A pivotal week for Brexit?

Chris Scicluna
Emily Nicol

With the S&P500 having closed little changed on Friday ahead of the Labour Day holiday and a busy week of domestic economic data, the US had provided little direction to Asian stock markets, which have offered a mix of gains and losses today. China’s indices were among the best performers – the CSI300 closed up 1.3% – as investors shrugged off an underwhelming set of PMIs as well as the new 15% tariffs on roughly $110bn of US imports from China which took effect yesterday. At the other end of the spectrum, Japanese stocks were in the red (the Topix closed down 0.4%) as the yen remained elevated while data confirmed a weaker second quarter for the country’s corporate sector and hinted at a downwards revision to Q2 GDP (detail on these figures and the Chinese PMIs below). JGBs, meanwhile, were a touch softer, with 10Y yields up about 1bp to -0.275%.

Elsewhere, euro area govvie bonds are also slightly weaker this morning, after yesterday’s German two regional elections saw the ‘establishment’ federal government coalition parties – Merkel’s CDU and the centre-left SPD – successfully fend off challenges from the nationalist AfD in Saxony and Brandenburg respectively. Gilts and sterling are little changed ahead of what will be a pivotal week for the UK’s political crisis, as MPs will try to pass legislation to compel PM Johnson to request an Article 50 extension if the only alternative is a no-deal Brexit. While a senior cabinet minister yesterday suggested that the government might simply ignore the law – further eroding the UK’s hard-won reputation for institutional quality – and Johnson has threatened to ban rebel MPs from standing as Conservatives at the next election, the parliamentary arithmetic suggests that the anti-no-deal legislation will progress through the House of Commons. So, while he might try to impede the legislation in the House of Lords, Johnson could be tempted to call a vote on whether to trigger an early general election.

Finally, among other politically dysfunctional economies, on the weekend Argentina imposed currency controls, having last week looked to defer payments on its government debt. The IMF has said that, for the time being, it will “continue to stand with Argentina during these challenging times”.

The MoF’s latest survey of financial statements of corporations – which will feed into the second release of GDP a week today – today flagged the possibility of a downwards revision to the initial 0.4%Q/Q estimate of growth while also suggesting that firms found things harder going last quarter. Among other things, the MoF’s survey suggested that nominal capital spending rose for the third consecutive quarter in Q2 and by a seemingly solid 1.5%Q/Q, underpinned by notable investment in software in the non-manufacturing sector. That left capex up 1.9%Y/Y, nevertheless the softest annual rate for two years. And when excluding software, capital spending fell 1.6%Q/Q and 1.7%Y/Y – the first annual drop since Q316 and the steepest since Q113 – with investment in the manufacturing sector down for the second successive quarter and by 4½%Q/Q, while capital spending in the non-manufacturing sector rose 0.1%Q/Q. (Including software, investment in the non-manufacturing sector rose 4.7%Q.Q).

The preliminary GDP report had seen nominal non-residential investment rise 1.4%Q/Q in Q2, while real private non-residential investment also rose by 1.5%Q/Q. So, when revised national accounts figures are published next Monday, we might well see limited revisions to capex growth in Q2. This notwithstanding, given the survey’s implied adjustments to inventories, on balance we might well see a downwards revision to GDP growth by 0.1ppt to 0.3%Q/Q.

Other details in the survey suggested that the prospects for investment over the near term are weaker. For example, sales were down for the second successive quarter in Q2 (-0.1%Q/Q), to leave them up just 0.4%Y/Y, the softest annual pace for almost three years. And this principally reflected declining sales at large firms (down 2.1%Y/Y), while sales at manufacturers also fell (-1.2%Y/Y) compared to a year ago for the first time since 2016. So, it was perhaps not surprising to see that profits were weaker in Q2 too, with the 5.0%Q/Q decline leaving them down a hefty 12.0%Y/Y, the steepest drop since the post-quake slump eight years ago, with profits at manufacturers declining a whopping 27.9%Y/Y and significant double-digit declines across the key export-orient sectors (ICT equipment -85%Y/Y; electrical and general machinery -33%Y/Y; transport equipment -12%Y/Y).

