Manic Monday

Emily Nicol
Chris Scicluna

A shocking start to the week for markets:

  • Stocks have been in free-fall. Japan’s TOPIX closed down 5.6%, European stocks have opened down more than that (FTSE 100 currently down more than 8.0%, DAX down more than 7.0%), and S&P500 futures are also down >5%.
  • USTs and Bunds have rallied hard, with the former pricing further rate cuts and QE. 2Y UST yields are down about 20bps to about 0.30% with futures suggestive of a further 75bps cut this month. And 10Y yields are down roughly 30bps to below 0.5% and 30Y yields down about 50bps to near 0.75%, obviously new record lows. In Europe, yields on 10Y Bunds are down more than 10bps to new lows close to -0.85%. But with Italy’s economic heartlands now under quarantine, those on 2Y BTPs have leapt 45bps to close to 0.50%.
  • In Japan, moves in yields have been somewhat less dramatic: 2Y yields are nevertheless down more than 4bps to about -0.35% with 10Y JGBs having briefly dropped to -0.20%. But the flight to quality saw the yen continue to appreciate sharply, now close to ¥102/$, prompting comments from the MoF’s senior official responsible for market intervention, Takeuchi, stating that overly volatile currency moves aren’t desirable but declining to comment on whether or not Japan’s authorities had intervened to try to slow the pace of appreciation. PM Abe announced plans for government agencies to provide support, including interest-free loans, to SMEs suffering a sharp hit to revenues due to the coronavirus, but a survey pointed to deep recession in Japan (detail below).
  • Following the failure of OPEC to reach agreement on production cuts, oil prices have plummeted by about one third (Brent crude down below $34bbl, the lowest since Q116), a move which, if sustained, will push inflation sharply lower over coming months, and further hit global trade and investment.

Against this dire backdrop, rate cuts as well as asset purchases and liquidity facilities (or at least amendments to current programmes in those respects) will be considered sooner rather than later by the major central banks. Indeed, a further emergency rate cut from the Fed before next week’s scheduled FOMC meeting is a distinct possibility. The BoE might also cut rates pre-emptively, albeit possibly not before Wednesday’s Government budget announcement, after which a new special liquidity scheme might well be on the table.

If the yen keeps appreciating, the BoJ might also be tempted to cut its negative policy rate (albeit with an adjustment in the tiering ratio) before next week’s scheduled policy meeting. And while it will wait for its scheduled policy meeting this Thursday, the ECB’s Governing Council seems bound to take action. And while the hurdles to act seem higher in Frankfurt than elsewhere, extra corporate bond purchases as well as a lower rate on its special TLTRO-III loans seems likely to be forthcoming, and a further cut in the deposit rate can also certainly not be ruled out.

While Japanese headlines focused on the downwards revision to Q4 GDP – which delivered the steepest pace of quarterly contraction since the consumption tax hike in 2014 (see more details below) – of more relevance for the near-term economic outlook was February’s survey of Economy Watchers. And this offered a dire assessment of current conditions, seemingly dashing any hopes that Japan might possibly avoid recession. Accordingly, the government confirmed over the weekend that it would offer financial assistance to firms affected by the coronavirus, with Japan Finance Corporation and other organisations set to provide interest-free loans for small- and medium-size companies that are experiencing a sharp drop in revenue.

Looking at the detail, the economy watchers survey saw the headline current conditions DI plunge 14½pts in February – the largest one-month drop since the April-2014 consumption tax hike – to 27.4, the lowest level since the 2011 Great East Japan earthquake, with a significant slump in both household and corporate-related demand. Indeed, economy watchers noted a rapidly deteriorating situation due to the coronavirus, with an even more severe outlook – the outlook component fell more than 17pts to 24.6, the lowest since the height of the Global Financial Crisis.

