Record levels of coronavirus cases; BoJ revises down forecasts and ECB set to be dovish

Chris Scicluna

Equities reopen on back foot due to fiscal impasse and as new coronavirus cases hit record levels
After opening positively but then quickly sliding into the red, Wall Street staged an afternoon recovery on Friday as investors reacted to White House Chief of Staff Meadows’ suggestion that a stimulus deal might be close at hand. As a result, at the close the S&P500 was up 0.3% for the session, thus paring its loss for the week to 0.5%. However, with no fiscal deal emerging over the weekend and coronavirus case numbers continuing to skyrocket to record levels in many countries – daily new cases exceeding 85,000 in the US and a shocking 52,000 in France, with Spain announcing new curfew rules and Italy announcing new restrictions on the leisure industry – markets have reopened with a risk-averse tone. As we write, S&P minis are down 1.1% and so near their lows for the session, with European stock futures down too. In the bond market, US Treasuries have strengthened, with the 10-year yield falling more than 3bps from Friday’s close to below 0.81%. In Europe, Bunds have followed USTs higher too, with 10Y yields down 1.5bps to below -0.59%. And after S&P on Friday revised up the outlook on Italy’s credit rating to stable from neutral, BTPs have rallied, with 10Y yields currently more than 8bps lower at 0.67%.

Given that background, Asian equity markets also began the week on a softer note during what was a quiet session for news in the region (and with markets in Hong Kong and New Zealand closed for national holidays). In Japan, the Topix fell 0.4% even as PM Suga, delivering his first policy speech in the Diet, pledged to seek a virtuous cycle between the economy and the environment that would make the country carbon neutral by 2050. Suga – whose approval rating fell 11ppts to 63% in the latest Nikkei poll – also reiterated his pledge to reinvigorate the economy, including by building an international financial centre in Japan. Outside of Japan, stocks also moved lower in South Korea and in China, too where the Communist party leadership is now holding its Fifth Plenum to set the course of policy over the coming five years. Bond yields also moved lower across the region, with the 10-year ACGB falling 5bps to 0.80% and JGB yields very slightly lower too.

Looking ahead, the intensification of the pandemic is bound to remain at the forefront of concerns this week, not least at the ECB and BoJ where policymakers will announce their latest decisions on Thursday. With the spread of the virus weighing particularly heavily in Europe, expect the former in particular to be dovish, while the latter will revise down its forecasts. The first estimates of US and euro area Q3 GDP, also due in the second half of the week, will suggest a relatively vigorous rebound in activity last quarter, but this is history and the outlook for Q4 is certainly clouding. Meanwhile, euro area and Tokyo CPI data, due on Friday, will remain extremely weak.

Japan’s services prices rise more than expected in September
This week’s Japanese data flow kicked off today with the BoJ’s services producer price report for September. The overall index increased 0.1%M/M, unexpectedly raising the annual rate of inflation by 0.2ppt to 1.3%Y/Y (the August reading was revised up 0.1ppt to 1.1%Y/Y). However, these figures continue to include the impact of last year’s consumption tax hike. Prices fell 0.5%Y/Y once that impact is excluded, although this did mark the smallest decline since March. And this price decline remains broad-based, with annual deflation recorded in six of the seven major groupings. Only the ‘other services’ group recorded an increase – and even then by just 0.1%Y/Y – as price increases for some items were largely offset by the impact of a 33.1%Y/Y decline in hotel charges (still held down by the Government’s ‘Go-to-Travel’ subsidy).

In other news, the Cabinet Office released the final values of its business conditions indices for August. The coincident index was revised down by 0.2ppts to 79.2 and the leading index was revised down by 0.4ppts to 88.4 respectively, slightly reducing their monthly gains to 0.9pts and 1.7pts respectively. Unfortunately these levels remain well below average, consistent with an economy operating well below trend.

BoJ set to revise down forecasts, with CPI and IP data to come on Friday
Looking ahead, the key event in Japan this week is Thursday’s BoJ Board meeting and updated Outlook Report. That said, with the Japanese economy presently undergoing a moderate recovery, the majority of the BoJ’s Board has shown little inclination to ease policy further at this stage. So it seems likely that the Board will again leave its key interest rate and YCC settings unchanged, and likewise maintain its current targeted pace of financial asset purchases and the corporate lending support it is providing via the banking sector – the latter probably the most important component of its policy at present.

