Japan’s manufacturing PMI shows resilience, but service sector clearly weaker

Chris Scicluna

Wall Street steady on Thursday but sentiment sours in Asian trading
Wall Street closed essentially flat yesterday despite news of an unexpected lift in US housing starts to a fresh 14-year high, the best Philly Fed manufacturing survey in 11 months and a welcome decline in initial jobless claims, albeit to a still-elevated 900k. After weakening towards the close, the S&P500 increased only 0.03% to eke out a new record high, but tech shares drove the Nasdaq to a more convincing 0.6% gain. The 10Y UST yield moved up as much as 4bps to a high of 1.12%, but has since settled just below 1.11%. Meanwhile, the greenback moved largely sideways against most counterparts. But it lost a little ground against a stronger euro, with forex markets unconvinced by Lagarde’s insistence yesterday that the ECB continues to monitor exchange rates carefully and is ready to act if necessary. Indeed, Lagarde’s repeated talk of a flexible approach to bond purchases that might well see the ECB’s bond purchases fall short of the full €1.85trn PEPP envelope, and rejection of the suggestion that the Governing Council is targeting bond yields, has seen BTPs open weaker yet again this morning having sold off yesterday afternoon.

Indeed, since New York went home risk sentiment has soured slightly in Asia, perhaps in part due to the latest economic data (see below) and worrying coronavirus headlines. As we write, S&P futures are down around 0.5% but UST yields are little changed. In Japan, a short time ago the TOPIX closed with a modest 0.2% loss as the country’s flash PMI reports pointed to somewhat weaker conditions in January, especially in the services sector. In other Japanese news, a media report suggesting that the Government expects the Tokyo Olympics to be cancelled was denied by the Deputy Chief Cabinet Secretary Sakai.

In China, the CSI300 inched up just 0.1% but the Hang Seng is currently down about 1.5% with the SCMP reporting that two areas in Kowloon would be forced into lockdown this weekend. In Australia, the ASX200 fell a modest 0.3% as retail spending retreated more than expected in December but flash PMI data continued to indicate positive economic momentum in January. Bucking the trend, Kiwi shares jumped 1.7% on strong local earnings reports while the Kiwi 10Y bond yield jumped 5bps due both to the sell-off in the Treasury market and a much stronger than expected local CPI report. Australia’s 10Y bond yield increased by an even larger 6bps, perhaps suggesting that markets now similarly see upside risk to next week’s local CPI report.

Japan’s manufacturing PMI shows resilience in January, but service sector clearly weaker
As had seemed likely, today’s Japanese flash PMIs for January were a mixed bag. On a positive note, the factory sector showed some resilience, with the headline manufacturing PMI declining just 0.3pts to 49.7. Disappointingly, in the detail, the output index declined 1.3pts to 48.7 and the employment index fell 1.5pts to 48.6. However, the new orders index increased an encouraging 0.8pts to 50.6 – the highest reading since December 2018. Moreover, despite the deteriorating coronavirus situation in many key markets, the new export orders index edged up 0.2pts to 48.8. Moreover, the employment index increased 1.0pt to 50.1 – the first expansionary reading since February. The pricing indices were also firmer again this month, with the input price index rising 1.7pts to 53.8 and the output price index rising 0.9pts to 51.1 – the latter the highest reading since May 2019.

Unfortunately, the news from the service sector was decidedly softer – not surprising given the rise in local coronavirus infections over the past month and the (admittedly soft) local restrictions now in place in 11 prefectures (probably only partially captured in today’s figures). The headline services PMI – the business activity index – fell 2.0pts to a 5-month low of 45.7. Similarly, the new orders index fell 2.1pts to an 8-month low of 44.3 and the business expectations index fell 2.1pts to a 5-month low of 52.1. Surprisingly, the employment index was unchanged at 49.9. Meanwhile, in contrast to the manufacturing sector, pricing pressures appear to have eased over the past month, with the input prices index falling 0.8pts to 50.6 and the output prices index falling 0.5pts to a 5-month low of 48.4.

