German and French manufacturing output lags recovery in orders

Chris Scicluna

Wall St rallies ahead of totals payrolls report; Asian equities lift too, with favourable local data offering support
While the Fed’s latest Financial Stability Report warned that “Should risk appetite decline from elevated levels, a range of asset prices could be vulnerable to large and sudden declines,” no such loss of appetite was evident on Thursday. Indeed, the S&P500 advanced 0.8% to sit just a fraction below last week’s record high and the DJI rose 0.9% to achieve a new record high. Financials were the top performers on the day, while technology stocks broke a seven-day losing streak. Ahead of today’s all-important US employment report, initial jobless claims fell below 500k for the first time since March last year, but bond investors were unperturbed and the 10Y UST closed unchanged at 1.57%. The greenback was generally weaker, losing ground against the euro and the commodity currencies in particular as commodity prices continued to set new cyclical highs.

Despite that favourable background, it has been a mixed day for most Asian equity indexes, despite positive economic news in Japan and China. In Japan, after advancing 1.5% yesterday despite the likelihood that PM Suga will later today confirm an extension to the state of emergency in four prefectures, the TOPIX rose just 0.3% today. Of note, the final Jibun services PMI for April was surprisingly revised up to a 15-month high and Japan’s labour cash earnings posted the first annual growth since February last year (more on these reports below). In mainland China, after declining yesterday, the CSI300 lost ground late in the day to fall a further 1.3% while stocks also dropped in Hong Kong. Encouragingly, China’s export growth in April was well above market expectations, and import growth remained strong after surprising on the high side in March. The Caixin services PMI for April also painted the services sector in a more upbeat light that the official PMI (see more below). In Australia, equities increased modestly with bond investors showing little reaction to the RBA’s Statement on Monetary Policy, even though it depicted a plausible scenario that might motivate a rate hike sooner than the baseline forecast of 2024 at the earliest.

Japan’s services PMI revised up to 15-month high in April
Considering recent developments in coronavirus cases, last month’s Japanese flash services PMI survey for April was surprisingly resilient with the headline business activity index steady at the prior month’s 14-month high of 48.3. And today’s final results were even more surprising, with the headline index revised up 1.2pts to a 15-month high of 49.5. Encouragingly, the more forward-looking new orders index was revised up an even larger 1.5pts to a 14-month high of 49.9, while the business expectations index – which had slumped 4.6pts in the flash survey – was revised up 2.7pts to a respectable 56.5. Meanwhile, the employment index was revised up 1.5pts to 52.5, marking the highest reading since May 2019. Revisions to the pricing indicators were minor, although the 0.1pt upward revision to the output prices index to 51.0 confirmed a 15-month high.

Given today’s revisions in the service sector, the composite PMI output index was revised up 0.8pts to a 19-month high of 51.0, suggesting that the economy made a positive start to the quarter despite the increase in coronavirus cases. Of course, it remains to be seen whether this resilience has carried through into May given the imminent extension of trading restrictions in Tokyo, Osaka, Kyoto and Hyogo.

Japan’s labour cash earnings post positive growth for 1st time in 13 months
Turning to Japan’s labour market, today the MHLW released the preliminary Monthly Labour Survey for March. At the headline level, total labour cash earnings (per employee) increased 0.2%Y/Y – a slightly stronger outcome than the market was expecting, 0.6ppts firmer than recorded in February and the first positive annual growth recorded since February last year. Earnings were flat in the manufacturing sector but perhaps surprisingly, grew solidly in the wholesale and retail sector.

The overall growth in wages owed to a 0.8%Y/Y lift in scheduled contractual earnings, which was the largest increase in 14 months. By contrast, overtime earnings fell 6.2%Y/Y, albeit the smallest decline in 12 months. Bonus earnings fell a negligible 0.3%Y/Y. After accounting for inflation, real wages increased 0.5%Y/Y, which was the largest increase since December 2018. It is worth noting that given base effects associated with last year’s first wave of coronavirus cases, these annual growth rates will rise to flattering levels over the next few months.

Elsewhere in the survey, after declining 2.8%M/M in February, total hours worked rebounded 3.4%M/M in March. And so hours worked increased 0.4%Y/Y – also a 14-month high – despite a 1.9%Y/Y decline in overtime hours. The number of people in regular employment grew 0.4%M/M, lifting annual growth by 0.1ppts to 0.7%Y/Y. Employment in the manufacturing sector increased 0.1%M/M – the first increase in 12 months – but was down 0.7%Y/Y. By contrast, for obvious reasons, employment in the medical, healthcare and welfare sector increased 1.9%Y/Y. Finally, the preliminary breakdown – which usually overstates full-time employment – suggests that growth in the number of full-time employees increased 0.5ppts to 1.7%Y/Y. By contrast, the number of part-time employees fell 1.1%Y/Y – 0.1ppts more than reported in February.

