Sterling slides and Gilts rally as tabloids suggest Johnson ready to quit Brexit talks

Chris Scicluna

Equities down in China & Japan, USTs and Gilts rally, sterling slides
A smaller-than-forecast rise in US employment proved to be no barrier to new highs on Wall Street on Friday, with the S&P500 rising a further 0.9% gain to end the week with a 1.6% advance. Indeed, the soft result was viewed as increasing the odds of timely fiscal stimulus, and so the 10Y Treasury yield increased to as high as 0.98% on Friday, before settling back at 0.97%. But US equity futures have traded a little lower today – and the 10Y UST yield has slipped back below 0.95% – following a Reuters report suggesting that the US is close to announcing new sanctions on more than a dozen Chinese officials linked to the disqualification of legislators in Hong Kong. And that prospect of increased US-China tensions has seen China’s CSI300 drop 0.9% despite China releasing a November trade report that revealed the strongest export growth in almost three years. The Hang Seng is down an even greater 1.3%.

Despite some positive local data (see below), Japanese equities have also started the week on the back foot, with the TOPIX down 0.9% as investors await the imminent announcement of a third supplementary budget to support the recovery. Reportedly, PM Suga has said that he wants to reach a decision on the package tomorrow. And when he makes that decision, he will do so knowing that increasing coronavirus case numbers have seen approval ratings for his Cabinet fall precipitously – a Japan News Network poll recording its largest decline since 2013. Elsewhere in Asia markets were generally in the black, however, with the TAIEX advancing 0.9% and the KOSPI rising 0.5%. And Australia’s 10Y bond yield increased to the highest level since late August with news of a 7th consecutive lift in job ads reinforcing the direction provided by higher UST yields.

At the start of a very busy week in Europe, however, the mood is uneasy, with conflicting headlines about the prospects of a deal between the EU and UK ahead of Thursday’s EU Summit, which is starting to look like the key deadline. This morning’s headline from the jingoistic Sun, that PM Johnson is ready pull out of the talks ‘within hours’, has been echoed in the other UK right-wing papers and might be part and parcel of the brinkmanship to be expected at this stage of the negotiations. But clearly the outcome is in the balance, and Gilts have leapt on the back of those headlines at the open with 10Y yields 6ps lower back below 0.30% and sterling slipped about 1.0% to close to 0.91/€. Johnson and Commission President von der Leyen should be having another call today, as will Johnson’s de facto Deputy Gove and Commission Vice President Sefcovic. However, Johnson’s threat to present legislation today once again inconsistent with the Withdrawal Treaty is hardly an act supportive of trust between the camps. And so, ahead of Thursday’s ECB policy announcements – which will extend the PEPP and TLTRO programmes – euro area govvies are firmer across the board too.

Japanese consumption up solidly again, leading index best since June 2019
This week’s Japanese economic dataflow got off to an encouraging start today, with further signs of recovery in consumer spending and the economy more generally. First, the BoJ released its Consumption Activity Index, providing the first reliable estimate of how overall consumer spending evolved in October. Following on from a 1.4%M/M lift in September that was 0.1ppts larger than estimated previously, the real index rose a further 1.1%M/M. As a result, the level of spending in October sits 2.3% above the average level through Q3 and at the highest level since February (but still 4.3% lower than in February).

In the detail, spending on durable goods increased 5.9%M/M and so was up 21%Y/Y – albeit the latter exaggerated by base effects associated with the pullback in spending last year following the consumption tax hike. Spending on non-durable goods fell 1.3%M/M but was up 2.1%Y/Y. Meanwhile, after increasing an upwardly-revised 4.9%M/M in September, spending on services – hit especially hard by the pandemic – increased a further 1.8%M/M in October. Even so, spending on services remained down 8.9%Y/Y.