Combining results from both sectors, the composite PMI output index fell a notable 1.8pts to a 4-month low of 46.7, while the composite PMI new orders index fell 1.2pts to a 4-month low of 46.3. With both indices at risk of additional weakness in the February survey – if not before when the final results for January are released early next month – a modest contraction of GDP appears to be in the offing during the current quarter (at present, our colleagues in Tokyo estimate a contraction of around 0.2%Q/Q).

Japan’s CPI offers no major surprises in December; department store sales remain down sharply too
Turning to today’s other Japanese economic data, as signalled by the advance CPI for the Tokyo region, the pace of annual deflation picked up in December, albeit once again driven by weakness in the prices of food and energy. After adjusting for seasonality, the headline CPI index declined 0.1%M/M – albeit a smaller decline than originally seen in the advance Tokyo CPI, which is also now smaller following revisions released today. As a result, given base effects, annual inflation fell to 0.3ppts to -1.2%Y/Y – the lowest reading since April 2010 but a notch firmer than the market’s expectation. Fresh food prices fell a further 4.0%M/M in December, leading to an annual decline of 4.6%Y/Y. As a result, overall food prices 0.7%M/M and 0.8%Y/Y. Meanwhile, energy prices fell a further 0.4%M/M – petroleum, gas and electricity prices all moved lower – extending their annual decline to 8.1%Y/Y (the largest annual decline in energy prices since September 2016).

Given those movements, after adjusting for seasonality, the core index forecast by the BoJ, which excludes only fresh food prices from the CPI, was unchanged in the month, but base effects meant that annual inflation on this measure fell a further 0.1ppts to -1.0%Y/Y (also 0.1ppts firmer than market expectations and the lowest reading since September 2010). The narrower measure of core prices preferred by the BoJ – which excludes both fresh food and energy – was unchanged for a third consecutive month, but annual inflation still fell 0.1ppts to -0.4%Y/Y. This outcome, which was in line with market expectations and the lowest since April 2013, essentially reflects the downward contribution to inflation made by the impact of the Government’s currently-suspended ‘Go To’ travel subsidies. The narrower measure of core prices used in many other countries, which excludes all food and energy, was also unchanged for a third consecutive month, but base effects mean that annual inflation ticked lower to -0.5%Y/Y.

As far as the other key aggregates are concerned, after excluding the impact of lower fresh food prices, goods prices fell 0.3%M/M in December and were down 1.2%Y/Y. Industrial product prices fell 0.5%Y/Y but after excluding the impact of lower energy prices were up 0.7%Y/Y. Services prices eked out a 0.1%M/M increase in the month – the first since July – but were down 0.9%Y/Y due to the earlier reductions in prices in the hospitality sector as a result of government subsidies (hotel charges remained down 33.5%Y/Y).

Looking ahead, annual inflation is likely to remain in negative territory until the second half of this year, at which point the impact of last year’s energy price slump will drop out of the calculations and – depending on government decisions – travel-related prices may begin to normalise. But as we noted following yesterday’s BoJ Outlook Report, the Bank’s forecast of core inflation averaging 0.7%Y/Y in FY22 – well below target – appears too optimistic, with our colleagues in Tokyo forecasting inflation of just 0.4%Y/Y.

Finally, in other news, nationwide department store sales fell 13.7%Y/Y in December, which was similar to the 14.3%Y/Y decline reported in the previous month. The ‘stay-at-home’ economy continued to weigh heavily on sales of clothing, which fell 19.6%Y/Y, while other accessories and cosmetic sales continued to register double-digit annual declines. However, the 6.6%Y/Y decline in spending on household goods was only about half as large as reported in November.

