Financial markets in free-fall

Emily Nicol
Chris Scicluna

Risk continues to evaporate ahead of a weekend that seems far more likely than not to bring bad news on the coronavirus epidemic. Asian stock markets fell markedly across the board. Japan’s TOPIX closed down 2.9%, not helped by an appreciation of the yen through 106/$, or some weak domestic spending figures and a fall in the Cabinet Office’s leading index to its lowest since the Global Financial Crisis (see discussion of all the Japanese data below). Meanwhile, Korea’s KOSPI fell 2.2% and China’s CSI300 was down 1.6%. European stocks have unsurprisingly fallen at the opening and US futures are down too.

But most striking were bonds, and in particular USTs, with 10Y yields down another 10bps in Asian time to hit new all-time lows around 0.81%, 30Y yields down by even more to new record lows near 1.40%, and 2Y yields also about 10bps lower at 0.50% as markets fully priced in another 50bps Fed rate cut on 18 March.

In the JGB market, 7Y cash yields fell most, down 7bps to -0.34%, while a margin call was made on long-term futures. Elsewhere on the cash curve, 2Y yields were down 3bps to -0.30%, 10Y yields down just 2bps to -0.14%, and 30Y yields were down about 3bps closer to 0.30%.

In Australia, the ACGB yield curve flattened significantly (2Y yields down just 2bps to 0.39%, but 10Y yields down 10bps to 0.67% and longer-dated yields down by even more than that) as the market upped its expectation that the RBA will soon move to QE, which it previously signalled would be contemplated once its cash rate is cut to 0.25%.

And euro govvies have rightly overlooked a very strong German factor orders data release, with Bunds making further gains and periphery bonds down. Looking ahead, the US payroll report later today might similarly point to economic growth, but that will probably also do nothing for the market mood. 

At face value, today’s Japanese trade figures for the first twenty days of February were much better than expected given that China had been in lockdown for that period (exports to that country account for 20% of Japan’s total shipments). Indeed, the value of exports was down just 0.8%Y/Y, admittedly likely flattered to some extent by the timing of the Lunar New Year. But even including January’s figures, the aggregate drop so far this year was relatively modest (2.3%Y/Y).

Of course, these data include just shipments of goods, with services exports last month bound to have been hit very significantly by reduced tourism on the back of the travel restrictions in place across much of Asia. And today’s data did flag some potential initial distribution to supply chains, with the value of Japanese imports down a whopping 16.6%Y/Y in the first twenty days of February. While some of this weakness no doubt reflects price effects (not least due to the drop in the price of oil and other commodities), if a similar pace of decline is maintained for the month as a whole it would exceed the annual drop in October 2019 when domestic demand was hit by the consumption tax hike. Indeed, it would be the steepest decline since late 2016.  

But even before the COVID-19 outbreak gained greater prominence there was no shortage of signs that domestic demand was still struggling to recover from October’s tax hike. In particular, today’s household spending figures reported the third monthly drop out of the past four in January, with 1.6%M/M decline leaving spending down almost 4%Y/Y. And when excluding expenditure on the more volatile items, core spending was down an even steeper 2.4%M/M (4.6%Y/Y). Admittedly, the BoJ’s consumption activity index – which recently has provided a better guide to the national accounts measure of consumption than the household spending release – was somewhat more encouraging, reporting the third consecutive increase in January, by 0.5%M/M. When adjusted for spending by overseas visitors, expenditure was a touch softer at 0.3%M/M.

Within the detail, there was a solid improvement in the durable goods component at the start of the year (3.7%M/M), albeit leaving growth on a three-month basis still firmly in negative territory (13.8%3M/3M). But there was a modest drop in expenditure on services in January (0.1%M/M). And with the government having recommended the cancelation of sporting and cultural events, major tourist attractions having temporarily closed, travel restrictions still in place and consumer confidence hit by the spread of the coronavirus in Japan, spending on services seems bound to fall more significantly over coming months.  Accordingly, we now expect private consumption to have contracted again in Q120.

There was some better news with respect to the latest wage figures at the start of the year, at least at face value. In particular, average labour earnings growth jumped 1.7ppts in January to 1.5%Y/Y, the strongest reading since 2018. Regular wage growth was also much stronger (up 1.1ppts to 1.4%Y/Y), while a jump in special/bonus payments (almost 10½%Y/Y) more than offset continued weakness in overtime earnings (-1.8%Y/Y).

