Hopes for US fiscal stimulus and a breaking of Brexit trade deal deadlock

Chris Scicluna

Markets reopen with slight positive tone on US fiscal hopes and Brexit talk extension
Despite a rebound in the University of Michigan’s consumer sentiment survey, both the S&P500 and Treasury yields closed fractionally lower on Friday. But markets reopened in Asia today with investors seemingly in a slightly more positive mood. As we write, US equity futures are trading about 0.3% above Friday’s close and the 10Y UST yield is 1-2bps higher too, sitting just above 0.90%. In part this perhaps reflects optimism that a new US bipartisan fiscal stimulus bill, due to be unveiled today, might have more luck attracting broader Congressional support than previous efforts. Adding to the positive tone, of course, was yesterday’s news that the UK and EU will continue negotiations to unlock a post-Brexit trade deal, which has helped sterling to strengthen a little more than 1% against the USD, the euro to firm too and pushed UK and euro area yields higher too – the latter occurring despite the weekend’s announcement of an extension and tightening of Germany’s pandemic containment measures to include closure of non-essential stores and certain other businesses and schools until 10 January.

In local news, a larger-than-expected pickup in Japan’s key Tankan business conditions diffusions indices helped lift the TOPIX to a gain of 0.5%, even as the survey suggested that the pandemic had undermined near-term prospects for sales, profits and capex by more than estimated three months ago. After falling every day last week, China’s CSI300 gained 0.6% as investors awaited tomorrow’s dump of key activity indicators for November.

Looking ahead, focus in the coming week will remain on US fiscal policy and Brexit. And the latest Fed policy meeting could well bring action on asset purchases, while the BoJ will extend its special support for the corporate sector. The BoE’s MPC, however, seems bound to sit tight while it awaits news from the EU-UK negotiations.

Brexit talks continue for several more days after leaders agree to go the extra mile
Talks between the EU and UK will continue in Brussels today after yesterday’s self-imposed deadline for a deal was again missed. But following a “constructive and useful phone call” between Commission President von der Leyen and UK PM Johnson, which supposedly “discussed the major unresolved topics”, the leaders decided that “it is responsible at this point to go the extra mile” and “continue the talks and to see whether an agreement can even at this late stage be reached”. Reports from the UK side suggest the talks could go right up until Christmas, probably deliberately leaving minimal time for scrutiny before ratification in the European Parliament and Westminster. In addition, separate UK-based reports suggest that the EU position on the level playing field might have softened a touch, supposedly with the demands relaxed for a so-called “ratchet clause” that would have sought to compel the UK follow the EU if and when it tightened labour or environmental standards or else find its exports penalized by extra tariffs. In this context, reportedly the negotiators will now attempt to define more precisely unfair competition and the process for triggering offsetting measures if they might be required. Whether or not those reports misrepresent the extent to which the EU might have shifted position, they suggest that the UK will present the supposed climb-down as a negotiating victory on the path to a possible eventual deal.

BoJ Tankan suggests improved conditions in Q4, but also greater damage from the pandemic
Turning to today’s economic reports, the key focus in Japan was the BoJ’s latest Tankan survey. In summary, as suggested by Friday’s MoF Business Outlook Survey, respondents to the Tankan indicated some further improvement in business conditions over the past quarter. Indeed, as it turns out, the extent of improvement over the past quarter was more pronounced than the market had expected. However, consistent with the MoF survey, firms appeared unconvinced that conditions would improve further over the coming quarter. Meanwhile, with the benefit of more information, firms have revised down their forecasts for sales, profits and capex for the current fiscal year. Moreover, with firms continuing to operating with a degree of spare capacity and excessive inventories, inflation pressures and inflation expectations remained very weak too.