China’s trade surplus widens in April as exports surprise on high side
The focus in China today was on the international trade report for April. In summary, export growth proved much stronger than expected, albeit still slightly flattered by base effects associated with the first wave of the pandemic. Meanwhile, import growth was about as strong as had been expected, which was even firmer than in March. As a result, China’s trade surplus widened much more than expected, rising near $30bn to $42.9bn – the most this year but of a similar size to that seen in the same month a year earlier.

Turning to the detail, in dollar terms, exports grew 32.3%Y/Y in April, up from 30.6%Y/Y in March and about 8ppts higher than the consensus expectation (given the strengthening yuan, exports grew 22.2%Y/Y in local currency terms). As a result, exports grew 44.1%YTD/Y following a 9.3%YTD/Y decline a year earlier. Exports to the US increased 31.2%Y/Y, marking the slowest pace since October. Growth in exports to ASEAN countries picked up to 42.2%Y/Y, outstripping growth of 23.8%Y/Y in exports to the EU and growth of just 0.4%Y/Y in exports to Japan. Exports to the UK increased a particularly strong 60.2%Y/Y.

Meanwhile, in some good news for China’s trading partners, growth in China’s imports grew 43.1%Y/Y in April – up from 38.1%Y/Y in March, albeit inflated by the 14.4%Y/Y decline that had occurred a year earlier. As a result, imports grew 31.7%YTD/Y, compared with a 6.2%YTD/Y decline a year earlier. Imports from the US grew an especially substantial 51.7%Y/Y – maintaining the noticeable acceleration since December last year – although China’s bilateral surplus with the US still widened to $28.1bn in April after declining to a 12-month low of $21.4bn in March. China’s imports from the EU increased 43.3%Y/Y, while imports from Japan grew 25.5%Y/Y and imports from ASEAN nations grew 40.6%Y/Y. Notwithstanding the fractious state of bilateral relations, imports from Australia grew 49.3%Y/Y, not least due to a near 90%Y/Y increase in China’s imports of iron ore, so that China’s bilateral deficit with Australia stood at an unmatched $26.1bn in April.

China’s Caixin services PMI points to improved conditions in April
In other Chinese news, as was the case with its manufacturing counterpart, this month’s Caixin services PMI pointed to a solid improvement in April, contrasting sharply with the weaker conditions indicated by the official survey. Indeed, the headline index increased 2.0pts to 56.3, returning to where it had stood in December. In the detail, the new orders index also increased 2.0pts to a 5-month high of 55.7 and the employment index increased 1.4pts to a 5-month high of 52.7. The future activity index slipped 1.1pts to 67.2, which remains very robust relatively to that typically seen in recent years.

German & French manufacturing output continues to lag recovery in orders
Broadly in line with expectations, particularly following yesterday’s upbeat data on factory orders and turnover, this morning’s figures showed that German industrial production rose a firm 2.5%M/M in March to be up 5.1%Y/Y. That, however, followed a revised drop of 1.9%M/M in February, which was slightly sharper than previously thought. And so, the level of IP was still down a sizeable 4.3% from the pre-pandemic level in February 2020. Moreover, the headline figure was flattered by a sharp rebound in construction output, up 10.8%M/M following a steep decline in January and February due to the VAT hike and harsh winter weather. In addition, energy output was up 2.4%M/M.

So, manufacturing and mining output was up just 0.7%M/M in March and unchanged over the first quarter as a whole, clearly lagging behind the recovery in factory orders. And given the weakness of construction earlier in the quarter, total IP dropped 0.9%Q/Q in Q1. Within the detail, production of production of intermediate goods rose 1.2%M/M to be up 2.4%Q/Q in Q1. But with production of machinery dropping 0.9%M/M, output of capital goods fell 0.4%M/M despite a rise of 0.6%M/M in the motor vehicles category. So, while production of machinery rose 6.0%Q/Q in Q1, capital goods output fell 2.4%Q/Q as production of motor vehicles fell 12.2%Q/Q due to supply-chain problems. Meanwhile, output of consumer goods rose 2.9%M/M in March but fell 0.8%Q/Q in Q1.

French production in March also disappointed. Having dropped 4.8%M/M in February, manufacturing output rose just 0.4%M/M to be down 6.8% in March from the pre-pandemic level and also down 0.2%Q/Q in Q1. Again, supply-chain issues weighed heavily on output in the transport sector, which rose just 0.4%M/M in March following a drop of 11.2%M/M the prior month to be 25.1% below the pre-pandemic level and down 8.5%Q/Q in Q1. In contrast, production of machinery and equipment rose 0.4%M/M in March to be just 3.2% below the pre-pandemic level and up 3.7%Q/Q in Q1.

