Japan capex outlook unsurprisingly weak

Emily Nicol
Chris Scicluna

Overview:
After a late slump on Wall Street yesterday saw the S&P500 close 1.0% lower on the day, Asian stocks were somewhat mixed today, with China’s markets posting losses, while European equities have opened lower too. Nevertheless, Japan’s TOPIX trended gradually higher through the day to close up 0.6%. That followed the BoJ’s announcement, after markets had closed on Tuesday, that it will hold an emergency Policy Board meeting on Friday to discuss a new SME lending programme. A busy day of Japanese economic data, meanwhile, saw the latest machine orders data exceed expectations. But the underlying message of that release, as well as the latest Reuters Tankan and overseas visitors data, was still downbeat (see details below).

In government bond markets, moves were relatively limited. For example, having made modest gains yesterday, 10Y USTs have trended broadly sideways so far today, while JGBs were also little changed, with 10Y yields inevitably still hovering at the BoJ’s 0% target. In Australia, where yield curve control similarly remains highly credible, 10Y yields were a touch firmer even though the RBA extended to two weeks its run of making no bond purchases, while flash retail sales data reported a sharp double-digit slump in spending last month. After this morning’s UK inflation figures saw the headline rate predictably fall below 1% for the first time since 2016, Gilts were also making modest gains. And BTPs are a touch weaker ahead of the allotment of funds under the ECB’s first PELTRO funding operation, which has scope to provide support for bonds, particularly at the short end of the curve.

Looking ahead, today will bring final euro area inflation figures April, which might well see a downwards revision from the flash estimate, while the FOMC minutes are likely to further illustrate the Fed’s downbeat view of the economic outlook. BoE Governor Bailey will be speaking publicly.

Japan:
While the first estimate of Q1 GDP confirmed that private sector capex fell at the start of the year, the ½%Q/Q drop was perhaps smaller than might have been anticipated, even if it left it at the lowest level for three years. And today’s machinery orders data – which provide a guide to non-residential investment growth three months ahead – exceeded expectations in March too. In particular, core orders fell just 0.4%M/M following growth of more than 2%M/M in February. But the detail of the report was somewhat less encouraging.

Indeed, the increase of more than 5%M/M in orders placed by non-manufacturers was more than accounted for by a large one-off surge in orders for train carriages (orders in the transportation sector were up 82%M/M) and telecommunications equipment. In contrast, orders placed by manufacturers fell by more than 8%M/M, the largest monthly drop since September 2018, as orders placed by key export-oriented sectors declined sharply (e.g. electrical machinery -24½%M/M, autos -28½%M/M).

Of course, orders data are notoriously volatile. But when smoothing out monthly discrepancies, core orders still fell in Q1 for the third consecutive quarter and by 0.7%Q/Q. And given the current economic backdrop, the Cabinet Office’s orders forecast of a drop of just 0.9%Q/Q in Q2 seems on the optimistic side. Nevertheless, the forecast anticipates a much steeper contraction in orders from overseas (-13½%M/M), while government orders are expected to have risen around 4½%Q/Q following a 25½%Q/Q increase in Q1.

Today’s Reuters Tankan survey supported a more downbeat assessment of the near-term investment outlook, with a notable deterioration in business conditions reported among Japanese manufacturers and non-manufacturers alike in May. In particular, the headline manufacturing DI fell a further 14pts to -44, the weakest reading for almost eleven years, with a significant deterioration in sentiment among auto manufacturers – the relevant DI fell 25pts to -70. But non-manufacturers also expressed greater pessimism this month, with the headline DI down 13pts to -36, similarly the lowest since 2009. Retailers and wholesalers were unsurprisingly more downbeat, while the DI for the construction sector suggested that pessimists outweighed the optimists for the first time since 2012.

Moreover, despite Abe’s decision last week to lift the state of emergency across 39 prefectures, and the outbreak of coronavirus having remained relatively well contained even in Tokyo, Japanese firms were even more downbeat about the near-term outlook. Manufacturers forecast the DI to fall a further 7pts over the coming three months, with the non-manufacturing DI expected to drop to its lowest since the series began in the 1996.

Finally, but perhaps inevitably, data confirmed that the inwards flow of overseas visitors into Japan almost completely dried up last month. The number of visitors was down 99.9%Y/Y to just 2900, from more than 190k in March, 1.2mn in February, and 2,7mn in January.

UK:
Broadly in line with expectations, UK inflation fell sharply in April. In particular, the headline CPI rate fell 0.7ppt – the most in more than eight years – to just 0.8%Y/Y, the weakest rate since August 2016. Expect UK inflation to continue to fall steadily over coming months, and to be flirting with zero by year end.

The principle driver in April was, of course, the sharp drop in energy inflation, down 8.5ppt to -9.3%Y/Y, the steepest decline since 2015. Household energy inflation fell significantly thanks to the adjustment to electricity and gas price caps by the regulator OFGEM. And average petrol prices posted the steepest monthly decline since the current series for unleaded/ultra-low sulphur fuel was introduced 30 years ago.

Food and drink inflation provided some support, rising 0.3ppt to a four-month high of 1.7%Y/Y on firmer demand, with whisky and lager notable examples in this respect. Prices of toys and other recreational items were also higher as the housebound sought entertainment during the lockdown. But weak sales added further downwards pressure to inflation of several other goods, with clothes prices falling further on increased discounting online. And thanks not least to lower prices of transport, services inflation fell 0.5ppt to just 2.0%Y/Y, the bottom of the historical range. So, core inflation fell back too, declining 0.2ppt to 1.4%Y/Y, similarly the lowest since 2016.

Euro area:
Like in the UK, today will bring revised euro area inflation figures for April, which are expected to confirm the marked drop related not least to the slump in the oil price and the impact of the coronavirus pandemic. But after downwards revisions to the equivalent final French and Spanish figures last week, we would expect to see euro area headline inflation nudged lower from the preliminary CPI estimate of 0.4%Y/Y, which itself was 0.3ppt lower than in March and the weakest since September 2016. While the drop in headline inflation from March was due principally to lower oil prices, the flash estimate of the core CPI rate eased 0.1ppt to 0.9%Y/Y. Meanwhile, despite the easing of lockdown measures across much of the region this month, the Commission’s preliminary consumer confidence indicator is forecast to suggest that morale weakened further in May.

US:
In the US, attention will stay on the Fed, with the FOMC scheduled to release its late-April meeting minutes. While the minutes are not expected to provide any fresh clues on the Fed’s next moves, they will further illustrate the Fed’s gloomy view of the economic outlook, with many officials having recently downplayed the prospects for a speedy recovery.

Australia:
According to preliminary data released today by the ABS, following a surge in March (8.5%M/M) on panic-buying of essentials, the nominal value of Australian retail sales fell a record 17.9%M/M in April to be down 9.4%Y/Y. The drop was led by food retailers, whose turnover plummeted a little more than 17%M/M in April, reversing a good share of the extreme rise of about 24%M/M in the prior month. That, nevertheless, still left their sales up 5%Y/Y. Unsurprisingly, the ABS also reported that Australia’s social distancing rules continued to take their toll on cafes, restaurants and takeaway food services as well as apparel, leaving turnover in those sectors roughly half the level a year earlier. In contrast, online retail turnover continued to see strong growth.

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