Turning to the detail, a net 15% of the 9,507 respondents reported unfavourable business conditions in Q3, down 13ppts from Q3. The closely-watched diffusion index (DI) for large manufacturers improved by a larger-than-expected 17ppts to -10 (the long-term average is close to 0). The improvement was broad-based across industries – only the shipbuilding and heavy machinery industry reported a worsening of conditions – but the food and beverage industry was the only to report that business conditions had turned favourable on balance. Looking ahead, a net 8% of large manufacturers continue to expect unfavourable business conditions to prevail in Q1. Moreover, that forecast is based on an assumed exchange rate of ¥106.42/$ over the second half of FY20, so these firms would likely be even less confident if the yen were to remain around its current level. As is usually the case, small- and medium-sized firms were more downbeat in their assessment about both the past quarter and prospects for the coming quarter, albeit showing greater-than-expected improvement from Q3. For example, the DI for small manufacturing firms increased 17ppts to -27 (the long-term average is -12), while a similar net 26% of firms expect that business conditions will remain unfavourable in Q1.

Moving to the non-manufacturing sector, the DI for large firms improved a slightly larger-than-expected 7ppts to -5. Not surprisingly, conditions remained especially dire in the hospitality sector, with the relevant DI rising 21ppts but still leaving this at a dreadful -66. Firms providing services to individuals also remained very downbeat, with the relevant DI rising 22ppts to -43. However, a number of industries describe business conditions as favourable on balance, including communications, information services and retailers (the latter rising 5pts to 23). Looking ahead, a net 6% of large non-manufacturing firms expect conditions to remain unfavourable over Q1, indicating that in aggregate these firms expect no improvement over this period. This result reflects a notable weakening of expected conditions in the retail and construction industries, which largely offsets the expected improvement in several other industries (especially services for individuals). As in the manufacturing sector, small- and medium-sized firms were more negative about both Q4 and the outlook for Q1. For example, the DI for small non-manufacturing firms increased 10ppts to -12 (the long-term average is -9), but a net 20% of firms expect that business conditions will remain unfavourable in Q1.

Elsewhere in the survey, while business conditions are improving, firms’ assessment of the economic damage caused by the pandemic has increased. Firms now forecast that aggregate sales will decline 8.6%Y/Y in FY20 – a 2.0ppts deterioration from the prior survey – with broadly similar responses across the manufacturing and non-manufacturing sectors. This mainly reflects a more than 13%Y/Y decline in sales over the first half of the year, with sales over the second half expected to be down 4.1%Y/Y. In aggregate current profits are now expected to have fallen 35.5%Y/Y in FY20 – a deterioration of 7ppts from the prior survey. While the largest part of that decline has already occurred, firms still expect a 25.7%Y/Y decline in profits over the second half of FY20, led by a 31.9%Y/Y decline in the non-manufacturing sectors (manufacturing profits are forecast to fall 14.2%Y/Y over this period). As a result, the overall profit margin for all firms is forecast to decline to 3.70% in FY20, down from 5.23% in FY19. This is 0.31ppts lower than suggested in the prior survey and below the average over the past two decades by a similar amount.

Not surprisingly, the pessimistic outlook for sales and profits has translated into a weaker outlook for capital spending, with the deterioration appearing to be slightly larger than the market had expected (in contrast to the positive surprise in the business conditions indices). Following a 0.6%Y/Y decline in FY19, total capex (including land investment) is now forecast to fall 3.9%Y/Y in FY20 – a forecast that is 1.2ppts weaker than in the prior survey. This revision was driven by larger firms, which had been slower to adjust their capex plans. For example, large manufacturers now expect to reduce capex by 0.5%Y/Y, rather than raise capex by 3.5%Y/Y as was the case previously. Even so, these forecasts still appear high given slump that has already been measured in the first half of FY20. As far as employment is concerned, on balance manufacturers indicated that they were overstaffed in Q4, but expected to have rectified this by Q1. Non-manufacturing firms continue to report labour shortages, but these shortages are much less widespread than prior to the pandemic. A net 18% of firms described the lending stance of financial institutions as “accommodative” – down just 1ppt from the last survey and still favourable by historical standards – suggesting that finance remains available to firms (of course, supported by government and BoJ subsidies).