Construction PMIs to end the week’s UK dataflow
After the BoE yesterday revised up significantly its near-term growth outlook but continued to suggest that inflation would be close to target at the end of its projection horizon, it’s a relatively quiet end to the week for UK data with only the April construction PMIs due. Like the services and manufacturing PMIs, these should be consistent with solid expansion in the sector and thus a broad-based rebound in GDP in the current quarter.

A bumper US payrolls report ahead with the unemployment rate likely to fall to a 13-month low
The singular focus for investors today will be the April employment report. In light of recent elevated readings in the ISM employment indexes and job postings, together with the clear uplift in momentum evident in March, Daiwa America Chief Economist Mike Moran expects non-farm payrolls to have grown by about 1mn – the most since August – and the U-3 unemployment rate to have declined 0.2ppts to a new post-pandemic low of 5.8% (albeit still 2.3ppts higher than prior to the pandemic). As always earnings data from the payrolls survey will also be of interest, although annual growth will be distorted lower this month due to base-effects associated with the onset of the pandemic (average wages across the economy increased sharply in March last year as mainly low wage workers lost their jobs). Aside from the employment report, today will also bring consumer credit and final wholesale trade data for March.

RBA SMP upside scenario illustrates conditions required for earlier rate hike
As usual, following the Bank’s post-meeting statement earlier this week, the main point of interest in today’s RBA Statement on Monetary Policy (SMP) was the extra detail provided concerning the Bank’s updated economic forecasts and on the Bank’s discussion of risks surrounding the outlook. As the Bank outlined on Tuesday, the new baseline outlook is for GDP growth of 5¼% this year and 4% next year – upward revisions of 1¼ppt and ¾ppt from the previous forecasts made in February. The new forecasts assume an unchanged cash rate out to mid-2023 (currently the endpoint for the Bank’s projections); a constant effective trade-weighted exchange (TWI) of 64 and Brent crude at $68/bbl. Given the outlook for activity, the unemployment rate is now expected to end this year at 5% and next year at 4½% (in both cases down 1ppts from the February forecast). The Bank’s forecast for the end of June 2023 is 4½%, which would be the lowest level since 2008. However, in the Bank’s opinion, this would only be sufficient to generate a gradual uplift in inflation. The Bank’s expects trimmed mean inflation to end this year at 1½%Y/Y, next year at 1¾Y/Y and June 2023 at 2%Y/Y – in each case just ¼ppt higher than forecast in February. Given the Bank’s commitment not to raise the cash rate until actual inflation is sustainably within the target range, these forecasts make clear why the Bank still does not expect to raise the cash rate until 2024 at the earliest.

Of course, this is just the baseline forecast. In his speech yesterday, while outlining the baseline forecast, RBA Deputy Governor Debelle stated that “But I would highlight that it is the state of the economy that is the key determinant of policy settings, not the calendar”. With that in mind, perhaps of greater interest today was the Bank’s scenario analysis, and in particular the upside scenario given the consistent upward revisions made to the Bank’s baseline forecast in recent quarters. This quarters upside scenario envisages a stronger trajectory for household spending, perhaps due to stronger wealth effects or a decline in uncertainty that encourages households to draw down on their elevated savings. In this scenario, stronger GDP growth leads to a decline in the unemployment rate to just 3¾% by mid-2023. This causes wage growth to double from present levels to 2¾% and the trimmed mean inflation rate to climb to 2¼%. With inflation on an upward trajectory, in our view the likelihood of a further increase beyond mid-2023 could readily motivate the first lift of the Bank’s policy rate in the second half of that year, rather in 2024 (or later).

If the recent past repeats and the Bank’s baseline scenario is later replaced by the previous upside scenario, the Bank’s next SMP in August – at which the Bank will also extend its forecast horizon out to the end of 2023 – could be the first at which the possibility of a rate hike before 2024 is countenanced. Ahead of August, the Bank has already signalled that it will make a decision at the July meeting on whether to retain the April 2024 bond as the target bond for the 3-year yield target or to shift to the next maturity, the November 2024 bond (in either case, the 10bp target will be maintained). With the Bank today outlining a plausible – even if not central – scenario in which inflation moves back inside the target range in mid-2023, we find it difficult to see the Board concluding that a 0.1% target for the November 2024 bond is credible (the bond presently trades at a yield of 0.29%, suggesting that investors similarly expect some lift in short-term interest rates later in the bond’s life).

Kiwi inflation expectations lift in Q2
The RBNZ’s quarterly Survey of Expectations, a limited survey of mainly economists and business people, confirmed the uplift in inflation expectations seen in other surveys. Respondents forecast that year-ahead inflation would rise to 1.87% – up from 1.73% in the prior survey and almost identical to where it had been prior to the pandemic. More importantly, respondents’ two-year-ahead forecast of inflation increased to 2.05% from 1.89% previously, thus moving back above the mid-point of the RBNZ’s inflation target range for the first time in two years. Reflecting a more rapid than expected retightening of the labour market, forecasts of annual wage growth over the next two years also lifted by around ½ppt per year. 

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