In other news, the Cabinet Office released its preliminary business indicators for October. Following a significant upward revision to the September reading, the coincident indicator increased 4.9pts to 89.4 – also the highest reading since February. Meanwhile, following a smaller upward revision, the leading index increased 0.5pts to a higher-than-expected 93.8 – the highest reading since June last year and above the long-term average of 91.6.

Japan’s 3rd supp' budget, GDP revisions, October data and surveys to come
Over coming days the Japanese government is expected to announce the parameters of its third supplementary budget, which together with next week’s likely extension of the BoJ’s special support programme, will help to sustain the economic recovery next year. Bloomberg’s survey suggests that the median analyst expects the government to inject ¥20tn of additional spending (4% of GDP), which is a little less than the first two supplementary budgets. However, our Japanese colleagues think that the total size of the package could amount to as much as ¥34tn, including spending that will fall into the first Budget for FY21. They expect that spending to be directed mostly to supporting the corporate sector, including the continuation of the “Go-To” campaigns and the provision of compensation to businesses forced to curtail their activities due to local public health concerns. They also expect additional funding so that coronavirus vaccines are free-of-charge to all residents.

There are also a number of economic reports due over the remainder of this week, starting tomorrow with the second release of the national accounts for Q3. The MoF’s corporate survey suggested that business capex may have declined fractionally less than first estimate, but any revision seems unlikely to materially alter the preliminary estimate that GDP rebounded 5.0%Q/Q. Tomorrow will also bring the MIC’s survey of household spending and disposable income, together with the MHLW’s Monthly Labour Survey for October. The latter should report a slightly smaller decline in average labour incomes than the 0.9%Y/Y fall seen in September, reflecting a further recovery in overtime hours worked. The BoJ’s bank lending data for November, the Reuters Tankan for December and the Economy Watchers Survey for November complete tomorrow’s very busy diary. On Wednesday, the main focus will be on the machine orders report for October, especially after 4.4%M/M pullback in core orders reported in September. On Thursday, the MoF’s Business Outlook Survey will provide some pointers on how firms are viewing the outlook ahead of next week’s more widely followed BoJ Tankan survey, while the BoJ will release the goods PPI for October.

China’s trade surplus widens to record high; inflation and credit data due
In light of the recent strong PMI readings, analysts were expecting today’s Chinese external trade statistics for November to paint the economy in a positive light. As it turns out, growth in exports picked up to 21.1%Y/Y in US dollar terms from 11.4%Y/Y previously (14.9%Y/Y in yuan terms given the firming of the exchange rate over the past year). This was the strongest outcome since February 2018 – a month that was exaggerated by LNY-related timing effects – and almost double market expectations. Growth in exports to the US jumped to 46.1%Y/Y, while growth in exports to the UK was an even stronger 61.8%Y/Y. By contrast, exports to Japan increase just 5.6%Y/Y and exports to Hong Kong increased 12.1%Y/Y. Of course, given the weakness seen earlier in the year, on a year-to-date basis total exports increased just 2.5%Y/Y.

Less encouraging this month – at least for China’s trading partners – growth of imports was little changed at 4.5%Y/Y in US dollar terms (-0.8%Y/Y in yuan terms), which was less than the 7.0%Y/Y growth that the market had been expecting. Of note, China’s imports from the US rose 33.0%Y/Y – similar to last month – yet China’s bilateral trade surplus with the US still widened to a record $US37.4bn from $31.4bn previously. China’s overall trade surplus increased to a record $US75.4bn. China’s imports from Japan increased 7.1%Y/Y, up slightly from 5.5%Y/Y last month, while imports from Australia increased 9.2%Y/Y. Meanwhile, imports from France and the UK remained lower than a year earlier.

The only Chinese economic reports scheduled over the remainder of this week are Wednesday’s CPI and PPI reports for November. The reversal of earlier strength in food prices has pulled headline CPI inflation sharply lower in recent months and this is likely to have continued over the past month (indeed, according to Bloomberg’s survey, the market expects headline inflation to have declined to 0.0%Y/Y). Of greater interest will be any signs that economic recovery has begun to lift core inflation from the soft 0.5%Y/Y pace that has prevailed over the past four months. The PBoC’s money and credit aggregates may also make an appearance late in the week or over the weekend.