The ongoing challenges facing Japanese manufacturers were further illustrated by today’s final manufacturing PMIs for August. In particular, the headline index was revised down from the flash estimate by 0.2pt to 49.3, to leave it 0.1pt lower than July and below the key-50 level for the sixth month out of the past seven. While the output component was upwardly revised by 0.6pt to 48.9, a four-month high, this still signalled contraction in the sector for the eighth consecutive month. Moreover, the new orders PMI implied little improvement ahead, with the index revised notably lower from the initial release, to 47.6, a six-month low, with firms reporting China as a particular source of weakness.

Final services and composite PMIs for August are due on Wednesday. The preliminary release showed a marked improvement in the headline services index, up 1.6pts to 53.4, matching the more than two-year high reached in October 2017. But it is worth noting that the flash services PMI was revised significantly lower in the final release in July. So, despite the upwards revision to the manufacturing output PMI, the headline composite index might well be nudged lower from the initial estimate, which reported an increase of 1.1pts to 51.7, an eight-month high. The end of the week will bring an update on private consumption at the start of Q3, with the MIC’s household spending survey and the BoJ’s consumption activity index for July. Average labour earnings for the same month are likely to show that total wage growth eased to just 0.1%Y/Y.

Meanwhile, with questions having mounted about its yield curve control policy – not least with the 10Y yield well below the target range – BoJ Governor Kuroda’s speech at a conference in Tokyo tomorrow will no doubt be closely watched, while Policy Board member Kataoka – who has repeatedly expressed the need to strengthen the current monetary policy framework – will speak with business leaders in Hakodate. In the markets, the MoF will sell 10Y JGBs tomorrow and 30Y JGBs on Thursday.

This week will likely be a pivotal one for Brexit. Tomorrow, MPs are set to vote on a proposal to provide parliamentary time to prepare legislation compelling the Prime Minister to request an extension to the Article 50 deadline beyond end-October if the alternative would be a no-deal Brexit. If there are sufficient Conservative party rebels – despite being threatened by expulsion from the party over the weekend – to allow the proposal to pass, one question over the remainder of the week will be whether MPs have sufficient time to pass a bill ahead of Johnson’s forced extended shutdown of Parliament next week. It is possible that one House or the other will sit through the weekend, but even then anti-no-deal MPs could run out of time. It is also possible that a vote of no confidence in the government will be called. If the government was to lose such a confidence vote, MPs from a range of parties might have to hold their noses and unite around a coalition led by Labour leader Jeremy Corbyn to avoid the alternative of a general election which Johnson might otherwise choose to hold after the Article 50 deadline.

Aside from the politics, this week’s data calendar will be dominated by August sentiment surveys, with particular focus on the PMIs in the first half of the week. While market expectations are for a modest improvement in the manufacturing survey (due today), the headline index (48.0 in July) seems highly likely to signal ongoing marked contraction in the sector in August for the fourth consecutive month. Likewise, the construction PMI (due tomorrow) is likely to remain little changed from July (45.3) to remain firmly in contractionary territory. The services PMI (due Wednesday) might well reverse some of the 1.2pts increase in July (to 51.4) to signal very subdued growth in the sector in August. As such, the composite PMI might well slip back from the 50.7 reading in July, with a chance the all-sector PMI will fall below the key-50 level.

Elsewhere, BoE policy makers, including Carney, Haldane, Haskel and Vlieghe, will appear before the Treasury Select Committee on Wednesday to testify on the Bank’s most recent Inflation Report and the UK’s economic relationship with the EU. In the markets, the DMO will sell 10Y Gilts tomorrow and 5Y Gilts on Thursday.

Euro area:
There are also a number of noteworthy data releases this week, including on Friday the euro area’s updated national accounts for Q2. While we expect GDP growth to align with the previous estimate of 0.2%Q/Q, this release will provide the first official expenditure breakdown, in which the weakness of exports will be striking. Friday will also see revised euro area employment data for Q2, which are similarly expected to confirm that growth moderated 0.2ppt to 0.2%Q/Q, with the accompanying country breakdown likely to show softer growth across the member states.

