Trump backtracks on tariff threats, but Chinese economy already weakening

Emily Nicol

After the US appeared to curb Trump’s earlier tariff threats, delaying the additional 10% tariff on some Chinese products until mid-December to spare the Christmas spending period, US and European equities posted solid gains yesterday, with the S&P 500 posting the largest intraday gain for two months. But while Asian equities started today on the front foot, some softer Chinese IP and retail sales (see details of these and other Japanese, Aussie, German and French data already released below) saw gains in the main Chinese CSI 300 index pared back to leave it just ½% higher on the day. And while the yen fell sharply on the back of the tariff comments (depreciating briefly to ¥107/$), some stronger than expected Japanese data indicating ongoing capex growth helped support the Topix to leave it 0.9% higher on the day.

While Japanese government bonds weakened – with 10Y yields rising 2bps to -0.23% – and Aussie bonds were also lower, other major bond markets made further gains. In particular, with data this morning confirming that Germany’s economy contracted in Q2, 10Y Bund yields were down a further 1bp to -0.63%, a new record low. And while Italian lawmakers last night called for Prime Minister Conte to appear before the Senate on 20 August (although not yet confirming that a no-confidence vote would be held that day), yields on Italian 10Y BTPs were also 1bp lower to 1.6%. Looking ahead, today will bring updates on euro area GDP, IP and employment, as well as UK inflation.

After last week’s Japanese GDP estimate suggested that fixed investment rose for the third consecutive quarter in Q2, the overnight release of June’s machine orders offered cautious optimism that investment will remain on an upward trend over coming months too. Indeed, core orders – which offer a guide to capex growth three months ahead – surprised significantly on the upside in June, with the 13.9%M/M increase the largest since the start of 2003 and more than offsetting the near-8%M/M decline in May. As such, this left orders 12½% higher than a year earlier and at their highest level for eleven years.

Within the detail, the improvement reflected a more-than 30%M/M increase in orders placed by non-manufacturers, the fastest monthly growth since 1996! But this principally reflected large-scale (and likely one-off) orders in the electricity supply (+68%M/M) and transportation (91%M/M) sub-sectors. In contrast, orders placed by manufacturers fell for the third month out of the past four, with weakness across the key-export oriented sectors. Nevertheless, given the strength in April, this still left manufacturing orders up 2½%Q/Q in Q2, the first rise in four quarters. And with non-manufacturing orders up a whopping 13%Q/Q, total private sector core orders were 7½% higher over the quarter as a whole, the strongest such increase for six years. But while public sector orders also posted a solid increase in Q2 (40%Q/Q), orders from overseas were predictably weaker last quarter (-15%Q/Q) – a trend that might be expected to continue over coming quarters given the more challenging global environment.

Euro area:
We have already seen a key economic release from the euro area, with the first estimate of German GDP in Q2 confirming that the economy slowed markedly last quarter. In particular, GDP declined 0.1%Q/Q, in line with expectations, following growth of 0.4%Q/Q in Q1, to mark the second contraction in the past four quarters. This left GDP up just 0.4% compared with a year earlier, the weakest annual rate for six years. The detailed expenditure breakdown has yet to be released. But the German statistical agency reported that growth came from domestic demand, with private and government consumption higher in Q2. Meanwhile, fixed investment in equipment and machinery rose to more than offset a decline in construction. But while both exports and imports fell, a steeper drop in exports left net trade subtracting from growth for the first quarter in three.

So, the second estimate of euro area Q2 GDP, due later this morning, seems bound to confirm the initial estimate of growth of 0.2%Q/Q, half the pace seen in Q1, to leave output 1.1% higher compared with a year earlier, the softest annual rate for 5½ years. Notwithstanding still positive GDP growth, June industrial production data are likely to confirm a notable drop that month and over the second quarter as a whole. So, against the backdrop of softer growth, euro area employment data for Q2, also due this morning, might well show a moderation in job growth from 0.3%Q/Q, 1.3%Y/Y in Q1.

Finally, after yesterday’s final figures of July inflation in Germany aligned with the flash estimate (with the EU-harmonised CPI rate down 0.4ppt to 1.1%Y/Y), the equivalent French CPI data were also unrevised, with the EU measure down 0.1ppt from June to 1.3%Y/Y. As such, given downward revisions to the Italian and Spanish figures, we now expect the final euro area CPI data, due on Monday, to report a downwards revision in the headline CPI rate of 0.1ppt to 1.0%Y/Y, but confirm the flash core rate of 0.9%Y/Y.

Focus in the UK today will be on July’s inflation release, which is expected to show both the headline and core CPI rates moving sideways at 2.0%Y/Y and 1.8%Y/Y respectively. But producer price figures are likely to flag the disinflationary pressures down the pipeline, not least associated with falling energy prices. This morning will also bring the official ONS house price index for June, which is expected to show that year-on-year growth declined to just 1.0%Y/Y, which would be the softest annual rate since 2012.

After data last month suggested improved momentum in China’s economy at the end of Q2, today’s monthly activity and spending figures provided a stock-take on conditions at the start of Q3. And these were particularly disappointing, emphasising the negative impact of the ongoing US-China trade war on the manufacturing sector. Indeed, industrial production growth slowed sharply in July, by 1.5ppts to 4.8%Y/Y, the weakest rate since early-2002, with manufacturing growth 1.7ppts lower at 4.5%Y/Y. Of course, this no doubt to some extent reflects the direct impact of higher US tariffs that month when the 25% rate on $250bn of Chinese goods came into full effect. And there are also signs that multinationals are starting to relocate their production lines, which will weigh on production over the longer term. Fixed investment figures were also softer in July, with the year-to-date increase easing slightly to 5.7%YTD/Y, with weakness dominated by the private sector and services in particular. But after some softer lending data this week, today’s retail sales figures for July suggested that domestic demand remained subdued at the start of Q3 too, with growth moderating to 7.6%Y/Y from 9.8%Y/Y in June.

Ahead of tomorrow’s jobs report for July, the main focus in Australia today was on the Wage Price Index for Q2, with both data sets important in light of the RBA’s Board emphasis on developments in the labour market as central in determining future policy moves. Today’s figures, however, provided no major surprises. The headline index – which excludes bonuses – rose 0.6%Q/Q, a touch stronger than consensus but in line with the RBA’s updated forecast, leaving annual growth unchanged at the 2.3%Y/Y rate recorded in three of the past four quarters. There was a pickup in public sector wages in Q2, rising 0.8%Q/Q, boosted in part by an increase in the health care sector as Victoria began to ensure wage parity with other states. As such annual growth in public sector wages rose 0.2ppt to 2.6%Y/Y. In contrast, annual growth in private sector wages edged slightly lower to 2.3%Y/Y. Once bonus payments are included, annual wage growth eased 0.1ppt to 2.5%Y/Y, the softest pace for a year, with the private sector figure down 0.3ppt to 2.4%Y/Y. Of course, all these rates remain stubbornly below the rates of 3-4%Y/Y required for the RBA to meet its inflation target.

In the US, it should be a quiet day for economic releases with just import and export price indices for July due.

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