Firm Japanese capex survey, ahead of ECB & RBA decisions

Chris Scicluna
Emily Nicol

After a particularly weak end to the week in European and US stocks (on Friday the S&P500 closed down 1.3%, slightly more than the drop on the Euro Stoxx) and with government bonds still very well supported (yields on 10Y USTs fell to 2.13% the lowest since September 2017 and 10Y Bunds fell through -0.20% to a new record low), the major Asia-Pacific markets have on the whole maintained a negative tone not least as geopolitical uncertainty remained to the fore.

While today’s Japanese surveys reduced the likelihood of a downward revision to the surprisingly strong GDP growth initially reported in Q1 (see more below), the final manufacturing PMI remained weak in the middle of Q2 and so the Topix fell a further 0.9% today, leaving it down 7% over the past month and at its weakest level since the start of the year, while the yen strengthened to its highest rate for more than 5½ months. But while China retaliated to the recent rise in US tariffs on Chinese goods and the Caixin manufacturing PMI surprisingly suggested no further deterioration in the sector last month, Chinese equities ended the day little changed. Ahead of tomorrow’s RBA meeting (where a 25bp rate cut is widely anticipated), equities fell sharply in Australia (ASX 200 down 1.2%) as the latest housing market data remained weak, while the forthcoming Q1 GDP report (due Wednesday) was likely to show the weakest annual growth since Q309.

The downbeat tone appears to have continued at the open in Europe, as the weekend saw a potential rise in political uncertainty in Germany as the leader of the CDUs coalition partner stepped down in light of the SPD party’s poor performance in the European Parliament elections. It will be a busy week ahead in the euro area, with most notably the ECB’s latest policy announcement on Thursday to be watched closely for the pricing details of the forthcoming TLTRO-IIIs operations (see more below). The flash euro area inflation release (due tomorrow) will be weak, with headline CPI likely to fall to 1.2%Y/Y, the lowest since February 2018. The final manufacturing PMIs are due today from the euro area, UK and US. Tomorrow will see Fed Chair Powell speak at the start of a two-day Fed conference, while focus at the end of the week will be on the US payroll figures.

While last week’s activity and spending figures signalled a subdued start to the second quarter – adding to the downbeat tone of recent sentiment surveys including today’s final manufacturing PMI (see below) – the MoF’s survey of corporations for Q1 published overnight suggested that we might well see a modest upwards revision to the second reading of Q1 GDP (due a week today) from the surprisingly strong growth of 0.5%Q/Q initially estimated. Of particular note, firms indicated that their capex (excluding software) rose for the second successive quarter in Q1 and by 1.1%Q/Q, underpinned by a near-3%Q/Q increase in capital spending by non-manufacturers. In contrast, manufacturers reported a decline of 1.7%Q/Q, albeit following growth of almost 9%Q/Q previously. So, compared with a year earlier, total investment rose a stronger-than-expected 6.9%Y/Y. Meanwhile, despite a modest decline in sales in Q1 – the 0.3%Q/Q drop was the first quarterly decline in six – profits were up more than 13%Q/Q, reversing some of the weakness seen in the previous two quarters. Indeed, compared with a year earlier, profits were up more than 10%Y/Y, with profits in the non-manufacturing sector up 18½%Y/Y, the strongest annual growth since Q316.

Today’s release contrasted with a decline of 1.0%Q/Q in nominal non-residential investment reported in the preliminary GDP report. And real private non-residential investment also fell in the initial GDP estimate, by 0.3%Q/Q. So, we might well see a modest upwards revision to the national accounts measure of capex growth in Q1. This notwithstanding, given the survey’s implied adjustments to inventories, on balance, we expect no revision to overall GDP growth of 0.5%Q/Q in Q1.