As far as the Outlook Report is concerned, despite favourable developments in some key trading partners – notably China and the US – we can see little grounds for the BoJ taking a more optimistic view on growth than already espoused in the last Outlook Report in July (a median forecast contraction of 4.7% in FY20, followed by growth of 3.3% and 1.5% in FY21 and FY22 respectively). Rather, it seems more likely that the BoJ’s Board will forecast a slightly larger contraction in FY20, while the balance of risks to growth will remain to the downside given the still very uncertain path of the pandemic and the impact that this will have on Northern Hemisphere countries over the winter. Meanwhile, the near-team inflation outlook appears marginally weaker due to ongoing government measures to boost demand in the hospitality sector. Reports last week suggested that the BoJ will highlight the impact of those measures in its forecasts, to better expose the underlying trend and
– optimistically – lean against a further decline in inflation expectations.

Turning to this week’s Japanese data, following on from Friday’s national CPI report, tomorrow the BoJ will release its range of underlying inflation measures for September (last month the trimmed mean reported no change in prices over the past year). The retail sales report for September is released on Thursday, together with the Cabinet Office index of consumer confidence. While both reports should reveal sequential improvement from the previous month, annual growth in retail sales will weaken sharply due to the high base provided by last year’s pre-tax hike surge in spending.

The highlight of a busy Friday will be the preliminary IP report for September. Improved business survey and exports data point to a solid lift in output, perhaps reducing the annual decline in production to less than 10%Y/Y. Perhaps of more interest will be manufacturers’ forecast for output over the next two months. That day will also bring information on housing starts and construction orders during September, together with the monthly household labour force survey. The latter seems likely to continue the recent trend of employment growth insufficient to soak up new labour market entrants, leading to a slight uptick in the unemployment rate. Finally, the advance CPI report for the Tokyo area for October will be also be released on Friday. This month will see the first round impact of last year’s consumption tax hike and reduction in school fees drop out of the annual calculation. And prices will remain depressed by government measures to boost demand in the hospitality sector. As a result, after rising slightly last month, the BoJ’s forecast measure of core inflation (i.e. CPI ex fresh food) is likely to dip deeper into negative territory in October.

ECB likely to be dovish ahead of GDP and CPI data at end of the week
The main event in the euro area this week will be the conclusion of the ECB policy meeting on Thursday. Since the previous meeting in early September, the pandemic has worsened markedly, with a significant second wave underway across the region. As illustrated by Friday’s flash PMIs, the intensified spread of Covid-19 and associated re-imposition of restrictions on activity has taken its toll on the economic recovery in the services sector. At the same time, core inflation has weakened to a record low. And fiscal policy looks set to be broadly neutral, with member state governments seemingly reluctant to tap loans under the EU’s Recovery and Resilience Facility due to concerns about conditionality. So, it’s unsurprising that the tone of recent commentary from various Governing Council members has been increasingly dovish. Indeed, even the more usually hawkish – e.g. Dutch Central Bank Governor Knot and soon-to-depart Executive Board member Mersch – have acknowledged that more stimulus might be merited in due course.

Nevertheless, with a little less than half of the €1.35trn PEPP envelope filled, the Governing Council will see no need to add stimulus at this month’s meeting. Instead, reports suggest that the members will discuss the effectiveness of all of its asset purchase programmes, perhaps as a first step to deciding with which policy tool to add further accommodation at the final meeting of the year in December. However, with the account of the September meeting – which had a more dovish tone than the press conference – having made clear that the PEPP is currently the preferred tool, and the pandemic is becoming increasingly rife, we expect the envelope for that programme to be increased by about €650bn to €2trn at the December meeting. In her press conference, therefore, Lagarde might well signal the likelihood of additional easing by the end of the year if conditions do not improve.