Reflecting soft demand, while there was some improvement in Q4, sizeable net proportions of both manufacturing and non-manufacturing firms continued to report excess supply conditions and excessive inventories. Therefore, unsurprisingly, the Tankan also contained bad news for the BoJ’s long-term goal of lifting inflation towards its 2% target. While a small proportion of firms reported rising input prices, firms continued to report that they had cut output prices and that they would do so again in Q1. In aggregate, firms forecast a 0.1% cut in their output prices over the next 12 months and only a cumulative 1.3% increase over the entire 5-year forecast horizon (both figures just 0.1ppts firmer than in the prior survey). Regarding general consumer prices, firms expect only a 0.3% increase over the next 12 months, with inflation expected to be running at just 0.9% in five years’ time – the latter forecast revised up just 0.1ppt from the previous response, which had been the lowest since this part of the survey began in 2014.

Japanese manufacturing and service sector activity expands at brisk pace in October
Moving to the rest of today’s Japanese news, METI released both its final IP report for October and the Tertiary Industry Activity Index for October. Beginning with the manufacturing report, as usual the revisions were minor. Growth in total production was revised up 0.2ppts to 4.0%M/M and growth in shipments was revised up 0.3ppts to 4.9%M/M, leaving both output and shipments down 3.0%Y/Y. As a result, inventories fell 1.8%M/M – 0.2ppts more than first reported – and so were down 8.1%Y/Y. The inventory-shipments ratio fell 3.3%M/M – 0.3ppts more than first reported – and so was down a revised 0.9%Y/Y. Finally, the new content in today’s release concerned capacity use, which in aggregate increased by a further 6.0%M/M in October to the highest level since February. Capacity utilization is now down just 0.9%Y/Y – in part due to a 0.9% decline in productive capacity over that period – but remains over 4% below the levels that prevailed ahead of last year’s consumption tax hike.

Turning to the service sector, the Tertiary Industry Activity Index increased 1.0%M/M in October – 0.2ppts below market expectations, but following a 0.5ppt upward revision to September (which now reports a lift of 2.3%M/M). Even so, activity was down 1.9%Y/Y – a decline that is would have been somewhat larger were it not for the falloff in activity last year following the consumption tax hike. Nonetheless, more importantly, the level of activity in October was almost 3% above the average through Q3. So with manufacturing activity presently on track for an even larger increase, the early indications for GDP in Q4 are encouraging.

In the detail, all of the improvement in October was due to a further recovery in activity related to non-essential personal services – the category hardest hit by the pandemic. The index covering these industries increased 3.0%M/M but was still down 4.6%Y/Y. Of particular note, supported by government subsidies, activity in the living and amusement industry increased a further 5.4%M/M, reducing its annual decline to a still substantial 14.8%Y/Y. Meanwhile, the business services index decreased a modest 0.5%M/M in October – the first decline since May – and so was down 3.0%Y/Y (services provided to the manufacturing sector declining 5.0%Y/Y). By contrast, activity related to essential personal services was almost unchanged from a year earlier.

BoJ to extend corporate support programme this week; trade, PMI and CPI data also in focus
Looking ahead to the rest of this week, the next important economic reports in Japan are Wednesday’s merchandise trade report for November and preliminary PMIs for December. Given earlier strength in the PMIs, a further lift in exports should underpin a slight increase in the (seasonally adjusted) trade surplus from the ¥314bn recorded in October. Prospects for the PMIs are more uncertain given the mixed performance of other recent indicators, with last week’s timely Economy Watchers survey suggesting that rising coronavirus cases may have begun to weigh on sentiment of late. On Friday, earlier indications from the Tokyo area suggest that weaker food and energy prices are likely to have depressed the national CPI in November, causing headline inflation to fall to around -0.8%Y/Y from -0.4%Y/Y previously. The BoJ’s preferred core measure – which excludes fresh food and energy prices – is likely to have remained near the -0.2%Y/Y result for October.

When the BoJ concludes its final Policy Board meeting for this year, also on Friday, we expect the Bank to retain all of its pre-pandemic policy settings, including its -0.1% short-term policy rate, the 0% target for 10Y JGB yields and the targets set for its various types of asset purchases. However, the BoJ is very likely to announce an extension of its ‘Special Program to Support Financing in Response to the Novel Coronavirus’, which is currently set to expire at the end of March. This programme lowers funding costs to small and medium-sized businesses, via direct purchases of corporate bonds and by offering cheap funding to banks that make loans to these businesses.

