Over to Abe

Emily Nicol
Chris Scicluna

Following yesterday’s surge on Wall Street (the S&P500 closed up 7.0% on the day), the feel-good factor in stocks has continued to other major markets today. Japan’s Topix rose 2.0% ahead of this evening’s declaration of emergencies and fiscal stimulus announcement from PM Abe. Major indices in China and Hong Kong rose a similar amount. And most European markets are up more than 3% so far this morning, buoyed by evidence that regional lockdowns are working.

Bonds are weaker across the board too, with 10Y UST yields up a further 7bps to 0.74%, the highest for more than a week. The JGB curve steepened with super-long yields up 2-3bps. And ahead of this evening’s Eurogroup meeting to agree common crisis support, euro govvies are all weaker with Bunds underperforming (10Y yields up about 5bps to -0.38%). With UK PM Johnson admitted to intensive care last night, Gilts are lower too (10Y yields currently up 3bps to 0.36%) but sterling has recovered the cent and a half lost last night. In Australia, a suggestion from the RBA that it will look to slow bond purchases saw ACGBs and local equities underperform and the AUD rally.

Japan’s response to Covid-19:
A busy day in Japan is being dominated by PM Abe’s response to Covid-19. In particular, after much conjecture, at 7pm local time the Prime Minister is finally set to declare a state of emergency for seven prefectures. And we should also at last see confirmation of the substance of the government’s fiscal support package, which – if reports and government spin are to be believed – has steadily inflated in size over recent days to produce an unfeasibly large headline figure of ¥108tn (roughly 20% of GDP).

The emergency declaration will apply to Tokyo, Osaka and five other prefectures (Kanagawa, Chiba, Saitama, Hyogo and Fukuoka), which cumulatively account for almost half of all economic activity. That will allow local authorities to call for inhabitants to stay at home for one month. The ‘lockdowns’ will not be as strict as in other countries, not least as the authorities have no sanctions available to punish those who don’t conform. But we would expect observance levels to be high. And the similar measures undertaken in Europe and the US suggest that they should be effective at controlling the spread of Covid-19.

The details of Abe’s fiscal support programme, meanwhile, will hopefully clarify the precise breakdown of the headline ¥108trn figure between (1) direct stimulus via actual new tax and spending measures and (2) new loans and credit guarantees, and hence (3) how much new government borrowing will actually be required. We will also look for clear differentiation between concrete new measures and those already in the pipeline. Certainly, the headline number appears already to be inflated by December’s ¥26.9trn supplementary budget, which itself was puffed up by plenty of ‘quasi-fiscal’ measures such as lending from Japan’s government agencies, as well as spending from local governments, to magnify the more modest contribution from central government. As ever in Japan, the true impact of the package will be much smaller than meets the eye.

As far as we’re concerned, a key metric of the extent of support to the real economy will be the amount of new government borrowing required to deliver it. Bloomberg has reported that ¥16.8trn (roughly 3% of GDP) of additional JGBs will be issued. That would suggest that the package of new support, as a share of GDP, is rather smaller than that already being implemented in the US and (admittedly from a lower baseline) in Germany, but larger than the average package in Europe (closer to 2%). It would also suggest that the lending and credit guarantees from the government agencies will do lots of the heavy lifting.

That’s not to say that there will not be a lot of worthwhile policy in today’s package that will reduce the extent of the inevitable decline in GDP, limit the rise in unemployment and contain the number of corporate bankruptcies. Indeed, many of the measures will look a lot like those implemented previously in Japan during the global financial crisis, and implemented in the US and Europe over the past few weeks.

¥300k in cash handouts for households whose incomes have been hit by the pandemic, as well an additional ¥10k in per child for families receiving child allowances, will support consumer incomes and expenditure. Past experience in Japan and Europe suggests that the enhanced support for affected firms that retain employees through the downturn will also be effective at limiting both joblessness and bankruptcies. As ever in Japan, there will also be incentives for households to make certain purchases, including of new cars, over the coming six months. Extra funds for healthcare will obviously be welcome in the current crisis. Lower tax rates and corporate tax deferments for SMEs will provide breathing space for firms. And crisis lending schemes should maintain the flow of credit to firms affected by the global restrictions on activity.

Eurogroup meeting:
This evening will bring the most notable economic event of the week in the euro area, the Eurogroup videoconference aiming to agree forms of common pandemic crisis support to facilitate funding the policy response to the Covid-19 outbreak. Ideally, from a sustainability perspective, this would have taken the form of issuance of common ‘coronabonds’. But that remains taboo in Germany, the Netherlands and Austria. So, a piecemeal approach, using existing mechanisms, appears likely.

Following the previous videoconference, the Eurogroup’s chair Mario Centeno reported “broad support” among the finance ministers to make support available via the ESM, which currently has a lending capacity of just €410bn. The proposal was based on making available about €240bn, with a limit of just 2% of GDP per member state, an amount likely to be too modest to be of much use for Italy and Spain. Similarly, loans with relatively short maturities (i.e. less than five years) might also do little to boost confidence in fiscal sustainability. And any conditionality attached to the loans would act as a further deterrent to their recourse.

