of Monday’s Japanese GDP data (Daiwa Securities' forecast is for a drop of 5.4%Q/Q annualised), the Topix closed up 0.5% (to be down just 0.3% over the week) supported by yesterday’s lifting of the state of emergency in 39 out of 47 prefectures and further signals that even more fiscal stimulus is on its way. Perhaps with an eye on that next supplementary budget, the JGB curve steepened (30Y yields up about 2.5bps), even though Japan’s producer price figures came in well below expectations to illustrate the new deflationary impulse from the crisis (see more on the day's data below).

Moving westwards, European bourses have largely opened up more than 1% after yesterday’s steep losses and S&P futures are higher too ahead of today’s US retail sales and IP data, which are nevertheless bound to confirm extremely steep declines in activity last month. In bond markets, however, USTs and euro area government bonds are little changed ahead of the German GDP data due on the hour.

China:
China’s latest activity data highlighted how the supply-side shock from Covid-19 has been dwarfed by what risks becoming a lasting hit to demand. With the large-scale easing of pandemic-related restrictions by the authorities, industrial production rose a firmer than expected 3.9%Y/Y in April. That rate, however, was still something of a damp squib following the decline of 1.1%Y/Y the previous month and a plunge of 13.5%Y/Y over January and February.

Weak demand certainly appears to have played a role in restraining IP last month. According to the government’s PMI survey, export orders fell sharply last month, with the respective index down to 33.5, suggesting that external demand is shrinking at a similar pace to the Global Financial Crisis as the lockdowns in the US and Europe bite. And today’s other main data releases highlighted a persisting and substantive shock to Chinese domestic demand.

In particular, retail sales missed expectations once again, falling a steep 7.5%Y/Y in nominal terms after the drops of 15.8%Y/Y in March and more than 20%Y/Y in January and February. Given the inevitable hit to employment not least from the drying up of demand for labour-intensive face-to-face services (for what it’s worth, the surveyed unemployment rate edged back up to 6.0%), it is difficult to believe that household consumption will rebound with vigour anytime soon – an illustration of what to expect from the other major economies as they emerge from lockdown.

Meanwhile, urban fixed asset investment was down 10.3%YTD/Y, while property investment was down 3.3%YTD/Y. With the PBOC now putting to one side its concerns about leverage and allowing an acceleration in new credit last month, these components of demand might be expected to rebound more substantively in coming months. But that will only refuel the structural headwinds – including excess debt, surplus capacity and low productivity – that China was already facing ahead of the outbreak of Covid-19. And so China’s deflationary impact on the rest of the world is only likely to grow.

Japan:
After the Tokyo CPI figures for April showed the BoJ’s forecast measure of core inflation slipping back into negative territory for the first time for three years, today’s goods PPI data flagged further significant disinflationary price pressures down the pipeline. In particular, producer prices fell for the third consecutive month and by a much larger-than-expected 1½%M/M in April, the most since the start of 2009. This left the annual rate down 1.9ppts at -2.3%Y/Y. When excluding the effects of the tax hike, the rate stood at -3.7%Y/Y, the lowest since mid-2016. Within the detail, the weakness principally reflected a sharp drop in petroleum and coal product prices (-19.6%M/M) in April, to leave them more than 30% lower than a year earlier. And so, the cost of raw materials fell more than 20%Y/Y. Intermediate goods prices were down more than 5%Y/Y too – largely due to lower imported prices.

But most significantly for the near-term CPI profile, final consumer goods PPI fell sharply in April, with the drop of 4.1%Y/Y the largest for 3½ years and reflecting weaker price pressures both domestically and overseas. So, we expect to see the national measure of consumer inflation fall sharply in April – reflecting not least lower energy prices, a steeper decline in school fees and weaker mobile phone charges – with some measures possibly falling into negative territory. And against the backdrop of significantly softer demand, we expect inflation to trend lower still over coming quarters too and remain in negative territory throughout the remainder of the year.

Euro area:
The main focus today will be the release of updated Q1 GDP figures, which will include the first estimate from Germany. We expect German GDP to have contracted by as much as 2%Q/Q, the steepest pace of decline since the global financial crisis, albeit by some margin the softest in Q1 of the large member states. Indeed, on aggregate, euro area figures are expected to confirm the record contraction of 3.8%Q/Q in Q1, leaving output down more than 3% compared with a year earlier. This morning will also bring euro area employment figures for Q1, although the impact of job losses seen since the escalation of the coronavirus crisis will not be evident until Q2 data are published. Euro area trade numbers and Italian industrial orders data for March are also due for publication.

In terms of inflation, the final release of French CPI figures for April released earlier this morning brought a slight downwards revision, with the EU-harmonised measure of headline inflation now assessed to have declined 0.4ppt on the month to 0.4%Y/Y (to two decimal places the downwards revision was 0.14ppt). This comes on the back of weaker than initially estimated outturn in Spain too (down to -0.7%Y/Y). So while yesterday’s final reading of German inflation was unchanged at 0.8%Y/Y, there seems to be a significant probability that final figures for the euro area as a whole (due for release next Wednesday) will be revised lower by 0.1ppt to just 0.3%Y/Y. Negative inflation is just around the corner in the euro area too.

US:
It will be a busy day in the US too, with retail sales and industrial production data for April set to show a sharp pace of decline in activity last month as the country remained in lockdown. Daiwa America’s Mike Moran forecasts a drop of 9%M/M in retail sales and 10%M/M in industrial production. Today will also bring the University of Michigan’s consumer sentiment and Empire Manufacturing surveys for May, which will undoubtedly suggest that conditions remain extremely unfavourable, but perhaps no more so than in April.

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