In terms of Q4 GDP, headline growth was revised 0.1ppt lower to -1.8%Q/Q, only a fraction smaller than the drop seen immediately after the consumption tax hike in 2014. And with the modest growth previously estimated in Q3 completely revised away, this left the annual rate down 0.7%Y/Y. Within the detail, the revision reflected private non-residential investment, which fell a steeper 4.6%Q/Q in Q4, the largest quarterly drop since Q109. But other expenditure components remained weak – i.e. household consumption fell 2.8%Q/Q, residential investment fell 2.5%Q/Q, while government consumption rose just 0.2%Q/Q. And so, with the absence of a notable drop in imports (-2.7%Q/Q) boosting net trade by 0.5ppt, the drop in GDP in Q4 would have been even steeper.

Later this week (Thursday) we’ll see the first large-scale business sentiment survey result for Q1, compiled by the MoF and Cabinet Office. This seems bound to show a notable deterioration in overall business conditions in the first quarter of the year as overseas and domestic economic outlook worsened in light of the coronavirus outbreak. This survey’s forecast for the coming two quarter might also anticipate the weakness to be maintained into Q2 too. Thursday will also bring the latest goods PPI figures for February, which are expected to show the headline inflation rate fell back due to weaker energy prices.

Euro area:
All eyes this week will be on the ECB, with the Governing Council’s latest scheduled meeting set to conclude on Thursday. Based on early indications of the hit to activity in various sectors, not least travel, tourism, recreation and hospitality, as well as recent market moves, recession in the euro area in first half of the year is a non-negligible probability. And inflation will likely drop to below 1%Y/Y in March, and close to ½%Y/Y in Q2 and perhaps also well into the second half of the year too. And given the appalling financial market backdrop, it would simply be absurd if the ECB didn’t act this week.

Quite what the ECB will agree to do, however, is unclear. Just as last September’s easing package proved divisive, with several Governing Council members opposed particularly to the resumption of net asset purchases, there will also be opposition to aggressive monetary easing this time around. Many members remain sceptical about the wisdom of that last decision to recommence QE. Several also have doubts about the appropriateness of cutting the deposit rate further given concerns about potential negative side-effects. And another TLTRO-III operation is already to be conducted this month, with bids due by 18 March.

Reports have suggested that, like the BoJ and BoE, the ECB is considering a special facility to support lending to SMEs affected by the coronavirus. But designing an effective system for a region of nineteen member states, where governments might be required to indemnify against losses, will be complex. And while Lagarde might announce plans to develop such arrangements, the detail would likely need to be finalised at a future meeting.

In the meantime, however, the Governing Council would be justified in announcing more generous conditions, including a lower interest rate, for the current round of TLTRO-III loans. It might also announce an explicit increase in its corporate bond purchases, which have averaged just over €4.5bn per month over the past four months. And, if the euro keeps appreciating and financial market measures of inflation expectations keep falling, we certainly would not rule out a further 10bp cut in the deposit rate to -0.60%, offset somewhat with an increase in the increase the share of banks’ deposits exempt from the negative deposit facility rate to soften the impact on the banking sector.

Against the current backdrop, this week’s data releases for January should be of relatively little relevance for the ECB’s decision. Nevertheless, they will still provide an insight into the strength of the incipient recovery in the manufacturing sector at the start of the year, with euro area IP figures due for release on Thursday. These have been expected to show that output rose almost 1½%M/M in January, albeit not fully offsetting the drop of more than 2%M/M in December.

But this forecast is subject to upside risks following this morning’s mega showing from Germany. In particular, German IP rose a whopping 3.0%M/M in January – the most since November 2017 – following a smaller contraction (-2.2%M/M) in December than initially estimated. This in part reflected a more than 4½%M/M jump in construction. But production of intermediate goods also surged (5.1%M/M) by the most for more than two decades. So, with output of capital goods up more than 2%M/M, total manufacturing production rose 2.8%M/M. Admittedly, production of consumer goods was weak (-3.2%M/M). And total IP was still down compared with a year earlier (-1.3%Y/Y). French and Italian IP numbers are due tomorrow, followed by Dutch figures on Wednesday.