UK retail sales post minimal rebound from November slump while consumer confidence falls back too
Following a sharp drop in November as non-essential stores closed, the rebound in UK retail sales in December upon their reopening for most of the month was disappointingly subdued. In particular, following a drop of 4.1%M/M in November, which was 0.3ppt steeper than previously estimated, total sales rose just 0.3%M/M in December. Reflecting the vigorous growth in prior months, sales were still up 2.9%Y/Y and 2.7% above February’s pre-Covid level. However, that left sales down over Q4 as a whole, falling 0.4%3M/3M. And given the hit from the first wave, full-year sales in 2020 were down 1.9%Y/Y, the steepest such drop on record.

Within the detail, clothing retailers enjoyed rare success in December, with sales growth of 21.5%M/M following the drop of 19.6%M/M the prior month. That, however, left them down almost 16% from February’s level. In contrast, food stores fell 3.4%M/M following growth of 2.8%M/M in November but were still up 3.0% from February. With restrictions on movement persisting for most of the month, fuel sales remained subdued, edging down 0.1%MM to be almost one quarter below the pre-Covid level. Looking ahead, retail sales seem highly likely to have weakened again in January in response to the re-tightening of restrictions on a national basis. And despite decent progress implementing the vaccine programme in the UK, a deterioration in consumer confidence will not help matters either – the headline GfK indicator released overnight dropped 2pts in January to -28, still above levels in October and November but firmly below those registered from July to September.

The flash PMIs are due shortly and are expected to suggest that activity in the services sector fell at the start of year as national lockdown measures were re-imposed, while growth in the manufacturing sector slowed as the boost from stock-building ahead of the end of the Brexit transition period wore off. So, the composite PMI is expected to fall to 45.5 in January, firmly below the key 50 level and the lowest since May

Euro area flash PMIs likely to signal deterioration in activity at the start of 2021
The flow of flash January PMIs resumes shortly with the release of the results for France, Germany and the euro area. Given the intensification of the pandemic, the euro area composite PMI is expected to fall about 1.5pts to 47.6 due to an accelerated decline in activity in services and a slowdown in growth in manufacturing. A similar picture is likely in Germany, but France’s INSEE survey yesterday pointed to a modest improvement in France. Nevertheless, the flash PMIs are expected to indicate that German manufacturers continue to outperform their French counterparts, but also that Germany’s services firms are now more significantly hampered by the pandemic than those in France.

More housing data in the US today; flash January PMIs also due
This week’s US economic data flow ends today with more figures from the housing market and an update on business sentiment. Given three consecutive months of declines in pending home sales, Daiwa America Chief Economist Mike Moran expects existing home sales to report a modest 2%M/M decline in December, still leaving home sales at a very high level. As usual, the preliminary Markit PMIs for January will likely attract only a modicum of interest, but will provide some insight regarding economic momentum ahead of next week’s FOMC meeting.

Australian retail sales pull back sharply in December but flash PMIs remain upbeat
Given a whopping 7.1%M/M lift in retail spending in November – reflecting the first full month of unrestricted trading in the state of Victoria and the influence of Black Friday sales – analysts were anticipating that consumers would be more frugal in December. As it turns out, preliminary estimates released by the ABS pointed to a larger-than-expected 4.2%M/M decline in spending, which nonetheless remained up a very strong 9.4%Y/Y. Moreover, it is worth noting that nominal sales have lifted around 2½%Q/Q in Q4 even if today’s figures are confirmed when the final estimate is released next month, which together with the performance of the labour market points to a further rebound in GDP during the quarter/

According to the ABS, the largest decline in spending was recorded for household goods – these had received an especially strong boost last month from Black Friday discounting – but spending was said to have decreased across all categories aside from cafés, restaurants and takeaway food. Reflecting the dissipation of previously pent-up demand, the largest decline in spending occurred in the state of Victoria (7.0%M/M). However, the ABS also noted a 5%M/M fall in spending in New South Wales, with trading impacted by localised restrictions in parts of Sydney late in the month.