This week will also be a busy one for top-tier economic data, with the most noteworthy releases the first estimates for Q3 GDP and October inflation at the back end of the week. Despite a recent slowing in the recovery, with activity having posted significant growth during the summer after lockdown measures were initially relaxed, euro area GDP – due for release on Friday – is expected to have risen at a historical magnitude this quarter, with our forecast for growth of 10½%Q/Q. Of course, this would mean that just 60% of the pandemic-related slump had been reversed, with output still more than 6% below its Q419 level. The country releases – the largest four member states will also publish figures on Friday – are all are expected to show that GDP rebounded vigorously in Q3. We expect German GDP to have risen by around 7½%Q/Q, while data from France, Italy and Spain will reveal significantly stronger rates of growth following significant double-digit rates of decline in Q2.

Meanwhile, given the still significant amounts of spare capacity, as well as temporary Covid-related disruption to demand, October’s inflation release will continue to show that underlying price pressures remain subdued. But likely reflecting a pickup in clothing inflation as the impact of delayed summer discounting plays out, we expect the euro area’s headline and core CPI rates to rise, perhaps ticking up 0.1ppt each to -0.2%Y/Y and 0.3%Y/Y respectively. Friday also brings euro area labour market figures for September, which are expected to show a further uptick in the headline unemployment rate from 8.1% in August, although this will remain limited by the various government employment and wage-support schemes in place across the region.

Ahead of this, today’s German ifo business climate survey should highlight the favourable conditions in that country’s manufacturing sector suggested by the flash PMIs. Tomorrow’s ECB monthly bank lending figures and quarterly bank lending survey should continue to suggest that financial conditions remain favourable and supportive of economic recovery. But the European Commission’s sentiment survey for October – on Thursday – is likely to add to evidence of weakening services activity at the start of Q4.

Thursday’s Q3 GDP report the highlight of a busy week in the US
This week’s busy US economic diary kicks off today with new home sales data for September and the Dallas Fed’s manufacturing survey for October. Tomorrow the main focus will be on the durable goods orders report for September and the Conference Board’s consumer confidence survey for October. The Richmond Fed’s manufacturing survey for October is also released tomorrow, alongside the S&P/Corelogic and FHFA home price reports for August. On Wednesday we will receive advance goods trade and inventory data for September, which will allow analysts to fine-tune their estimates for the advance release of GDP for Q3 on Thursday. As far as GDP is concerned, at present Daiwa America’s Mike Moran estimates that the economy rebounded about 30%Q/Q in Q3 – impressive enough but still only sufficient to reverse about 60% of the contraction recorded during the first half of this year. Aside from the GDP report, Thursday will also see the release of pending home sales data for September, together with the weekly jobless claims report.

On Friday the week concludes with the release of the personal income and spending report for September, which will make explicit the monthly profile that underpinned the previous day’s national accounts consumption aggregate. That report will also provide the monthly profile for the core PCE deflator, which is expected to rise 0.2%M/M to push the annual rate up to 1.7%Y/Y in September reflecting the recent reversal of some pandemic-driven discounting. Friday will also bring the release of the Employment Cost Index for Q3, the Chicago PMI for October and the final results of the University of Michigan’s consumer survey for October. Given the proximity of the next FOMC meeting there is no Fedspeak scheduled over the coming week. However, aside from data, with the Presidential election now just over a week away, there will clearly be a heavy focus on politics and the prospect of post-election policy stimulus. It is also a very busy week for corporate earnings with 180 S&P500 companies due to report this week.

A quiet week for UK data as Brexit negotiations continue in the background
In contrast to the euro area and US, this week should be very quiet for UK economic data. Tomorrow’s CBI distributive trades survey for October will be of most interest in the first half of the week. With new Covid containment restrictions in place and consumer confidence having weakened significantly, retail sales growth might be expected to have slowed at the start of Q4. However, stock-piling of essentials might provide additional support. In addition, the Bank of England’s latest lending figures (due Thursday) are likely to show that demand for consumer credit remained weak in September. In contrast, mortgage lending is likely to have remained relatively robust, with mortgage approvals close to multi-year highs as the impact of lockdown-related backlogs and Stamp Duty holiday boosted demand. Thursday will also see the release of the SMMT auto production figures for September.