Elsewhere, the Bank of France’s latest business sentiment survey for February suggested this morning that conditions held up relatively well last month as activity in manufacturing and services increased. For example, the headline sentiment indicator was unchanged at 96 as manufacturers (particularly in the autos sector) saw improved production. However, the headline services indicator fell 2pts to 96, to its lowest level since August 2016. And business leaders expected activity to decrease in March in most sectors given the coronavirus outbreak. Overall, the Bank of France revised down its expectation for Q1 GDP by 0.1ppt to 0.1%Q/Q. But this might seem somewhat optimistic. Certainly, we see a significant probability that the economy entered recession at the turn of the year.

Also of note will be tomorrow’s release of updated euro area national accounts figures for Q4, which will provide the first official expenditure breakdown. While GDP growth is expected to be unrevised at 0.1%Q/Q, we expect household consumption growth to have slowed to its weakest rate since Q114 to provide only modest support. And a boost from net trade will likely be more than offset by a drag from inventories. That day will also bring updated Q4 employment figures. Tomorrow will also bring German labour costs figures for Q4. The end of the week will see the release of final February inflation figures from Germany, France and Spain. In the markets, Germany will sell 10Y Bunds on Wednesday.

Last week, Mark Carney wouldn’t rule out an emergency policy announcement from the BoE before the next scheduled MPC meeting on 26 March. And we certainly wouldn’t be surprised to see one this week, albeit perhaps not before the Chancellor’s Budget statement on Wednesday. Certainly, the Government will announce budgetary stimulus that day, increasing the profile of borrowing over the course of the Parliament with a relaxation of its fiscal rules to allow for that. And while UK Finance, which represents the main High Street banks, announced last week that its members would support customers hit by the virus by possibly increasing overdrafts or offering repayment relief, the Chancellor looks set to unveil a new programme of loan guarantees for affected firms. To support that agenda, the BoE might be expected to bring back a variant of its Term Funding Scheme to support lending. An adjustment to banks’ countercyclical buffer rate, which is currently scheduled to be increased at the end of the year, could also be made. And an emergency rate cut – of either 25 or 50bps – might yet be forthcming this week too.

Wednesday will also be the most notable for UK economic releases, with monthly GDP, output and trade figures for January due. GDP is expected to have increased by 0.2%M/M that month, reflecting modest growth in services and manufacturing output. But having recorded the first surplus since the mid-1980s in December, the goods trade balance is expected to have returned to deficit as the one-off effect boosting December’s outturn reversed. This week will also bring the BRC retail sales monitor for February (tomorrow) and the RICS house price survey (Thursday). In the markets, the DMO will sell 10Y Gilts tomorrow.

In the US, while all eyes will be on the Fed, the coming week’s data calendar kicks off tomorrow with a noteworthy survey – the latest NFIB small business optimism index – and will also conclude with the preliminary University of Michigan’s consumer sentiment survey for March on Friday. Both should be closely watched seem bound to suggest a drop in confidence as the coronavirus spread in the US. Indeed, while February’s headline consumer confidence index rose to its second-highest reading since the early 2000s, the survey flagged some growing concerns in the latter responses and global equity markets have subsequently plummeted.

In between, Wednesday’s release of February CPI figures will be most noteworthy. With prices expected to be unchanged on the month, the annual inflation rate is forecast to have fallen back last month, by 0.3ppt to 2.2%Y/Y on the back of lower energy inflation. Indeed, core inflation is anticipated to be little changed at 2.3%Y/Y. In terms of politics, tomorrow will also bring the results of the Democrat primaries in a further 6 states, to leave 48% of delegates determined. In the markets, the Treasury will sell 3Y notes tomorrow, 10Y notes on Wednesday and 30Y bonds on Thursday.

With expectations rising that the RBA will cut rates again next month and move to QE sooner rather than later, sentiment surveys will dominate the Aussie data flow this week, with the NAB business survey for February due on tomorrow and the monthly Westpac consumer confidence survey for March due on Wednesday. Both surveys are likely to point to a deterioration in sentiment, with the tourism sector significantly disrupted by ongoing travel restrictions due to the coronavirus outbreak.

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