All eyes on ECB strategy review outcome

Chris Scicluna

Wall Street sets new highs but Asian equities mostly weaker today
Despite the JOLTS report indicating over 9mn US job vacancies in May – the second month at around that level roughly 2mn above pre-pandemic levels – Treasury yields remained under downward pressure on Wednesday. Bears received no relief from the minutes from last month’s FOMC meeting, which pointed to differences of opinion about the timing and form of an eventual tapering of the Fed’s asset purchases. As a result, the 10Y UST yield closed down a further 4bps at 1.31%, with the 30Y UST closing at a near five-month low of 1.94%. The decline in bond yields and a partial rebound in industrial metals provided support to Wall Street, with the S&P500 advancing 0.3% to a fresh record high. Industrial and materials stocks rallied 1%, but a further decline in crude oil weighed on energy stocks and the flattening yield curve saw financial stocks underperform. 

US equity futures have weakened a couple of tenths since the close and a negative tone is evident across most of the major markets in the Asia-Pacific region. In Japan, despite a much-improved Economy Watchers survey for June, the TOPIX declined 0.9% with most focus being on the plight of the forthcoming Olympics. Sadly, with new infections in Tokyo rising to a near two-month high yesterday, the Nikkei newspaper is reporting that Tokyo will enter a new state of emergency from Monday until 22 August, with the decision set to be announced later today following a formal meeting between the officials and medical experts. Not surprisingly, as a consequence, the Asahi newspaper is reporting that all events in the Tokyo, Kanagawa, Chiba and Saitama prefectures will be held without spectators, with a formal decision to be made this evening after discussion with other stakeholders. 

In Mainland China the CS300 is down about 1.0% today, notwithstanding a decline in money market and bond rates following late-yesterday’s signal from the State Council that authorities “will use monetary policy tools, including a cut in the reserve requirement ratio at an appropriate timing to enhance financial support to the economy, particular to smaller businesses”. This statement – though not necessarily binding the PBoC to a course of action – comes following recent disappointing PMI data, with the market perhaps concluding that next week’s Chinese Q2 GDP reading might fall short of market expectations (which according to Bloomberg’s survey, presently sits at 8.0%Y/Y). In South Korea, the KOSPI is also down 1.0% after a record 1,275 coronavirus cases, with the country’s disease control agency suggesting that daily case numbers could hit 2,000 by the end of the month. Meanwhile, stocks have declined in Hong Kong for an eighth consecutive session, with today’s slump of more than 2% in the Hang Seng erasing its gains for the year.

In the Antipodes, despite another 38 virus cases in Sydney – the most yet during this outbreak – the ASX200 has outperformed and is modestly positive for the session, amidst a further decline in the Aussie dollar and lower bond yields. The 5bps decline in the 10Y AGCB to 1.33% was not dissimilar to its counterpart in the UST market, with little reaction to a speech given by RBA Governor Lowe that focused on the link between the labour market and monetary policy. Much of the speech simply reiterated points that Lowe had made during Tuesday’s post-meeting press conference, including that the positive surprise in the jobs data has not yet been matched with equivalent surprises on wages and prices. Lowe also repeated his view that for inflation to be sustainably in the 2 to 3% range, as is required to prompt a lift in the cash rate, it is likely that wage growth will need to exceed 3%Y/Y – a pace last seen back in early 2013.

Japan’s Economy Watchers Survey improves markedly in June
The data focus in Japan today was on the Economy Watchers Survey for June. With around half of the economy moving out of full state-of-emergency conditions during the month – albeit perhaps not for long – the survey pointed to a marked improvement in business conditions that was also larger than analysts had expected. Mimicking the improvement seen back in March when the previous state of emergency was lifted, the headline current conditions DI increased 9.5pts to a three-month high of 47.6. Moreover, respondents indicated that they expect a further improvement in conditions over the coming 2-3 months, with the overall expectations DI lifting 4.8pts to 52.4 – the highest reading since October 2017. We presume that the latter anticipates some lift from the Olympics – but such a lift is increasingly in doubt – and a hope that progress on vaccinations will begin to depress the current upswing in coronavirus cases.

In the detail, not surprisingly, the largest driver of the improvement in current conditions was a more upbeat account from those interacting with the household sector. The survey’s household sector index increased 11.1pts to a three-month high of 44.6, led by a significant reduction in pessimism amongst those respondents interacting with the depressed food and services sectors. That said, the corporate sector index increased a welcome 6.2pts to 53.1, which is the highest reading since December 2017. The manufacturing index climbed 6.3pts to an especially robust 56.6, whereas the non-manufacturing index increased 5.7pts to a barely expansionary 50.3. Looking ahead, relative to current levels, further improvement is expected in the household sector with the outlook DI improving to 51.5. By contrast, respondents interacting with the business sector appear to expect slightly less positive conditions, driven by the manufacturing sector where the outlook DI stands somewhat below current levels at 53.8.