But the outlook for Q2 remains less upbeat, particularly if today’s final manufacturing survey is anything to go by. Despite a modest upwards revision from the flash release, today’s survey showed that the headline index fell 0.4pt in May to 49.6, the third sub-50 reading in the past four months. And the output PMI (48.7) recorded the fifth consecutive sub-50 reading and indicated a steeper pace of growth than in April. Today’s survey also saw a notable downwards revision to the employment component, to leave it down 1.9pts in May at 50.9, the lowest since November 2016. On a brighter note, the output price PMI was revised notably higher (0.8pt) from the flash release, to leave the index at 51.7, broadly in line with the average so far this year.

While the equivalent services and composite PMIs will be published on Wednesday, the main focus this week will be on Friday’s household spending – including the BoJ’s consumption activity and MIC’s family income and expenditure survey – and labour earnings figures for April. Friday will also bring the Cabinet Office’s preliminary April composite business conditions indicators. Supply-wise, a 10Y JGB auction is scheduled tomorrow.

Euro area:
The main event in the euro area this week will be the conclusion of the ECB policy meeting on Thursday, which will be watched closely for the updated staff economic forecasts and additional details for the pricing of the forthcoming TLTRO-III liquidity operations, due to start in September. While we might well see a modest upward tweak made to its full-year growth forecast of 1.1% in 2019 – due principally to stronger than expected GDP growth in Q1 – the underlying economic momentum isn’t necessarily materially stronger than it was three months ago. So the ECB’s (overoptimistic) projections for 2020 and 2021 (1.6% and 1.5% respectively) seem unlikely to be amended, and the Governing Council will likely judge that the risks to the outlook are still skewed to the downside. The inflation outlook seems unlikely to be substantially different from March’s assessment too, with headline and core CPI forecast to increase 1.2%Y/Y in 2019, rising to just 1.6%Y/Y in 2021. And so, the ECB will unlikely feel the need to change its forward guidance at this meeting, with our expectation that it will merely reiterate that interest rates are still expected to remain unchanged “at least through the end of 2019”.

Of course, among other factors, the ECB’s economic assessment will help determine the pricing of its TLTRO-III operations, which were announced primarily to prevent a tightening of financial conditions that would have occurred as the remaining loans issued under the previous TLTRO-II programme matured. With the inflation outlook underwhelming, we see a strong case for the ECB to announce generous pricing on its forthcoming TLTRO-III loans, no less favourable than those attached to the TLTROs-II. Under that programme, the interest rate applied to the amount borrowed was initially linked to the refi rate prevailing at the time of take-up, but could fall to as low as the deposit rate (-0.40%) for banks whose net new lending exceeded a benchmark. And with the maturity of the new TLTRO-III loans to be just two years, only half that offered under the previous framework, it would seem unhelpful to have other conditions also significantly less generous this time, not least as any adverse market reaction could further negate the intended extra policy accommodation provided.

Data-wise, it will be a busy one for top-tier releases too, with the euro area’s flash estimate of May inflation due tomorrow the likely highlight. Last week’s national inflation releases came in much weaker than expected, with, for example, the German EU-harmonised rate falling 0.8ppt to 1.3%Y/Y, a thirteen-month low and the French EU-harmonised rate declining 0.4ppt to 1.1%Y/Y, a twenty-month low. As such, we expect a large step down in the aggregate euro area figure in May, with headline CPI likely to fall by 0.5ppt to 1.2%Y/Y, which would be the lowest since February 2018, and the core rate falling by 0.4ppt to 0.9%Y/Y, with risks to the headline forecast skewed to the downside.

Tomorrow will also bring April’s labour market report, followed on Wednesday by retail sales figures for the same month and on Thursday by the final Q1 GDP reading. While GDP growth is expected to align with previous estimates at 0.4%Q/Q, this release will bring the first official expenditure breakdown in Q1, which is expected to show that the acceleration at the start of the year was driven principally by domestic demand with a more modest positive contribution from net trade. Like in Germany, euro area retail sales are likely to have declined at the start of the second quarter, while the unemployment is expected to remain at the 10½-year low of 7.7%.