More up-to-date information about the extent of economic growth in Q3 will come on Wednesday from euro area retail sales figures for July, which are likely to indicate a soft start to the third quarter after a surge at the end of Q2. The first half of the week will also bring the final August manufacturing (today) and services PMIs (Wednesday). While the preliminary release showed a modest improvement in the headline euro area manufacturing and services PMIs, the former still recorded its second-lowest reading for more than six years. And while the flash composite PMI rose 0.3pt in August to 51.8, this was merely in line with the average in Q2, and therefore consistent with still-subdued GDP growth.

At the country level, Germany’s manufacturing sector will be the main focus, with factory orders and IP data for July due for release on Thursday and Friday respectively. Friday will also bring German labour costs figures for Q2, as well as French trade numbers for July.

After the weekend’s German regional elections passed without a major upset for the establishment parties, politics will remain in the spotlight in the euro area this week, with Italy’s Prime Minister-designate Giuseppe Conte set to compile his list of Cabinet members, with the identities of the key ministers likely to be named on Wednesday before a parliamentary debate, which could be held from Friday. Elsewhere, ECB chief economist Philip Lane will speak in London on Wednesday and Vice-President Luis de Guindos will speak in Frankfurt on Thursday. In the markets, Germany will sell 5Y BOBLs tomorrow, while France and Spain will sell bonds with various maturities on Thursday.

In the US, when markets re-open tomorrow, a busy week for top-tier releases kicks off with the manufacturing ISM and final Markit PMI for August, and construction spending figures for July. Wednesday’s highlights will be July’s full trade report and vehicle sales figures for August. Meanwhile, Thursday will bring the non-manufacturing ISM and final Markit services PMI for August, factory orders data for July, revised productivity and labour costs figures for Q2 and the ADP employment survey for August. Of course, of more significance with respect to the labour market will be Friday’s employment report, with non-farm payrolls in August expected to have risen at a similar pace to the 164k increase recorded in July. As such, the unemployment rate is expected to remain unchanged at 3.7%, while average hourly earnings growth is expected to have moderated slightly.

A busy week in Australia will bring the latest RBA monetary policy decision (tomorrow) along with the first estimate of Q2 GDP (Wednesday). Having cut the target cash rate by 25bps at two consecutive meetings over the summer to a record low 1.00%, the Policy Board is widely expected to keep rates on hold tomorrow. But given that risks to the near-term outlook remain skewed to the downside and inflation looks set to fall short of the RBA’s target range for the foreseeable future all eyes will be on the post-meeting statement for further clues into the near-term policy outlook.

Q2 GDP looks set to have fallen well short of the RBA’s expectation, with its most recent forecast implying quarterly growth of 0.8%Q/Q. Certainly, today’s ABS business indicators showed a much steeper pace of decline in inventories in Q2 – with the 0.9%Q/Q fall the largest for more than five years and more than fully reversed the 0.8%Q/Q increase seen in Q1 when inventories added 0.3ppt to GDP growth. Tomorrow’s balance of payments data for Q2 will also provide more insight, while retail sales figures for July are also due that day. As things currently stand, expectations are for GDP growth to have ticked slightly higher from Q1 to 0.5%Q/Q, but this would leave output up just 1.4%Y/Y, which would be the softest annual rate for almost a decade.

As new tariffs from both China and the US came into effect over the weekend, the government’s official manufacturing PMIs continued to highlight ongoing weakness in August. In particular, the headline PMI fell 0.2pt to 49.5, the fourth consecutive sub-50 reading. Today’s private sector Caixin manufacturing PMI offered a somewhat (and surprisingly) more positive assessment of manufacturing conditions, with the headline index rising 0.5pt to 50.4 and the output component rising 0.9pt to 51.0, both five-month highs. But both surveys indicated further declines in new orders, with a steeper pace of contraction in new export orders in particular, suggesting little prospects of a marked improvement in output over coming months. In contrast, the government’s official non-manufacturing PMI continued to imply broadly stable conditions in the sector in August, with the headline index up 0.1pt to 53.8, nevertheless still the second-lowest reading in eight months. The only other release of note this week will be the Caixin services PMI survey on Wednesday.

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