Key BoJ Tankan measures improve slightly in Q3

Chris Scicluna
Emily Nicol

Asian markets quiet due to Tokyo exchange hardware fault and start of Golden Week holidays
Positive risk sentiment returned to Wall Street on Wednesday, with the S&P500 gaining 0.8%, Treasury yields drifting higher and the US dollar continuing to give back some of its recent gains. That positivity appeared to owe to investors’ optimism that ongoing talks would lead to a resolution of the current impasse regarding additional fiscal stimulus. Speaking after his latest meeting with House Speaker Pelosi, Treasury Secretary Mnuchin said that talks had “made a lot of progress in a lot of areas”. However, as before, it remains far from clear that that the Republican-dominated Senate will accept a $2.2trn deal that will soon be voted on by House Democrats, with Senate Majority Leader McConnell saying that the two sides were still “far apart”.

While the gains on Wall Street provided a positive backdrop – and US futures have continued higher in Asia today – markets were always likely to be quiet in Asia with exchanges closed in China, Hong Kong, Taiwan and South Korea for national holidays. But the malaise was exacerbated by ‘technical’ problems at the Tokyo exchange which prevented the market from opening and eventually saw trading halted for the entire day – the worst ever outage for the bourse. According to the exchange the outage was caused by a hardware breakdown, as opposed to the hacking that impacted New Zealand’s stock exchange over four days last month. At the time of writing, the exchange is yet to confirm when trading will resume. Amongst the few markets that were open, gains of over 1% were seen in Singapore, while Australia’s ASX200 rose 1% thus erasing a good portion of the previous day’s losses.

In terms of economic data, the BoJ’s Tankan disappointingly suggested only modest improvement in conditions last quarter and only limited recovery anticipated this quarter too, while Japanese vehicle sales remained in reverse in September. Moving to Europe, govvies have maintained yesterday’s downward trend upon opening, despite some soft French car registrations figures published this morning, which suggested that the year to-date performance in the first nine months of 2020 was the weakest since 1975.

Japanese business conditions improve only slightly in Q3; only modest recovery expected in Q4
Aside from the problems at the Tokyo exchange, the key focus in Japan today was the BoJ’s Tankan survey for Q320. Investors were hoping to see some signs of improvement after the coronavirus pandemic had previously caused many of the key diffusion indices to plunge to post-GFC lows. And while the survey did indicate some recovery in business conditions in Q3, the extent of that improvement – and the further revival that was forecast for Q4 – was less than markets had expected. Meanwhile, with the full implications of the pandemic becoming clearer, firms revised down their forecasts for sales, profits and capex for the current fiscal year. And with firms now operating with a degree of spare capacity, inflation pressures and inflation expectations remained very weak too.

Turning to the detail, a net 28% of the 9,537 respondents reported unfavourable business conditions in Q3, down just 3ppts from Q2. The closely-watched diffusion index (DI) for large manufacturers improved by a smaller-than-expected 7ppts to a still very weak -27, with pessimism declining most in the petroleum sector and across various machinery-based industries. And looking ahead, a disappointingly high net 17% of large manufacturers continue to expect unfavourable business conditions to prevail in Q4. Moreover, that forecast is based on an assumed exchange rate of ¥107.02/$ over the second half of FY20, so these firms would likely be even less confident if the yen were to remain around its current level of around ¥105/$. As is usually the case small- and medium-sized firms were even less positive, both about the past quarter and prospects for the coming quarter. For example the DI for small manufacturing firms increased a very disappointing 1ppt to -44 in Q3, while a similarly disappointing net 38% of firms expect that business conditions will remain unfavourable in Q4.