Modest increase in Chinese home prices; key November activity data due tomorrow
This week’s Chinese data flow kicked off today with news regarding developments in home prices. New home prices increased a modest 0.1%M/M in November – the smallest increase since February – causing annual growth to slow a further 0.2ppts to 4.0%Y/Y. Existing home prices also rose 0.1% in November, leaving annual growth at 2.2%Y/Y. It is worth noting that the latter reflects low rates of inflation in second and third tier cities, as prices in first tier cities rose 8.3%Y/Y.

The remainder of this week’s Chinese economic data arrives in one dump tomorrow, when we will receive the balance of the key activity indicators for November. Given recent upside surprises in the PMIs, predictably the market is looking for further strengthening across all of these indicators. According to Bloomberg’s survey, IP growth is expected to rise to 7.0%Y/Y; retail sales growth is expected to rise to 5.0%Y/Y; capex growth is expected to rise to 2.6%YTD/Y; and the unemployment rate is expected to decline to an 11-month low of 5.2%.

Fed likely to tweak QE this week; IP, retail and housing data also due
The main focus in the US this week will be the Fed, with the final FOMC meeting of this year set to conclude on Wednesday. In light of Congress dithering on another round of fiscal stimulus, with the Treasury having pulled funding for some of the Fed’s pandemic-response credit facilities, and the labour market recovery faltering in the face of the intensified spread of Covid-19, Daiwa America Chief Economist Mike Moran suspects that the Committee will see the need for additional monetary policy support. In line with the discussion that took place at the Committee’s November meeting, that support is likely to take the form of some combination of increasing the pace of purchases, by concentrating purchases in the long end of the maturity spectrum, or by lengthening the horizon over which purchases would be made (so far the Fed has not provided any information on the latter, but could elect to announce dates that it judges to be longer than currently expected by the market). Even so, supported by the Fed’s own actions, the updated Summary of Economic Projections could also show a somewhat more favourable outlook, especially as regards the unemployment rate, which is already nearly a full percentage point below the Fed’s previous expectation for Q4. And whereas in September the ‘dot plot’ indicated that the median Fed official expected no hike in the fed funds rate until beyond 2023 (just 4 of the 17 contributions showing at least one hike in 2023), the median official might even signal a tentative liftoff in 2023 – a forecast that might spook the market, were it not accompanied by the announcement of additional QE.

On the data front, ahead of the Fed’s announcement, Tuesday will bring news from the factory sector in the form of the IP report for November and the New York Fed’s manufacturing survey for December. As far as the former is concerned, indicators from the labour market lead Mike to expect only modest growth in output of about 0.2%M/M. On Wednesday, attention turns to the consumer with the release of the retail sales report for November. Here Mike expects a 0.2%M/M decline in total spending, led by weaker auto sales. Core spending is likely to be broadly unchanged from October, but still noticeably above pre-pandemic levels. Also on Wednesday, we will receive the flash Markit PMIs for December and the NAHB housing market index for December. The latter leads into Thursday’s housing starts and building permits reports for November. Mike expects only a modest decline in starts, which would nonetheless remain elevated relative to the most recent period of expansion. Also of interest on Thursday will be the Philadelphia Fed’s manufacturing survey for December and the weekly jobless claims report – the latter especially after initial claims hit a 3-month high last week. On Friday, the dataflow concludes with current account data for Q3 (likely revealing the largest deficit in 12 years) and the Conference Board’s leading Indicator for November (likely pointing to a 7th consecutive month of expansion).

BoE to sit on its hands as it awaits outcome of Brexit talks
Beyond Brexit, this week will be a busy one for top-tier economic data from the UK, while it also brings the final BoE MPC meeting of the year. Of course, the MPC agreed only last month an increase in its asset purchase programme to last well into the second half of next year. So, unless the Brexit talks collapse in unlikely spectacular fashion by Thursday, the MPC seems bound to sit on its hands this week, although it might also be expected to discuss how best to respond should an EU-UK FTA not be agreed by year-end.