In other Aussie news, today also saw the release of the flash PMI readings for January. While these reports attract less attention than the more established NAB Business Outlook Survey, the news from the PMIs remained encouraging and consistent with the positive trading conditions reported in the last published NAB survey. The composite PMI declined a modest 0.6pts to 56.6 in January – still well above the average recorded since this indicator began in 2016. This owed to developments in the services sector, with the services PMI falling 1.2pts to a still very respectable 55.8. While the new orders index fell back to 54.1, the employment index increased to 51.6 – the highest reading since May 2019 – pointing to a degree of underlying optimism about the future. Meanwhile, conditions improved further in the factory sector in January, with the manufacturing PMI rising 1.5pts to 57.2 – the highest reading since December 2016. In the detail, the output index jumped 3.1pts to 57.2 and new orders index increased 2.1pts to a 3-year high of 57.8. Despite growing coronavirus cases offshore and associated restrictions on activity, the new export orders index increased 1.2pts to 49.2. However, this remains slightly below the long-term average for this series.

Kiwi CPI provides large upside surprise in Q4, but manufacturing PMI disappoints
Both markets and the RBNZ had expected today’s CPI report to point to subdued inflation in Q4, in part reflecting the usual seasonal weakness. However, the headline CPI increased a solid 0.5%Q/Q – 0.3ppts above both market and RBNZ expectations – and so annualising at a rate consistent with Bank’s inflation target. Of course, given the weakness seen at the onset of the pandemic – not least due to the decline in energy prices – the annual inflation rate remained low at a steady 1.4%Y/Y. But given today’s result, annual inflation will likely be return to 2%Y/Y or higher by the middle of this year. This further lowers the prospect of the RBNZ opting to add additional policy stimulus this year, which is now more-or-less accepted by both market pricing and the forecasts of most leading local commentators.

Turning to the detail, tradeables prices rose just 0.2%Q/Q in Q4, in part due to a near 12%Q/Q decline in fruit and vegetable prices from previous high levels. So with past declines in energy prices continuing to weigh, tradeable prices remained down 0.3%Y/Y. More importantly, non-tradeables prices – which better reflects pressures associated with domestic demand – increased a solid 0.7%Q/Q in Q4. This lifted annual inflation for these items to 2.8%Y/Y – 0.4ppts greater than the RBNZ had projected in November. Of particular note was a near 20%Q/Q increase in the price of domestic accommodation services, with prices now almost back to pre-pandemic levels as strong growth in domestic tourism has picked up some of the slack left by the absence of foreign tourists. In addition, buoyant conditions in the housing market contributed to steep increases in prices for furniture (7.2%Q/Q), AV equipment (12%Q/Q) and telecommunications equipment (8.0%Q/Q), while home-building costs increased by the most in two years. Meanwhile, used car prices recorded their largest quarterly increase since 1997 (4.6%Q/Q). As far as the key analytical measures of core inflation are concerned, the 10% trimmed mean increased 0.6%Q/Q, causing the annual trimmed mean inflation rate to increase 0.4ppts to 1.9%Y/Y – almost at the mid-point of the Bank’s inflation target. The RBNZ’s two model-generated measures of core inflation came in at 1.6%Y/Y and 1.8%Y/Y respectively – the former steady and the latter up 0.1ppts to a 1-year high.

In other Kiwi news, the Business NZ manufacturing PMI fell a steep 6.0pts to 48.7 in December – a result that would be very worrying were volatility in this survey not a common feature during the summer holiday period. In the detail, the production index fell 3.5pts to 51.5, while the new orders index fell 6.6pts to a 7-month low of 49.9. Given the worsening coronavirus situation in offshore markets, the weakness in this month’s survey cannot be dismissed entirely, but the strength in the aforementioned Australian manufacturing PMI tends to rule out the possibility of darker forces being at play. The first ANZ Business Outlook survey for this year, released on 4 February, will provide a better indication of how recent offshore developments are impacting the local business sector.

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