Dire Japanese PMIs depict downside risks

Emily Nicol
Chris Scicluna

Concerns about the spread of the coronavirus and its economic consequences have intensified. Further revisions to China’s data have added to the unease about the full extent of the outbreak there, while more than 50 extra cases in South Korea highlighted the transmission across borders. Moreover, an extraordinary drop of 92%Y/Y in Chinese passenger car sales in the first 16 days of February (according to the China Passenger Car Association) together with a marked deterioration in Japan’s flash February PMIs into recession territory (detail below) starkly illustrated the growing hit to economic activity across the region from the epidemic. The decision of Tokyo’s Metropolitan government to cancel or postpone all major indoor events over the next three weeks, as well as the closure of a major amusement park in Tokyo, added to the sense of widening disruption to a range of sectors.

So, while US markets regained some of their early losses throughout yesterday afternoon (the S&P500 closed down 0.4% and the NASDAQ closed down 0.7%), many of Asia’s bourses are in the red today. Korean stocks have fared worse (KOSPI closing down 1.5%, with the KOSDAQ down 2.0%). But with the yen broadly steady close to ¥112/$, its weakest levels for ten months, ahead of Monday’s national holiday Japanese markets fared somewhat better, with the Nikkei 225 down 0.4% but the TOPIX closing little changed on the day.  Similarly, China’s CSI300 ended the day little changed.   

The dollar was also little changed overnight, remaining at its strongest levels in almost three years in trade-weighted terms (DXY still just shy of 110). But in the bond markets, yesterday’s rally in USTs extended into Asian time today, with 10Y yields falling below 1.49%, about 9bps below yesterday morning’s peak, for the first time since early September. Apart from among super-longs, JGBs made gains too, e.g. with 10Y yields down 2bps to about -0.065%. And with Australia’s flash PMIs falling the most since the series began in 2016, ACGBs inevitably also played catch up with USTs, pushing 10Y yields down more than 6bps to about 0.93%, just above their lows earlier this month.  And ahead of the imminent release of the euro area flash PMIs, euro govvies have also inevitably opened stronger. 

It was a busy end to the week for Japanese economic news, with various data providing an update on activity and inflationary pressures around the turn of the year. But by far the most striking were the flash February PMIs, which, contrasting markedly with the Reuters Tankan survey released at the start of the week, strongly suggested that the economy is now in technical recession.

Of course, given concerns about the impact of the coronavirus on both demand and supply conditions for Japanese manufacturers, the respective PMIs were anticipated to have taken a turn for the worse this month. So, arguably, the 1.2pt decline in the headline manufacturing PMI to 47.6 (the lowest reading since 2012) might have been worse. Certainly, the output PMI (47.5) remained above December’s recent low. But this still implied ongoing contraction in the sector. And there was a striking deterioration in the survey’s new orders component, down more than 3pts to 43.7, the weakest since the Great Japan Earthquake in April 2011. As such, manufacturers were unsurprisingly less upbeat about the near-term jobs prospects, with the employment PMI (50.5) at its lowest for 2½ years.     

But given the growing importance of tourism to Japan’s economy over recent years and the travel restrictions that came into place towards the end of January, today’s surveys also implied a big hit to services firms this month. Indeed, the headline PMI fell a whopping 4.3pts in February to 46.7, only just above the low after the 2014 consumption tax hike. The new business PMI also slumped more than 5pts – the largest one-month drop since the quake in 2011 – to 47.6, while the employment PMI signalled no growth for the first time since 2016.

So, while the composite PMI had returned to the key-50 threshold in January for the first month in four, February’s survey once again implied marked contraction. Indeed, the composite PMI fell a marked 3.1pts to 47.0, leaving the average so far in Q1 more than ½pt lower than the Q4 average. And given the sizeable decline in the new orders index – down 4.6pts to 46.3, the lowest since May 2011 – today’s survey raises a significant probability that, despite the government’s efforts with its headline grabbing stimulus package late last year, things will get worse before they get better.

