Japan’s Reuters Tankan points to slightly improved business conditions

Chris Scicluna

Markets mostly little changed as investors await direction from the Fed
With a key FOMC meeting looming large, investors were understandably reluctant to drive asset prices sharply one way or the other yesterday. After opening fractionally higher, the S&P500 closed with a modest loss of less than 0.2% while the Nasdaq eked out an advance of just 0.1%. In the bond market, the 10Y UST closed little changed at 1.62%. There were similarly few notable moves in the FX market (the euro nudged lower but the greenback was largely unchanged against other major currencies).

Against that backdrop, it has been a similarly quiet day in most of the Asia-Pacific region today, with a slightly negative tone creeping into the equity market mid-session but then reversing as the session progressed. A short time ago, the TOPIX closed up 0.1%. While Japan’s February export data disappointed market expectations, albeit with interpretation clouded by LNY-related variability, the Reuters Tankan pointed to improved business conditions in March and an expectation of further improvement in coming months. Meanwhile, media reports suggested that PM Suga would imminently announce the lifting of the state of emergency in the Tokyo area on 21 March as scheduled, and that he had agreed to hold the Tokyo Olympics as scheduled in July but with no foreign spectators in attendance.

In China, the CSI300 shrugged off modest early losses to advance 0.4% ahead of tomorrow’s much-awaited first meeting between new US Secretary of State Antony Blinken and Chinese Foreign Minister Wang Yi. While in Tokyo for a meeting with his Japanese counterpart today, Blinken was critical of China’s “vaccine diplomacy” and naval presence near the Senkaku Islands. Elsewhere, South Korea’s KOSPI fell 0.6% with Samsung telling shareholders that the global semiconductor shortage would impact its business over the coming quarter. In the bond market, yields on longer-dated JGBs fell but the ACGB curve reversed a little of the prior day’s flattening, with Aussie investors now looking ahead to both today’s Fed meeting and tomorrow’s all-important local Labour Force Survey results.

Japanese exports disappoint in February, LNY-holiday variability like a factor
Turning to today’s economic data, in Japan the MoF released the merchandise trade report for February, casting further light on whether export demand might help to moderate the impact of a pandemic-induced contraction in domestic demand in Q1. Following an upwardly-revised seasonally-adjusted surplus of ¥551bn in January, a small deficit of ¥39bn was recorded this month due to both a decline in exports – clearly influenced by the variable timing of the LNY holiday – and a further strong lift in imports. In unadjusted terms, the trade surplus of ¥217bn was about ¥200bn less than the consensus estimate, driven by a shortfall in exports compared with expectations.

In the detail, following two months of solid growth, export receipts fell 4.7%M/M in February, resulting in an annual decline of 4.5%Y/Y – much worse than the roughly flat outcome that markets had expected and contrasting with the 6.4%Y/Y growth recorded in January. Notably, whereas exports to China had increased more than 37%Y/Y in January, growth slowed to just 3.4%Y/Y in February. A less pronounced slowdown was also evident across other Asian markets. In addition, exports to the US fell 14%Y/Y in February – a 9ppt deterioration from the prior month.

Meanwhile, import values increased 4.7%M/M in February, building on a 7.3%M/M lift in January. As a result, coming off a low base, import values increased 11.8%Y/Y, contrasting sharply with the 9.5%Y/Y decline reported in January. Imports of manufactured goods, general machinery and electrical machinery all increased by around 30%Y/Y, while the 9.1%Y/Y decline in imports of mineral fuels was much smaller than the 27%Y/Y decline reported in January.

As usual, a little later in the day the BoJ released its analysis of the export and import data, helpfully adjusting the MoF’s statistics to remove the influence of both seasonality and changing prices. According to the BoJ’s analysis, real exports declined a steep 5.6%M/M in February to a four-month low and were up just 0.4%Y/Y. Even so, for the first two months of the quarter, real exports were running about 1% above the average level through Q4. However, the BoJ estimates that real imports increased 6.6%M/M in February to the highest level in nine months, which given a very weak base implies an annual increase of over 17%Y/Y. And as a result, for the first two months of the quarter, imports were running a considerable 5.6% above the average level through Q4. So, even if exports rebound somewhat in March, as seems likely, the BoJ’s calculations imply that net merchandise exports will very likely make a negative contribution to GDP growth in Q1. Fortunately, we suspect that the ‘excess’ imports will show up in the national accounts as a large rebound in private inventories, which last quarter made the largest negative contribution to growth in more than eight years.

The BoJ will release more details regarding the commodity breakdown and destination of these exports early next week. In the meantime, the MoF’s own volume estimates indicate that growth in exports to China slowed to 10.0%Y/Y in February from almost 45%Y/Y in January. Exports to the rest of Asia fell a modest 0.4%Y/Y, down from growth of over 18%Y/Y in January. Exports to the US fell 16.4%Y/Y – almost twice as large as the decline registered in January – and the situation with respect to European markets remained very weak, with the 23.9%Y/Y decline in February only slightly smaller than that recorded a month earlier.

Japan’s Reuters Tankan points to further incremental improvement in business conditions
In other Japanese news, today’s Reuters Tankan indicated that both manufacturing and non-manufacturing firms detected an incremental improvement in business conditions over the past month. However, unsurprisingly, the diffusion index (DI) for non-manufacturers continues to lag that for manufacturers due to the ongoing impact of pandemic-induced restrictions on business activity in the hospitality sector.

