Morning comment: May vote & Japan orders

Chris Scicluna

The UK’s political fiasco has entered a new stage this morning with confirmation that Conservative Party MPs will hold a confidence vote in Theresa May’s leadership from 18.00-20.00 GMT this evening. Not least given the lack of an alternative credible unifying candidate to replace her, it seems highly unlikely that more than half of all Tory MPs (158) will vote against the Prime Minister to force her exit from Downing Street, particularly at such a late and delicate stage in the Brexit process. And with May having come out fighting this morning, and her Cabinet colleagues publicly giving her support, sterling has strengthened about half a cent since the announcement.

However, the ultimate outcome is uncertain. Given the immense challenge of winning any future Brexit-related votes in the House of Commons without the support of her enemies within her own party, May’s authority would be seriously diminished if, say, 100 MPs or more voted against her this evening. So, even if she wins the vote later today, although Conservative Party rules would mean that she could not be challenged from within for a full twelve months, her resignation could yet ensue.

Moreover, even if May wins relatively comfortably this evening, that would not prevent her removal from office via a subsequent vote of no-confidence in Parliament, triggered by the Labour party but perhaps also backed by Tory rebels. And such a parliamentary no-confidence vote might still seem highly likely to follow a defeat in any forthcoming Brexit ‘meaningful vote’ – after all, most importantly, this evening’s vote will not alter the balance of opinion on Brexit within the House of Commons.

The announcement of the Tory leadership vote this morning was not unexpected. And perhaps also given the response of May and her cabinet, it has not done anything to upset what was already set to be a positive market mood. Gilts (and Bunds) have made modest losses, 10Y UST yields are close to 2.89% (about 5bps higher than this time yesterday), while European equities have started the day on the front foot.

That follows a positive day for markets across Asia, seemingly reflecting more upbeat noises around the US-China trade dispute. Among other things, President Trump remarked that he would intervene in the case of Huawei CFO Meng Wanzhou, arrested to face extradition to the US, if that was required to secure a trade deal (Meng has been granted bail by Canadian authorities, also helping to ease tensions) and added that he was prepared to meet China’s President Xi again if that was needed in orders to progress a trade deal. Interestingly, these remarks seemed to impress investors outside mainland China more than those inside. Although the yuan was firmer, the CSI300 posted a modest 0.3% gain today, while gains of 1-2% were seen typically in other major Asian markets. One of the top performers today was Japan, where the TOPIX rebounded 2.0%. While growth in core Japanese machinery orders during October was slightly less than had been expected, the Tertiary Industry Index cast the service sector in a stronger-than-expected light, and improved risk sentiment led to a modest weakening of the yen (currently close to ¥113.5/$).

As far as economic data are concerned, the key focus in Japan today was the machinery orders report for October – of particular interest in light of the record 18.3%M/M decline in core private orders reported in September. Given the positive outlook for capex depicted in various business surveys – and reaffirmed in yesterday’s MoF/Cabinet Office Business Outlook Survey – the market went into today’s report expecting at least some rebound in orders in October. As it turns out, the rebound in core orders fell just a little short of expectations, albeit still sufficient to restore a positive rate of annual growth.

Turning to the detail, total machinery orders recovered a strong 19.5%M/M in October after slumping 17.8%M/M in September, so that annual growth rebounded to a very solid 9.3%Y/Y. However, the closely-watched series of core private orders – which excludes ships and other volatile categories – reported a somewhat less emphatic 7.6%M/M rebound in October. This was still good enough to raise annual growth to 4.5%Y/Y from -7.0%Y/Y previously, however. In the detail, orders by manufacturers rose 12.3%M/M after declining 17.3%M/M in September, but core orders in the non-manufacturing sector rebounded just 4.5%M/M from their prior 17.1%M/M decline. Foreign orders rose 15.5%M/M in October, more than erasing a steep 12.5%M/M in September, and were up 5.2%Y/Y. Public sector orders, which are especially volatile, rose 25.0%M/M and 44.4%Y/Y.