For how long, and by how much, will the ECB boost its PEPP and TLTROs?
An extremely busy week ahead in the euro area will bring (on Thursday) the long-awaited announcement from the ECB of its latest monetary policy initiatives, an important leaders’ summit (on Thursday and Friday) that might resolve the impasse with Poland and Hungary over the Recovery and Resilience Facility and EU Budget, and a few top-tier economic data releases.

Following the ECB’s previous policy meeting on 29 October, President Lagarde made clear that the Governing Council would respond to the intensification of the pandemic with new monetary policy action at the forthcoming meeting. She also stated that the Governing Council would consider a recalibration of all of its policy tools, suggesting the possibility for surprises. However, subsequent information from the published account of the meeting, as well as repeated public commentary from various Governing Council members (both hawks and doves), has emphasised that the PEPP purchases and TLTRO funding operations will be the main tools to be used. Moreover, recent comments from highly influential Executive Board members Lane and Schnabel have suggested that the Governing Council will look to extend the current level of monetary accommodation to better match the duration of the pandemic, rather than increase the amount of current accommodation.

As such, we should not expect an acceleration in the current pace of asset purchases. Instead, we should simply look for the PEPP purchases to be extended, at least to the end of 2021 but perhaps as far as mid-2022, initially at the current pace of roughly €15bn per week. The extension to mid-2022 would seem to merit an increase in the PEPP purchase envelope of up to €650bn, although the Governing Council would also then emphasise that the resulting €2.0trn envelope might not be used in full. In addition, the regular €20bn per month Asset Purchase Programme, which has been augmented by an additional envelope of €120bn to the end of this year, might be expected to continue into 2021. The Governing Council seems likely too to announce further quarterly TLTRO-iii operations beyond next March, perhaps also into 2022, and extend the period beyond next June during which the minimum interest rate of -1.0% will be applied to those loans. Adjustments to other policy tools, including the tiering multiplier and collateral rules, cannot be ruled out. However, we certainly do not expect any changes to the ECB’s main policy interest rates.

The extension of the monetary policy measures will be justified by the ECB’s updated macroeconomic projections. Despite stronger-than-expected growth in Q3, the setback of a likely drop in GDP in Q4 and persistent weakness into Q1 means that full-year GDP forecasts for 2020 and 2021 will be little changed. So, the Q419 level of GDP will still likely not be reached before the second half of 2022. And while inflation will be expected to rise next year due to the end of the German VAT cut and higher energy inflation, the outlook will be weighed by persistent spare capacity and the stronger euro. So, the ECB is likely to project that inflation will remain below its target over the horizon to end 2023. And the post-meeting statement will likely again flag concerns about the downside risks posed by exchange rate movements.

German IP surges at start of Q4
As foreshowed by the strong turnover and orders data released at the end of last week, German industrial production took a further big step forward at the start of Q4, rising 3.2%M/M following upwardly revised growth of 2.3%M/M in September. While it was still down some 3.0%Y/Y and 4.9% below the pre-pandemic level, it was 4.9% above the Q3 average, suggesting a sizeable contribution to GDP growth in the current quarter. We doubt, however, that it would be sufficient to offset the significant weakness in the services sector due to the pandemic and associated containment measures. Within the detail, production of autos and associated parts leapt 9.9%M/M but was still almost 6% below February’s pre-pandemic level. Output of intermediate goods rose 4.0%M/M while capital goods increased 5.2%M/M, but production of consumer goods fell 2.4%M/M. Energy production was also strong, up 4.0%M/M albeit still down 1.0%Y/Y, while construction output rose 1.6%M/M to be up 3.4%Y/Y.