Moving to the non-manufacturing sector, the DI for large firms improved 5ppts to -12 – a pickup that also fell short of market expectations. Not surprisingly, conditions remained especially dire in the hospitality sector, with the relevant DI rising just 4ppts to -87. Firms providing services to individuals also remained very downbeat. However, retailers were notably more positive, with a net 18% of firms now describing conditions as favourable – up 16ppts from the prior survey. The communications industry also reported a double-digit improvement, with its DI rising 13pts to +21. Looking ahead, a net 11% of large non-manufacturing firms expect conditions to remain unfavourable over Q4, indicating that in aggregate these firms expect very little improvement over this period. This result reflects a notable weakening of expected conditions in the retail, construction and information services industries, which largely offsets the expected improvement in several other industries (especially services for individuals). As in the manufacturing sector, small- and medium-sized firms were even more negative about both Q3 and the outlook for Q4.

With the full impact of the pandemic becoming clearer, firms now forecast that aggregate sales will decline 6.6%Y/Y in FY20 – a 2.8ppts deterioration from the prior survey. This mainly reflects a 10%Y/Y decline in sales over the first half of the year, with sales over the second half expected to be down 3.3%Y/Y. Manufacturers’ sales are forecast to decline 7.4%Y/Y, whereas non-manufacturers expect a 6.2%Y/Y drop. In aggregate current profits are now expected to have fallen 28.5%Y/Y in FY20 – a deterioration of almost 11ppts from the prior survey. While the largest part of that decline has already occurred, firms still expect a 15.7%Y/Y decline in profits over the second half of FY20, with similar declines forecast in the manufacturing and non-manufacturing sectors alike. As a result, the overall profit margin for all firms is forecast to decline to 4.01% in FY20, down from 5.23% in FY19. This is 0.35ppts weaker than suggested in the prior survey and below the average over the past decade by a similar amount.

Not surprisingly, the pessimistic outlook for sales and profits has translated into a weaker outlook for capital spending, although the deterioration appears to have been less than the market had expected. Following a 0.6%Y/Y decline in FY19, total capex (including land investment) is now forecast to fall 2.7%Y/Y in FY20 – 1.9ppts weaker than in the prior survey. While large manufacturers expect to lift capex by 3.5%Y/Y, large non-manufacturers expect little change in their spending and large declines in spending are forecast by small and medium-sized firms across both sectors. In our opinion these capex forecasts still appear overly optimistic, especially given the slump that has already been measured in Q2 and the early indications for Q3. Moreover, as was the case in the prior survey, manufacturers indicated that they were overstaffed in Q3 and they expect to remain so in Q4. So in contrast to the situation before the pandemic, labour shortages are unlikely to be a key driver of investment spending at present. A net 19% of firms described the lending stance of financial institutions as “accommodative” – unchanged from the previous surveys – suggesting that finance remains available to those firms that are willing to invest.

Reflecting soft demand, sizeable net proportions of both manufacturing and non-manufacturing firms continued to report excess supply conditions and excessive inventories. Therefore, unsurprisingly, the Tankan also contained bad news for the BoJ’s drive to lift inflation to its 2% target. While a small proportion of firms reported rising input prices, firms continued to report that they had cut output prices and that they would do so again in Q4. Indeed, in aggregate, firms forecast a 0.2% cut in their output prices over the next 12 months and only a cumulative 1.2% increase over the entire 5-year forecast horizon. And regarding general consumer prices, firms expect only a 0.3% increase over the next 12 months with inflation expected to be running at just 0.8% in five years’ time – the latter forecast revised down 0.1ppt from the previous survey and weakest response since this part of the survey began in 2014.

Japan’s manufacturing PMI revised up slightly; vehicle sales still weak in September
In other news, the Jibun manufacturing PMI was revised up 0.4pt to a final reading of 47.7 in September, leaving it 0.5pt above its August reading and just shy of where it had stood in February. The output index was upwardly revised by 0.8pt to 46.0, more than unwinding the decline reported in the preliminary report. Less positively, the new exports orders index was revised lower, erasing almost all of its previously reported gain. The new orders index was little changed, however, leaving it with a solid 1.3pt gain for the month and at an 8-month high of 47.3. On the pricing side, the preliminary sharp decline in the output prices index was largely revised away, with the final reading of 49.4 sitting above the long-run average for the series – albeit an average that has not been consistent with achieving the BoJ’s inflation target.