Given the relatively modest rebound seen in October, core orders are still sitting 4.2% below the average level recorded through Q3. This compares unfavourably with the forecast offered by respondents to the Cabinet Office survey of machinery manufacturers, published with the release of the September data, which envisaged a very strong 3.6%Q/Q increase in core private orders in Q4. While that forecast may now be out of reach, we expect further gains in machinery orders over November and December, as necessitated by widespread labour shortages and funded by high levels of corporate profits. As a result, orders through Q4 will likely prove somewhat firmer than suggested by today’s data. 

Turning to the day’s other news, METI released the Tertiary Industry Activity Index for October. The index rebounded a much greater-than-expected 1.9%M/M during the month – more than double market expectations – following a September decline of 1.2%M/M (0.1ppts larger than estimated previously). As a result, annual growth rose to 2.2%Y/Y – a sharp improvement from the 0.7%Y/Y decline reported in September. In the detail, after falling sharply in September – a consequence of disruptions caused by two major typhoons and the Hokkaido earthquake – activity in the wholesale trade sector rebounded 5.0%M/M in October, while activity in the living and amusement sector rose 2.8%M/M. Importantly, today’s outcome leaves the overall index 1.2% above the average level recorded through Q3. So while a modest decline in the index would not surprise next month, as trading patterns return to normal levels, the service sector appears well on track to contribute to a rebound in GDP growth in Q4.

In pricing news, the BoJ released the goods PPI for November. The headline index fell 0.3%M/M – the largest decline since August 2016 – so that annual inflation slowed to 2.3%Y/Y from a slightly upwardly-revised 3.0%Y/Y pace in October. Within the detail, prices in the manufacturing sector fell 0.4%M/M, in large part due to a 4.3%M/M drop in prices for petroleum and coal. Chemicals prices fell 0.8%M/M, adding additional downward impetus. This decline was only partly offset by a 0.6%M/M rebound in prices in the agriculture sector (still down 1.6%Y/Y) and a 0.7%M/M lift in prices in the utility sector (now up 8.1%Y/Y). Given a slightly weaker yen during the month, measured in yen terms, import prices rose a further 0.9%M/M in November and were up 9.5%Y/Y. In contrast to the PPI, prices for energy products were reported to have increased a further 2.5%M/M (up 35.2%Y/Y).

Politics-wise, the UK is obviously not the only dysfunctional country in the EU. And plenty of noise continues to surround Italy’s government budget discussions, which were supposed to reach a conclusion sometime today. League leader and Deputy Prime Minister Salvini, meanwhile, has claimed that reports that he plans to seek a new general election in March represent ‘fake news’.

Elsewhere, ahead of tomorrow’s ECB meeting and EU Summit, today should be relatively quiet for economic news in the euro area with October’s industrial production report most notable on the data front. However, we already know that output fell in Germany, posted solid gains in France and Spain, and remained little changed in Italy. So, aggregate euro area IP was likely broadly flat on the month following a dip of 0.3%M/M previously and thus still suggestive of a stuttering manufacturing sector performance.

Data-wise, there are no top-tier economic releases out of the UK today, but the DMO will sell 30Y index-linked Gilts.

In the US, the CPI report for November is due today with a moderate 0.2%M/M increase in the core measure expected. That would likely nudge the annual core inflation rate back up 0.1ppt to 2.2%Y/Y. With energy prices likely to have declined, meanwhile, headline CPI might come in at zero on a monthly basis, which would likely take the annual headline rate down 0.3ppt, also to 2.2%Y/Y. Among other new data, the November monthly budget statement is also due today, while the Treasury will sell 10Y Notes.

The Westpac consumer confidence survey pointed to little change in consumer sentiment over the past month. The headline index rose just 0.1%M/M to 104.4 in November, thus remaining just a little above its long-term average. The largest contributor to this month’s improvement was substantial pick-up in perception about the 5-year-ahead outlook for the economy. Respondents indicated that that they were a little less optimistic about the economy’s longer-term prospects but, nonetheless, more inclined to buy a major household item.

In other news, ahead of next Monday’s Mid-Year Economic and Fiscal Outlook, the Government reported a final FY18 net operating deficit of AUD8.4bn and an overall cash deficit of AUD13.7bn. These outturns compare with the AUD12.6bn and AUD18.2bn deficits forecast in the Budget, and so confirm earlier indications that next week’s updated forecasts will reveal a slightly improved picture with a clear return to an operating surplus likely in FY19/20.

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