China’s 5-year plan and official PMIs in focus this week
Today marked the beginning of the 4-day plenary session of the CPC’s Central Committee, at which Chinese leaders are primarily meeting to discuss the 14th 5-year plan that will be used to guide the economy’s development during 2021-2025, and which will eventually be approved at the National People’s Congress in March. The meeting is not open to the public and the plan won’t be released in full ahead of its approval, but some elements may be released after the session concludes on Thursday. Recent speeches by President Xi have already provided clear hints that a key focus of the plan will be building China’s self-sufficiency in a range of products, including technology products, in light of deteriorating relations with the US.

Looking ahead, tomorrow’s industrial profit report for September is the only economic report released during regular market hours. Of greater interest will be the release on Saturday of the official PMI indices for October. According to Bloomberg’s survey, analysts expect the manufacturing PMI to have remained at the more than 2-year high of 51.5 reached last month, while the non-manufacturing PMI is expected to have edged up to a fresh 7-year high of 56.1. If realized, these outcomes would bode well for China extending its enviable economic rebound in the current quarter.

Australian goods trade surplus widens in September; Q3 CPI the highlight
The only economic news in Australia today was the preliminary merchandise trade report for September. These data, only presented in original (i.e. non-seasonally adjusted) form, pointed to a 3%M/M rebound in exports during August, albeit leaving them down 12%Y/Y. As in recent months, the movement in total exports was dominated by volatility in exports of non-monetary gold, which this month rebounded 69%M/M. However, a little over half of the annual decline in exports is due to a 53%Y/Y decline in exports of gas, while over a third is due to a 30%Y/Y decline exports of coal.

Meanwhile, imports were estimated to have declined a further 1%M/M in September and so were down 9%Y/Y. Imports of consumption and capital goods increased during the month, but imports of intermediate goods and non-monetary gold fell. Around half of the annual decline in imports was accounted for by a 40%Y/Y decline in imports of petroleum, not least due to lower prices, while about a third reflects an 11%Y/Y decline in imports of capital goods. Imports of consumption goods increased just over 1%Y/Y. Taken together these results point to a merchandise trade surplus of around A$5.1bn in September, up from A$4.1bn last month but down from A$6.9bn a year earlier. The final trade report, which will also include information from the services sector, will be released on 5 November.

Looking ahead, with next week’s RBA Board meeting looming large, the focus for investors over the remainder of this week will be on developments in inflation. The CPI for Q3 will be released on Wednesday. Consumer prices plunged 1.9%Q/Q in Q2 – taking annual inflation to -0.3%Y/Y – due to the impact of government childcare and pre-school subsidies and the slump in fuel prices. Even with an expected 1.5%Q/Q rebound in prices during Q3 – largely reflecting the removal of the childcare subsidy in all states other than Victoria – at 0.7%Y/Y annual inflation will remain well below the RBA’s 2-3% target range. According to Bloomberg’s survey, the closely-followed and much less volatile trimmed mean and weighted median measures of underlying inflation are expected to have increased 0.3%Q/Q apiece – thus also annualizing at well below the target range – in both cases leaving annual inflation steady at just 1.2%Y/Y and 1.3%Y/Y respectively. Clearly outcomes such as these would be very supportive of the RBA taking further policy action at next week’s meeting.

Among other data due, the external trade indices and PPIs for Q3 will be released on Thursday and Friday respectively. Both of these reports will also remain soft, not least due to the solid gains made by the Aussie dollar over the quarter. Friday will also bring the release of private sector credit data for September, with any growth likely to be driven by mortgage-related demand (general consumer and business loan demand is likely to have remained soft). The only other economic report scheduled this week is the quarterly version of the NAB Business Survey, containing additional information to that captured in the monthly survey, which is released on Thursday. As far as other diary entries are concerned, RBA Deputy Governor Debelle and Assistant Governor Bullock will appear before a Senate committee Budget Estimates hearing tomorrow.

Kiwi market on holiday today; trade and confidence reports due this week
The Kiwi market was closed today for the Labour Day holiday. Looking ahead to the rest of the week, following tomorrow’s September merchandise trade report, the only other releases this week are the final results of the ANZ Business Outlook Survey and the ANZ Consumer Confidence Index, both for October, released on Thursday and Friday respectively. The preliminary results of the business survey already pointed to a lift in confidence as public gathering restrictions were removed during the month and with later responses being added to those results an upward revision to the key activity indices seems more likely than not.

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