But the reported headline wage figures have been distorted by sampling errors over recent years. And when adjusting for such inaccuracies, MHLW wage figures were more disappointing. Indeed, these showed that average wage growth actually fell back into negative territory in January (-0.1%Y/Y) for the first time in six months, with scheduled earnings up just 0.2%Y/Y, less than half the average pace of the past two years. And while regular earnings growth was firmer (0.6%Y/Y), this was merely in line with the average of the past two years and less than half the rate implied by the headline figures.

Overall, today’s figures continued to illustrate the difficult conditions faced by Japanese households at the start of the year. And the Cabinet Office’s composite index of business conditions – which offers a guide to GDP growth – suggested only modest improvement in January too. For example, the coincident index rose for the first month in three, albeit by just 0.3pt to leave it at 94.7, still the second-lowest reading since February 2013. Moreover, even before coronavirus concerns increased, the leading index flagged the challenging environment ahead, declining to its lowest level since the Global Financial Crisis more than a decade ago, consistent with another quarter of negative GDP growth in Q1 at least.                   

Euro area:
For what it’s worth, Germany’s factory orders data released earlier this morning smashed expectations, rising an extraordinary 5.5%M/M in January to be down just 1.4%M/M to suggest that the manufacturing sector was turning for the better at the start of the year before the coronavirus hit. Admittedly, the rise came on the back of December’s drop of 2.1%M/M to a four-year low. And these data are typically highly volatile. Moreover, the rise was significantly flattered by major orders, particularly in the aerospace sector and machinery.

Nevertheless, even excluding such major orders, new German factory orders rose 2.3%M/M to be down just 0.2%3M/3M and 4.0%Y/Y, the smallest year-on-year decline on this basis in a year. Excluding those bulky items, domestic orders were still unchanged, but orders from elsewhere in the euro area were up 2.0%M/M while those from beyond the euro area were up 5.2%M/M.

Within the detail, most major categories saw growth in orders in January (e.g. chemicals were up 7.0%M/M, and basic metals were up 2.5%M/M). But the dire performance in the autos sector continued, with total orders down another 0.5%M/M and domestic orders down almost 10% at the start of the year. (We already learned earlier this week that German new car registrations dropped 11.0%Y/Y in February).

Meanwhile, overall manufacturing turnover rose 2.0%M/M in January to suggest that the IP figures due to be released on Monday will also show a firm rebound. The consensus forecast is for growth of 1.7%M/M. But given the extreme weakness in manufacturing and (in particular) construction in December, we see the risks to that as skewed to the upside.  

In UK, meanwhile, today’s REC/KPMG Report on UK Jobs predictably suggested a further improvement in labour market conditions last month as businesses continued to see improved activity in the face of diminished political uncertainties. In particular, recruiters suggested that permanent placements rose at the fastest pace in fourteen months in February, while demand for staff also improved with vacancies rising by the most for more than a year. So, with recruiters citing a shortage of skilled candidates, today’s survey also implied a pickup in starting salaries, by the most since June. However, the outlook for jobs growth over the near term will undoubtedly be impacted by increased concerns about the coronavirus, with a notable hit already underway in the tourism and recreation-related sectors in particular.   

In the US, attention today will be on the BLS labour market report, which is expected to show that non-farm payrolls increased by a solid 175k last month, down from the 225k rise seen in January but in line with the average of 2019. The unemployment rate is expected to be unchanged at 3.6%, while average weekly earnings growth remained close to 3%Y/Y. Today will also bring full-month trade figures for January and consumer credit numbers for the same month.

While Q4 GDP growth came in a touch stronger than expected (0.5%Q/Q), household consumption remained disappointingly subdued against the backdrop of higher employee compensation. And today’s retail sales figures for January signalled a weak start to 2020 too. In particular, the value of sales was down 0.3%M/M following a steeper-than-previously-estimated drop of 0.7%M/M in December to their lowest level for a year. And the weakness was broad based, with department store sales down more than 2%M/M, household goods retailing down more than 1%M/M and cafes, restaurants and takeaway food services down almost ½%M/M.

Of course, bushfires in January negatively affected sales as interruptions to trading hours and tourism took their toll. Retailers will also continue to be impacted by the hit to tourism in light of the coronavirus-associated travel restrictions – indeed, RBA Deputy Governor Dubelle suggested in the past week that exports of tourism and education are likely to fall around 10%Q/Q, knocking around ½ppt off quarterly GDP growth in Q1. Taken together with the Reserve Bank’s expectation that the bushfire will knock a further 0.2ppt of growth, we would expect Q1 to deliver the first quarter of negative growth for nine years. Accordingly, markets are fully pricing in another 25bp cut in the cash rate to a record low (and lower bound) 0.25% next month.  

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