Japan’s bank lending growth slows; Tokyo office vacancies rise to near 7-year high
Turning to the rest of today’s Japanese news, the BoJ reported that total bank lending increased just 1.4%Y/Y in June – just half the pace in May and well down from the peak of 6.7%Y/Y reached in August last year. This slowdown reflects both weakness in the current demand for credit and base effects associated with last year’s scramble to access bank liquidity, with this year’s modest 0.1%M/M decline in lending replacing a 1.4%M/M increase last June. Lending at the major city banks – which had been the key suppliers of liquidity to corporate last year – declined 0.3%M/M and so was down 1.6%Y/Y. Lending at regional banks grew just 0.1%M/M and so annual growth slowed 1.0ppt to 2.9%Y/Y. On the other side of the ledger, bank deposits grew only fractionally in June. Given base effects associated with last year’s receipt of government support payments – which initially went into bank accounts rather than retail stores – this meant that annual growth slowed 1.9ppts to 6.1%Y/Y – the slowest pace since April last year. Meanwhile, given the significant continuing support provided by banks and the government to the corporate sector, just 541 bankruptcies were recorded in June – up from May, but down 30.6%Y/Y.

In other news, reflecting the ongoing impact of the pandemic – which may yet prove to include a more persistent change in working habits – the office vacancy rate in the Tokyo business area increased a further 0.29ppt to 6.19% in June, marking the highest level since July 2014 and now materially above the long-run average (5.4%). Not surprisingly, the rising vacancy rate is continuing to weigh on office rental rates, which for buildings more than a year old fell 0.5%M/M in June – an eleventh consecutive decline with rates now down a cumulative 7.7% from the July 2020 peak.

Finally, balance of payments data revealed an adjusted current account surplus of ¥1.87trn in May, up from ¥1.55trn in April. This widening – which was larger than expected by the market – owed to an accumulation of small increases across the merchandise trade, services and income balances.

All eyes on the ECB today as outcome of strategy review set to be announced
All eyes in European markets should be on the ECB today, with the conclusions of its monetary policy strategy review set to be published at 1.00pm CET and a related press conference to be conducted by President Lagarde at 2.30pm CET.  

A key focus for bond markets will be the ECB’s inflation target. That is bound to be set at 2.0% (up from the current target of close to but below 2.0%) over a medium-term time horizon. And the Governing Council will also make clear that the target is symmetric, as it has done for some time since Mario Draghi’s term as President. But it remains to be seen whether the Governing Council also agrees to set a specific tolerance range around that rate, and if so how wide that will be. And most importantly, we should also watch to see whether the ECB will seek to mimic the Fed with an explicit average inflation targeting framework, with a commitment to try to exceed the target over the near term to compensate for periods of undershooting. Such a commitment would suggest that policy would be more accommodative for longer. However, not least as unanimity on the Governing Council is required, we doubt that it would make such a commitment in anything but a very loose way.

The ECB might also have news on its assessment of the effectiveness and design of its various policy tools, including negative rates, asset purchases and liquidity facilities. The TLTROs are likely to become a lasting feature in the toolkit. But, in terms of asset purchases, it remains to be seen whether the ECB will also have something to say about the need for ongoing PEPP-style flexibility to address bond-market fragmentation risks once the pandemic phase is over. Among other things, the Governing Council will likely also express an intention to take into account housing costs in setting policy, and thus encourage Eurostat to develop more robust inflation data to measure such costs more accurately and on a timely basis. Finally, Christine Lagarde seems bound to confirm the ECB’s intention to take greater account of climate change risks in its policy-making, including by “greening” its asset purchases and collateral rules.

Beyond the strategy review, the publication of the account of the ECB’s June monetary policy meeting is also due. At that meeting, the ECB published updated macroeconomic projections, which strongly suggested that current price pressures would be transitory, and thus committed to maintain net PEPP purchases over the coming three months at a significantly higher pace than at the start of the year. That policy decision was not unanimous, however, and the account will therefore reflect the range of views among Governing Council members.

A quiet day ahead in the US
Today’s US economic diary is also sparse, featuring just consumer credit data for May – with growth perhaps rising above its recent trend as the economy reopens – and the weekly jobless claims report. 

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