Indeed, even before the outbreak of the coronavirus, Japan’s economy was seemingly struggling to recover from the hit to domestic demand from October’s consumption tax hike. Today’s all industry activity figures suggested that total output merely moved sideways in December, leaving it down 1.4%Y/Y. Indeed, despite a pickup in manufacturing production in December (+1.2%M/M to be down 4.1%Q/Q in Q4 as a whole), tertiary activity slipped back (down 0.2%M/M in December and down 2.8%Q/Q in Q4) and today's release confirmed that construction fell for the seventh consecutive month and by a steeper 2.0%M/M, with a near-4%M/M decline in public sector work, to be down 2.9%Q/Q. Overall, this left all industry activity down more than 3%Q/Q in Q4, almost double the rate of contraction reported in the GDP release, and the steepest since the height of the Global Financial Crisis.

Turning to inflation, today’s figures broadly aligned with expectations. In particular, the headline CPI rate fell 0.1ppt to 0.7%Y/Y in January. (When adjusting for the effects of the consumption tax hike and government education polices, headline inflation stood at just 0.3%Y/Y). The weakness in the latest month principally stemmed from fresh food prices, which were down 2.0%Y/Y in January having risen by more than 2.0%Y/Y in December. Indeed, when excluding fresh food, the BoJ’s forecast core CPI measure edged slightly higher, by 0.1ppt to 0.8%Y/Y (although according to the Statistics Bureau on an adjusted basis it moved sideways at 0.4%Y/Y). But this rise reflected energy inflation (the first positive reading for six months). When also excluding such items, the BoJ’s preferred measure of core inflation fell 0.1ppt to 0.8%Y/Y (similarly unchanged on a tax-hike adjusted basis at 0.6%Y/Y).      

Overall, today’s figures suggest still very subdued underlying inflationary pressures. Indeed, services inflation fell to just zero in January, while non-energy industrial goods inflation moderated slightly too. Of course, if sustained, the recent sudden depreciation in the yen might offer some upwards price pressures in due course. And the disruption to supply chains might inject some extra pipeline pressures over the near term too. But there was little evidence of this in today’s PMIs – indeed, the composite input and output price indices fell 0.5pt in February. Overall, against the backdrop of weak economic growth, we expect underlying price pressures to remain very subdued and inflation (on all measures) to remain well below the BoJ’s 2% target.

Euro area:
Today will bring the week’s most notable new euro area data, the flash PMIs for February, which seem all the more important after the terrible Japanese figures. Last month, the manufacturing survey had suggested further progress towards stabilisation in the sector at the start of the year, with the respective euro area PMI up to a nine-month high of 47.9. And while the services PMI slipped back (52.3), the composite PMI rose to a five-month high (51.3). Uncertainty surrounding the impact of the coronavirus on both demand and supply seem likely to weigh on the flash manufacturing PMI for February, while the services survey is also expected to be a touch weaker again. So, the euro area composite PMI is also expected to fall in the latest month, and remain consistent with economic growth no firmer than the 0.1%Q/Q rate in Q4.

This morning’s other top-tier euro area data will be the final estimate of euro area consumer price inflation in January. While the final German figure on the EU measure aligned with the flash estimate of 1.6%Y/Y, yesterday saw the equivalent French figure revised up by 0.1ppt to a thirteen-month high of 1.7%Y/Y. Nevertheless, we expect the euro area headline rate to match its flash estimate of 1.4%Y/Y, marking a modest increase of 0.1ppt from December due principally to higher energy inflation. We do, however, see a non-negligible risk of an upwards revision of 0.1ppt to the core rate, for which the preliminary estimate declined 0.1ppt to 1.1%Y/Y. The final estimates of Italian inflation in January, as well as December industrial sales and orders data from the same country, are also due.

In addition, ECB Chief Economist Lane is due to give the keynote speech at the 2020 US Monetary Policy Forum, on “Monetary Policy for the Next Recession”, in New York. That event will also receive contributions from FOMC members Clarida, Brainard, Bostic and Mester.

Like in the euro area, the key economic focus in the UK today will be the flash PMI surveys for February. While the headline manufacturing PMI jumped in January to 50.0 (the first non-contractionary reading since April), it seems likely to have fallen back somewhat as concerns about external demand revived. The services PMI is also likely to have moderated from the sixteen-month high of 53.9 recorded in January, leaving the composite PMI consistent with only modest economic expansion in February. Finally, this morning will also bring January public finance figures, the last update before the 11 March Budget, at which a significant relaxation of the fiscal stance is now expected.

Finally, the US data-flow will similarly bring the respective flash Markit PMIs for February, as well as existing home sales figures for January.  In addition to the aforementioned appearances at the Monetary Policy Forum, Dallas Fed President Kaplan will also speak publicly.

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