German manufacturing weakness driven by auto supply constraints

Chris Scicluna

Risk off sends UST yields lower as ISM services index pulls back from record highs and pandemic concerns weigh; risk aversion boosts the greenback
US investors returned from the long weekend in a less positive mood on Tuesday, with the tone across markets firmly ‘risk off’. A pullback in the ISM services index – albeit leaving it at a still very healthy 60.1 – simply reinforced the early price action, which may be attributable to a mix of factors including the OPEC+ squabble, ongoing concerns about the delta variant of coronavirus and reaction to the weekend actions of China’s cybersecurity regulator (Didi Global stock fell almost 20% on Tuesday). The risk-off tone was especially evident in commodity markets, with crude oil falling nearly $4/bbl despite the weaker near-term production outlook and prices falling sharply across the industrial metals. At one point, the S&P500 was down as much as 0.9% with energy, materials, industrials and financials all down steeply. However, with risk aversion boosting the allure of bonds, the yield on the 10Y UST fell 7bps to 1.35%, thus revisiting the lows seen in Asian trading in the wake of last month’s FOMC meeting (and before that not seen since February). The decline in bond yields eventually drove investors back to equities, with the S&P500 recovering to be down just 0.2% at the close. Meanwhile, in FX markets, the greenback was clear beneficiary of the risk off tone, unsurprisingly making especially large gains against the commodity-linked currencies.

Against that background, and with US equity futures little changed today, it has mostly been a soft day for equity markets in Asia, with the notable exception of mainland China where the CSI300 has rallied more than 1.0% – investors perhaps taking comfort from the pullback in commodity prices, which doubtless will also please Chinese policymakers. In Japan, the TOPIX has sunk 0.9% with the worsening coronavirus situation continuing to cast doubt on spectator participation at the forthcoming Olympics – albeit a development that would increase the likelihood of a further large fiscal stimulus package ahead of the General Election. Markets were even weaker in Singapore, while South Korea and Hong Kong are also down more than ½%. Bond yields moved lower across Asia, with the 10Y JGB briefly falling to a near one-month low below 0.03%.

In the Antipodes, after declining yesterday in the wake of the RBA’s Board meeting, the ASX200 bucked the trend and rebounded 0.8% today, despite the announcement of a one-week extension to Sydney’s lockdown – now due to end on 16 July as a result of a continued stream of cases linked to the delta variant. As in the US, equities were offered some support by a sharp fall in bond yields – the 10Y AGCB yield plunging 8bps to 1.38% – while a weaker Aussie dollar provided some joy for exporters. After being rocked by revised rate hike calls yesterday – with further revisions today meaning that each of the big four domestic banks now expect a rate hike in November – Kiwi bonds also rallied, with the 10Y NZGB declining 7bps to 1.74%. With the RBNZ presently still engaged in QE, investors now await next week’s policy review to see whether the Bank validates these expectations.

BoJ estimates point to drop in consumption in Q2; coincident and leading indicators also weaker in May
Today the BoJ released its Consumption Activity Index for May, which is second only to the Cabinet Office’s synthetic consumption index as the most reliable indicator of the national accounts based measure of private consumption. With much of the retail and hospitality sector impacted by trading restrictions during the month, unsurprisingly the real index slumped a further 3.7%M/M in May. This follows a 1.3%M/M decline in April that was 0.5ppts larger than estimated previously. In the detail, the weakness was broad-based, but unsurprisingly led by 5.2% decline in spending on services. Spending on durables goods fell a similar 4.9%M/M while spending on non-durable goods declined 1.6%M/M.

Given the plunge in spending that occurred at the start of the pandemic, spending was over 10% higher than May last year, with spending on durable goods up more than 29%Y/Y. However, more meaningfully, the level of spending in May was the least since May last year. Given this result and prior revisions, the level of spending over the first two months of last quarter is tracking 1.7% below the average through Q1. And so with some restrictions on activity remaining in place through June as well, the BoJ’s estimates confirm that consumer spending is likely to have declined materially during the quarter.

In other Japanese news, the Cabinet Office released its preliminary business indicators for May, which are also being to reflect the impact of extended restrictions on trading activity. After reaching an 18-month high last month, the coincident indicator declined 2.6pts to 92.7, which was in line with market expectations. Meanwhile, after reaching a more than seven-year high last month, the leading index fell 1.2pts to 102.6, and so was just above the March reading.

German manufacturing output falls 0.5%M/M in May, with autos down for fifth successive month on supply constraints
As foreshadowed by yesterday’s turnover data, German manufacturing output fell for a second successive month in May and by 0.5%M/M to be more than 6.5% below the pre-pandemic level in February 2020. That also left the average level in the first two months of Q2 some 0.7% below the average in Q1. Within the detail, the weakness was driven by autos – still most affected by supply bottlenecks – production of which fell for a fifth successive month and by a hefty 7.2%M/M to be more than 22% below the level at the end of last year and almost 28% below the pre-pandemic level. In addition, output of machinery and equipment was down 3.4%M/M to be a little more than 2% below the pre-pandemic level albeit still up from the end of 2020. Among other major items, however, production of intermediate items rose for a third successive month and by 0.6%M/M to return close to the pre-pandemic level. Consumer goods output rebounded 4.1%M/M to a new pandemic-era high. And growth in construction rose 1.3%M/M, more than outweighing a drop in energy output, to leave overall industrial production down slightly less than manufacturing, at 0.3%M/M.

FOMC minutes and JOLTS job vacancy data the focus in the US today
In the US, most interest today will centre on the release of the minutes from last month’s FOMC meeting, which will be read especially closely for any further clues regarding the committee’s inclinations regarding the timing and form of future QE tapering. On the data front, even with non-farm payrolls having lifted 583k during the month, the JOLTS survey for May seems highly likely to indicate that job vacancies remained near the record high reached in April. 

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