The first half of the week will also bring the final PMI surveys for May for the euro area and member states, with a possible upwards revision to today’s manufacturing index from the flash reading which showed the headline index declining 0.2pt to 47.7. With respect to national releases, the focus will be on April’s industrial production figures from Germany and France (Friday) and Spain (Wednesday). Friday will also bring German and French trade reports for the same month, as well as German labour costs figures for Q1. In the markets, Germany is due to sell 10Y index-linked bonds tomorrow, while France will sell bonds with various maturities on Thursday.

Focus in the UK this week will no doubt remain on politics as Theresa May enters her final week as UK Prime Minister. But the start of the week will also bring a number of releases, with the manufacturing, construction and services PMIs due today, tomorrow and Wednesday respectively. In April, the headline manufacturing PMI fell by 2pts as the stock building seen ahead of the end-March Brexit deadline eased. And we expect this trend to have continued in May, with the survey’s output and new orders indices likely to have remained weak too. The equivalent services survey is expected to signal ongoing weakness in the sector too. So, the composite PMI is likely to have edged lower from its April reading of 50.9, consistent with slowing economic momentum in the second quarter. This week will also provide an update on consumer spending this month, with the BRC retail sales monitor due tomorrow and new car registration figures due Wednesday. Elsewhere, BoE Governor Carney is scheduled to speak in Tokyo on Thursday, while MPC member Ramsden will speak in London on Wednesday. In the markets, the DMO will sell 5Y Gilts tomorrow.

A busy week in the US kicks off today with the ISM and PMI manufacturing reports for May, along with vehicle sales numbers for the same month and construction spending figures for April. These will be followed tomorrow by April’s factory orders data. On Wednesday, focus turns to the service sector with the release of the non-manufacturing ISM and PMI for May. In addition, the ADP employment report will cast light on developments in private payrolls over the past month. Of course, of more interest will be Friday’s official employment report, with non-farm payrolls expected to increase by less than 200k following the 263k surge in April. So the unemployment rate is expected to remain unchanged at 3.6%, while wage growth moved sideways at 3.2%Y/Y. Friday will also see the release of April’s consumer credit report, while Thursday will bring April’s full trade report. There are plenty of Fed speakers in action this week too, including Fed Chair Powell tomorrow at the start of a two-day Fed conference discussing the central bank’s policy framework. In the markets, there are no UST bond auctions scheduled.

It will be a busy week in Australia too, with the RBA’s policy announcement tomorrow the highlight. With the RBA’s latest forward guidance having suggested that a tighter labour market is required to return inflation to target, and the most recent labour market report having fallen short of expectations, while this week’s GDP report is likely to further emphasise the weakness in the first quarter of the year, the RBA is widely expected to cut the cash rate target by 25bps to 1.25%.

Admittedly, today’s ABS quarterly Business Indicators report was a touch firmer. For example, inventories rose a stronger-than-expected 0.7%Q/Q in Q1, while nominal company operating profits rose 1.7%Q/Q following upwardly revised growth of 2.8%Q/Q in Q4. So, when the GDP report is due on Wednesday, growth is expected to have accelerated to 0.4%Q/Q in Q1, from growth of 0.2%Q/Q previously. Nevertheless, this would still leave output up just 1.8%Y/Y, the softest annual pace since Q309. But the latest housing market figures were again weak in April. And tomorrow’s release of April’s retail sales figures, followed by April’s trade report on Thursday are likely to indicate subdued economic momentum at the start of Q2.

Following last week’s disappointing Chinese government PMIs – which showed the headline manufacturing index back in contractionary territory for the fourth month out of the past six – today’s private sector Caixin manufacturing survey was similarly downbeat about current conditions in the sector. Admittedly, the headline index was unchanged in May although at 50.2, it barely consistent with expansion. And the detail showed the output index declining for the second successive month by 0.6pt to 50.1, a four-month low. Moreover, the pickup in the survey’s new export orders component – up 1.3pts on the month to 50.4 – seems at odds with the more negative tone surrounding the US-China trade war.


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