Meanwhile, the ministers will also discuss whether to supplement the ESM’s resources with additional vehicles. The European Commission has proposed a €100bn SURE programme (0.75% of EU GDP) to help provide fund wage subsidies for furloughed workers. And the EIB has proposed its own €200bn credit support programme, requiring €25bn of guarantees from member states.

With the RBA last month having cut its cash rate to 0.25% (its effective lower bound) and introduced yield curve control, targeting 3Y bond yields at 0.25%, there was no expectation for any additional action at the conclusion of today’s scheduled policy-setting meeting. Indeed, Governor Lowe’s statement just reaffirmed the respective cash rate and 3Y yield targets at 0.25%. While he noted that there had been some signs of improvement in global financial markets following the recent substantial measures undertaken by central banks, he also stated that the RBA will continue to do what is necessary to achieve the 3Y yield target. And he reaffirmed that it will remain in place until significant progress has been made towards achieving its targets for full employment and inflation.

Nevertheless, Lowe also stated that “If conditions continue to improve… it is likely that smaller and less frequent purchases of government bonds will be required”, wording that was interpreted by some observers as a hint of tapering to come. But with the 3Y yield now roughly 20bps lower than when the RBA announced its policy framework, and close to the current target, it would seem natural for the Bank to reduce somewhat the pace of buying from the A$36bn already purchased in the first 2½ weeks. And with the depth and length of the contraction in economic activity, both globally and domestically, still unclear but also likely to be unprecedented, we anticipate RBA bond buying to remain in place for a considerable period. Indeed, the Board restated its commitment to doing what it can to support jobs, incomes and businesses as Australia deals with the coronavirus.

Economic data:

With respect to the latest economic data, Japan’s household spending figures somewhat exceeded expectations in February, with some signs of stockpiling providing a boost. In particular, total expenditure rose 0.8%M/M, to leave it down just 0.3%Y/Y – the softest annual decline since September – with spending on food up for the second successive month to leave it 4.8% higher than a year earlier, the strongest annual rate since the series began in 2001. Spending on household goods was also much stronger following the initial retrenchment after October’s consumption tax hike (8.5%Y/Y), while expenditure of medical goods was up almost 7½%Y/Y. In contrast, however, spending on culture and recreation activities continued to fall for the third consecutive month, as households scaled back spending on unnecessary items and many cultural, sporting and tourist attractions closed halfway through the month. Indeed, total spending was still on average in January and February 1% below the Q4 average.

A similar picture was painted by the BoJ’s consumption activity index, which showed that spending on services fell more than 1½%M/M in February, while the non-durable goods component fell (0.7%M/M) for the first month in four. So, despite a near-2½%M/M increase in consumption of durable goods, the headline consumption activity index fell 0.8%M/M.

Admittedly, this more than fully reflected a decline in spending by overseas visitors as travel restrictions came into force in many Asian countries. Indeed, when excluding tourist spending, the BoJ’s consumption activity index rose 0.3%M/M. And contrasting with the household spending figures, on the BoJ’s measure, domestic consumption was trending 1½% higher than the Q4 average over the first two months of Q1. Nevertheless, with concerns about the coronavirus having heightened over the past month, and Tokyo residents having been urged to remain indoors over the past two weekends, spending seems bound to have fallen significantly in March and over the first quarter as a whole.

At face value, today’s labour earnings figures were broadly encouraging too, with headline wage growth up 1%Y/Y in February following growth of 1.2%Y/Y in January. While scheduled earnings were a touch weaker, an increase of 0.8%Y/Y still marked the second-strongest growth since November 2018, while bonus payments were up 21.5%Y/Y. In contrast, overtime earnings fell back for the sixth consecutive month (-1.2%Y/Y) and we would expect this to worsen significantly in March as firms scaled back their working hours. Moreover, the significant deterioration in employment prospects due to the current economic outlook will no doubt impact wage growth in due course too, which will provide an additional downwards pressure on consumption and inflationary pressures over coming quarters.

Like yesterday’s German factory orders data, this morning’s IP figures suggested limited impact on the country’s manufacturing activity from Covid-19 in February. Indeed, contrasting with an anticipated decline, total output rose 0.3%M/M in February following upwardly revised growth of more than 3%M/M in January. And with construction activity having fallen back by 1%M/M in February (unsurprisingly so, given the near-6½%M/M increase at the start of the year), the pickup in manufacturing was slightly stronger at 0.4%M/M, boosted by increased production of chemical and pharmaceutical products (up 5½%M/M and 12 ½%M/M respectively). In contrast, output of general and electrical machinery and autos fell further, a trend that will be exacerbated in March by the temporary closure of various factories in light of increased coronavirus restrictions.

Indeed, we already know that car production fell a whopping 37%Y/Y last month, while survey indices, including the ifo and PMIs, also suggest that output more widely fell off a cliff in March. So, while manufacturing output in the first two months of Q1 was trending 2% higher than the Q4 average, this increase seems likely to be more than wiped out in March, with further marked weakening certainly coming in April too.

It should be a relatively quiet day for UK top-tier releases, with just revised productivity and unit labour costs figures for Q4 due for release. And in the US, just February consumer credit and JOLTS job numbers are due.

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