Pleasingly, the overall manufacturing DI increased a further 3pts to 6 in March, marking the best reading since June 2019. Even more encouraging, the forecast DI – which measures expected business conditions three months ahead – increased 7pts to 15, indicating that respondents expect business conditions will continue to improve. The industry detail pointed to significantly improved sentiment amongst manufacturers of machinery, autos and oil products, while producers of chemicals built on their sector-leading optimism from February. By contrast, perhaps reflecting developments in commodity prices, optimism evaporated amongst food producers.

The overall non-manufacturing DI increased just 2pts to -5 in March, leaving the index a notch weaker than it had been in December before the winter surge in coronavirus cases triggered the imposition of trading restrictions across about half of the country. However, encouragingly, the forecast DI increased 5pts to 5 – the first positive reading since February last year – indicating that firms expecting modestly favourable business conditions to emerge over the next three months. Not surprisingly, much of the improvement was driven by retailers, with the respective DI rising 15pts to 23 – the highest level since October 2019 – and with conditions expected to remain similarly favourable over the next three months. The information services industry retained its pandemic-proof status, with its DI index falling just 2pts to an exceptionally healthy level of 42.

Widespread weakness in euro area car registrations in February; final inflation data likely to confirm flash CPI estimate at 0.9%Y/Y, unchanged from January
Data released this morning confirmed that new car registrations in the euro area remained extremely weak in February, down 20.9%Y/Y to be down a slightly larger 22.7%YTD/Y. And the declines from a year earlier were widespread. We already knew that new car registrations in Germany (-19.0%Y/Y) continued to be affected by the reversal of last year’s temporary VAT cut as well as pandemic restrictions, while French registrations were similarly subdued (down 20.9%Y/Y). While registrations in Italy were down a more moderate 12.3%Y/Y, they plummeted 38.4%Y/Y in Spain and saw the steepest decline in Portugal (-59.0%Y/Y). And of all the member states, only in Ireland (+4.9%Y/Y) were new car registrations higher than a year earlier in February. But, given the poor start to the year, even there they were still down 11.1% over the first two months of 2021 compared to the same period last year.

Final euro area inflation data for February are due later this morning. The flash estimate of headline inflation was unchanged at January’s eleven-month high of 0.9%Y/Y, as upwards pressure from energy offset the reversal of certain other temporary factors. So, core inflation fell back 0.3ppt from January’s five-year high to 1.1%Y/Y. The final German, Italian and Spanish data aligned with their respective flash estimates. So, while yesterday’s French figures saw an upwards revision to the HICP rate to leave it unchanged from January at 0.8%Y/Y, we expect no meaningful revisions in today’s euro area numbers. Euro area construction data for January are also due, with a double-digit percentage rebound in France set to be offset by marked declines in Germany and Spain.

All eyes on the Fed today, especially the all-important dot plot
The focus for investors today will be the Fed, which will announce the outcome of the FOMC’s second review of policy settings for this year and release its first new forecasts of the economic and policy outlook since December. Of course, no change to the target range for the Fed Funds rate is widely expected. While some commentators have raised the possibility of the Fed leaning against the steepening of the yield curve by lifting the IOER and/or shifting QE purchases to the longer-end of the curve, on balance we expect neither. Rather, Fed officials will probably be neither surprised nor alarmed by the shape of the curve, with the steepening viewed as the normal shift that occurs over the course of a business cycle during the expansion phase. Indeed, it would be more worrying if the curve was not steepening given the scale of macroeconomic stimulus being deployed.

So, perhaps most interest will centre on the Fed’s new projections, which will surely portray a more positive outlook in light of the recent steep decline in new coronavirus cases, the accelerated vaccination programme and the passage of President Biden’s $1.9trn American Rescue Plan – the latter almost certainly larger than anything envisaged by Fed policymakers when they last produced forecasts in December.

Recent momentum already points to a stronger growth outlook for the current year and according to CBO estimates over a quarter of Biden’s stimulus will help boost growth in 2022. So given the likelihood that the Fed will forecast the unemployment rate to end next year below 4% – and thus move below its assumed longer-run level – the revised ‘dot plot’ will likely indicate that the median policymaker now expects the first lift in the Fed Funds rate to occur in 2023 (just 5 of 17 participants expected tightening when the last forecasts were produced in December), while more than one policymaker may even forecast a degree of policy tightening next year. This could put upward pressure on Treasury yields, especially if the Fed opts not to extend in some form the current Supplementary Leverage Ratio (SLR) exemption applying to institutions’ Treasury holdings, which is due to expire at the end of this month.

On the data front, ahead of the FOMC announcement we will receive news on housing starts and building permits for February. Starts are very likely to have been constrained by the poor weather during the month, with Daiwa America Chief Economist Mike Moran pencilling in a 5%M/M decline.

Kiwi current account deficit widens in Q4 but full-year deficit at 19-year low
Ahead of tomorrow’s national accounts report, today Statistics New Zealand released the Balance of Payments for Q4. The seasonally-adjusted current account deficit widened by $NZ1.6bn to $NZ2.1bn, with a small surplus on merchandise trade more than offset by a deficit on services – not least due to a 67%Y/Y decline in income from foreign tourists – and the perennial deficit on the primary income balance. Even with that widening, the full-year deficit of NZ$2.5bn, 0.8% of GDP, was the smallest annual deficit since 2002 and NZ8.1bn narrower than a year earlier. New Zealand’s net external liabilities stood at 55% of GDP, down slightly from the previous quarter.

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