The equivalent IP figures for France and Italy are due on Thursday and Friday respectively, with goods trade data for the same month due from France (tomorrow) and Germany (Wednesday). And investor sentiment surveys for December will come from Sentix (Monday) and ZEW (tomorrow). Revised Q3 euro area GDP figures (current growth estimate of 12.6%Q/Q) are also due tomorrow and will be accompanied by the expenditure components for the first time – household consumption, fixed investment and net trade will all have made substantive positive contributions. Final estimates of German and Spanish inflation in November are due on Friday. Finally, also on Thursday, the ECB will publish the allotment under the latest TLTRO-iii operation, the sixth to be conducted.

October UK GDP and BoE Financial Stability Report overshadowed by Brexit
Beyond the Brexit negotiations, the UK data highlight this week will be Thursday’s first estimate of GDP in October, which we expect to show a drop of 0.5%M/M to be down a hefty 9.1%Y/Y as the revival in the pandemic hit spending on services. In contrast, output of manufacturing and construction is likely to have posted positive growth. Goods trade data for the same month are due the same day. The other noteworthy figures due come from the BRC retail sales survey for November, out Tuesday, which will highlight the impact of the closure of non-essential stores last month.

CPI data the highlight of a light US economy diary this week
With attention state-side to be firmly on Congressional talks on fiscal simulus, this week’s US economic diary is relatively light with only a small number of economic reports scheduled and no monetary policy related Fedspeak due to next week’s FOMC meeting. Today brings just consumer credit data for October, while tomorrow will see the NFIB’s small business survey for November and the final productivity and unit labour cost readings for Q3. While GDP was unrevised, Daiwa America Chief Economist, Mike Moran, thinks that productivity may be revised down slightly to 4.1%AR on account of an upward revision to hours worked. On Wednesday, the final wholesale trade report for October is accompanied by the release of the JOLTS labour market report for October. On Thursday, most attention will centre on the CPI report for November. Here, Mike expects that tame food and energy readings will constrain the headline index to a 0.1%M/M gain, but that the reversal of pandemic-related discounting will lead to a 0.2%M/M lift in the core index. Federal Budget data for November is also released on Thursday, which Mike expects will point to a monthly deficit of $US200bn – just slightly less than in November last year. On Friday, the week will end with the release of the November PPI and the preliminary results of the University of Michigan consumer survey for December. Mike expects both the headline and core PPI indices to have increased 0.2%M/M and thinks that gains in the stock market might have been enough to lift confidence slightly following the sharp decline seen in October.

Australian jobs ads up again; sentiment indicators in focus this week
This week’s Australian diary got off to a positive start with some good news from the labour market. According to the ANZ, the number of job advertisements increased a further 13.9%M/M in November, building on an upwardly-revised 11.9%M/M increase in October. As a result, the level of advertising was down just 3.3%Y/Y – a far cry from the almost 60%Y/Y decline recorded back in May.

Looking ahead, tomorrow’s NAB Business Survey for November is the key release over the remainder of this week. After rising into positive territory last month for the first time since February, we expect that business conditions will likely be judged to have improved somewhat further. Given the improvement in the weekly ANZ-Roy Morgan survey, on Wednesday the monthly Westpac survey should point to a lift in consumer confidence too. Wednesday will also bring the release of the ABS quarterly measure of home prices for Q3. While higher frequency indicators point to a lift in house prices over recent months, the ABS measure is likely to still report a modest decline during Q3.

GDP partials, consumer spending, PMI and house sales data ahead in NZ
This week’s Kiwi data flow begins on Wednesday when the quarterly manufacturing activity and wholesale trade surveys for Q3 will provide further clues ahead of next week’s national accounts report. On Thursday, most interest will centre on Statistics New Zealand’s the monthly indicator of consumer spending for November, while the manufacturing PMI for November will be released on Friday. The REINZ housing survey for November will likely be released in the second half of this week, and given other indicators will doubtless point to a very buoyant housing market. 

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