Data-wise, the week brings the final top-tier releases before the New Year, including the latest labour market report (tomorrow), the December flash PMIs and November inflation figures (Wednesday), and November retail sales and December GfK consumer confidence survey (Friday). Despite the belated extension of the Job Retention Scheme, tomorrow’s labour market report will likely show a further drop in payroll employment and a pickup in the ILO unemployment rate above 5.0% to its highest level since 2015. Meanwhile, after inflation ticked up to a three-month high of 0.7%Y/Y in October, we currently expect it to slip back 0.1ppt in November, and the core measure to fall back by as much as 0.2ppt to 1.3%Y/Y. The flash PMIs will probably continue to flag the likelihood that the economy is contracting in Q4, although the composite PMI might edge up from 49.0 in November reflecting the easing of some pandemic containment restrictions as well as Brexit-related stock-building. But with non-essential stores having been closed last month, retail sales seem bound to fall back sharply even though online and click-and-collect sales will have provided some support.

Euro area flash PMIs likely to underscore likelihood of a contraction in Q4
This week also brings several new top-tier economic data from the euro area, similarly including the flash December PMIs on Wednesday. These seem likely to underscore the likelihood of a contraction in euro area GDP in Q4 with another sub-50 reading expected in the headline composite index, which fell to 45.3 in November inevitably dragged lower in particular by weakness in services. The latest survey will be watched for continued resilience in the manufacturing sector in Germany, where the composite PMI encouragingly remained above 50 last month. Other December survey results due in the coming week include the French INSEE and German ifo business climate indices on Thursday and Friday respectively.

Today brings the euro area industrial production report for October. Given firm results from each of the four large member states, we expect IP to rise around 2.0%M/M, which would leave it about 4.0% down from February’s pre-pandemic level. Among other data due this week, tomorrow will bring the final estimate of French and Italian inflation in November, ahead of the release of the euro area figures on Thursday. According to the flash estimates, the euro area headline and core inflation rates were both unchanged last month at -0.3%Y/Y and 0.2%Y/Y respectively. On Friday the equivalent headline final estimate from Germany was confirmed at the flash estimate of -0.7%Y/Y, but the Spanish figure was revised up by 0.1ppt to -0.8%Y/Y and we certainly don’t rule out an upwards revision to the euro area figures. Euro area goods trade data for October and labour cost figures for Q3 are also out on Wednesday, while November’s EU new car registrations and October’s euro area construction output figures are due on Thursday.

Labour market the main focus in Australia this week
This week’s Australian economic diary kicks off tomorrow with the release of the minutes from this month’s RBA Board meeting – unlikely to add anything new – together with weekly indicators of consumer confidence and employment. The preliminary PMIs for December follow on Wednesday, although these relatively new series continue to attract much less investor attention than the long-running NAB business survey. The key report this week is Thursday’s Labour Force survey for November. Despite the bumper 179k lift in employment in October, Bloomberg’s survey indicates that the median analyst expects a further 40k increase this month – a forecast that probably reflects the further significant rebound in job advertising over the past month. As a result, the unemployment rate is expected to remain at 7.0% – a full percentage point below the RBA’s recently lowered estimate of where the unemployment rate would peak.

Kiwi services PMI back below 50; Q3 GDP report to reveal a strong rebound
In contrast to the improvement seen in the manufacturing PMI, New Zealand services PMI fell a somewhat surprising 4.1pts to 46.7 in November – the lowest reading since May. All of the key components were softer this month, with the activity index down 4.3pts to 45.8, the new orders index down 4.9pts to 52.6, and the employment index down 0.5pts to 49.1. The weakness this month could hint at slower momentum ahead due to the unwinding of pent-up demand following earlier restrictions on activity.

Looking ahead to the remainder of this week, the key focus for markets will be Thursday’s national accounts for Q3. After declining by 12.2%Q/Q in Q2 due to the nation’s strict lockdown, Bloomberg’s survey suggests that the median analyst expects a 12.9%Q/Q rebound in Q3 – a forecast that is underpinned by a range of strong partial indicators released in recent weeks. Ahead of the GDP report, tomorrow’s quarterly Westpac consumer confidence survey for Q4 should confirm the pick-up seen in higher frequency indicators such as the ANZ consumer confidence index, with the latter due to print its December reading on Friday. Also on Friday, and completing the Kiwi dataflow for 2020, we will receive the final results of the ANZ’s Business Outlook Survey for December and merchandise trade data for November. 

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