In other news, the number of vehicle sales fell 15.6%Y/Y in September, representing only a modest improvement on the 18.5%Y/Y decline registered in August. Most of the improvement was due to smaller declines in bus and truck sales, with the 16.0%Y/Y decline in car sales during September being almost unchanged from the previous month.

French car registrations remain in reverse
Today will also bring car registration figures from three of the four largest euro area member states. And this morning’s French release continued to offer a relatively bleak assessment for the sector, with registrations down 3%Y/Y in September. Admittedly, this was an improvement on the near-20%Y/Y drop recorded in August despite the recent spike in coronavirus cases across the country. Nevertheless, it left sales in the first nine months of the year at just 1.17mn, a drop of almost 30%Y/Y compared with the equivalent period in 2019 and the lowest number of units registered during that period since 1975. Spanish figures – due later this morning – are similarly likely to report ongoing weakness, while Italian registrations might well have fared a little better, not least given that new daily coronavirus infections have remained under control.

Euro area unemployment expected to tick slightly higher
The weakness in demand is hardly surprising given the bleak outlook for the labour market. This notwithstanding, with various job support schemes still in place, the pickup in unemployment across the region has so far been limited. And today’s euro area labour market figures for August are expected to show the unemployment rate tick only slightly higher, albeit rising above 8% for the first time in more than two years.

This morning will also bring the final September manufacturing PMIs from the euro area and member states. These are likely to confirm the uptick seen in the flash estimate, which saw the headline euro area PMI rise 2pts to 53.7, a more-than two-year high, seemingly driven by a rebound in the German sector. This release will also include PMI outturns from Italy and Spain for the first time. Elsewhere, ECB Chief Economist Lane will again be in action at an online conference in the afternoon.

UK final manufacturing PMIs likely to have slipped back
In the UK, today will bring just the final manufacturing PMI for September. In contrast to the euro area, the flash headline manufacturing index fell back this month (down 0.9pt to 54.3), with the output component down a steeper 1.7pts, albeit to a still elevated level of 59.3, the second-strongest reading in six years. And while the government has subsequently announced stricter containment measures affecting customer-facing services, this seems unlikely to have had a material impact on conditions in the manufacturing sector.

Australia’s CBA manufacturing PMI still solid after revision; housing and job data improving
In contrast to Japan, Australia’s final CBA manufacturing PMI was revised down 0.1pt to 55.4 in September, albeit still leaving it up 1.8pts for the month and at its highest level since April 2018. In the detail the most significant downward revision was to the new export orders index, which nonetheless remained up 5.6pts for the month and at an 8-month high of 50.5.

In other Aussie news, the improving trend in the housing market was highlighted by the Corelogic house price index, which fell just 0.2%M/M in September – the smallest fall since prices began declining in May, but still sufficient to lower annual growth to 4.9%Y/Y. Not surprisingly, the weakest market remained Melbourne, where prices fell 0.9%M/M. Prices also fell 0.3%M/M in Sydney, but increased in each of Australia’s remaining capital cities. Indeed, prices increased in Brisbane and Perth for the first time since the onset of the pandemic.

Finally, after declining by over 40% in Q2, the ABS measure of job vacancies rebounded a record 59.4% in Q3. Even so, the number of vacancies remains over 9% below pre-pandemic levels.

US spending and income data and manufacturing ISM due for release later
A busy day for US economic releases will bring several releases of note, including August personal income and spending figures. These are expected to show that income declined as the impact of job growth was more than offset by the waning of fiscal transfers. Even so, retail and auto sales data point to a further lift in consumer spending during the month. The reverse of spring discounts should see the core PCE deflator post a further 0.3%M/M lift, nudging annual inflation up 0.1ppt to 1.4%Y/Y. This afternoon will also bring auto sales data for September and the manufacturing ISM for the same month. Regarding the latter, while the manufacturing sector remains in recovery mode, the recent pace of activity appears to have waned and we might well see the headline ISM fall back from the elevated level seen in August (56.0) which was the highest since late 2018.

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