Japan’s services PMI falls to 5-month low, as restrictions weigh

Chris Scicluna

Chinese stocks slump as regulator activity and fractious trade talks worry investors; weighs on markets elsewhere in Asia, but Japanese stocks move higher following last week’s holiday
A week of generally stronger-than-expected corporate earnings news saw Wall Street end last week on a very positive note, with the S&P500 advancing 1.0% to a new record high. That sentiment failed to flow through to the bond market, however. A modest sell-off in USTs proved very short-lived, as the 10Y note closed virtually unchanged at a yield of 1.28%. The advance in stocks gave the greenback a small boost while improved investor sentiment was also evident in the commodity complex.

Unfortunately, that sentiment has not carried into the new trading week with large parts of Asia in the red today (US equity futures have also reopened several tenths weaker and the 10Y UST yield has slipped to 1.25%). The centre of that weakness is China, with the CSI300 and Hang Seng presently down more than 3.5%. Chinese regulators were again the centre of attention. Over the weekend, the State Council confirmed earlier speculation that new rules will prevent private education companies that teach school curriculums from making profits or raising capital, with overseas investment in these companies also banned. Not surprisingly, stock prices have plunged for the impacted companies, while investors are also clearly pondering which sectors might be next to attract regulatory scrutiny. Probably not helping sentiment has been the latest US-China trade talks, held in Tianjin. These appear to have begun as acrimoniously as the previous talks in March, with China’s Xie describing the relationship as in a stalemate and facing “serious difficulties”. The decline in China has weighed on stocks in South Korea and Singapore, where the major bourses are presently down over ½%.

By contrast, re-opening after a two-day holiday – during which time the S&P500 increased more than 2% – Japan’s TOPIX has advanced 1.1%. The rally in Japan came despite the services PMI hitting a five-month low in July and Tokyo recording more than 1,750 new coronavirus cases yesterday. Meanwhile, PM Suga’s cabinet approval rating hit a new low of 34% according to a Nikkei/TV Tokyo survey – the worst rating for a government since 2012 when the DPJ was in office. In Australia, ahead of a big week of inflation data, the ASX200 has held its ground today. However, with USTs tracking lower, Aussie bond yields have moved a little lower too. In virus news, Sydney reported a further 145 new coronavirus cases today, with officials clearly concerned that cases may continue to rise in coming days following weekend lockdown protests in which thousands took to the streets in defiance of public health rules. Indeed, according to reports, NSW officials are mulling extending Sydney’s lockdown – currently due to end on 30 July – until as far as mid-September, with a decision possible later today. More positively, Victoria recorded just 11 cases today – all in isolation – and along with South Australia appears on track to end its lockdown on Wednesday.

Japanese service sector PMI falls to five-month low in July; BoJ trimmed mean inflation rate turns positive in June; nationwide department store sales rebound in June but still down 1.6%Y/Y
The focus in Japan today was on the flash PMI readings for July. As had seemed likely, led mainly by a renewed weakening in the service sector, the composite PMI output index declined 1.2pts to a six-month low of 47.7 (also 1.9pts below the average level through Q2). In the detail, the headline services index – the business activity index – fell 1.6pts to 46.4, thus more than fully erasing last month’s gain to record and the lowest reading since February. With restricted trading conditions remaining in place in the hospitality sector, the new orders index declined 1.3pts to a five-month of 47.4. And with the renewed state of emergency in the Tokyo area impacting activity that might have been expected to flow from the Olympics, the business expectations index slumped 4.2pts to a six-month low of 54.0. The employment index was also weaker, declining 1.0pts to an eight-month low of 49.8. Despite the weakening of the activity indicators in this sector, the pricing indicators were mixed. While the input prices index increased 1.6pts to 54.0, the output prices index declined 0.5pts to a five-month low of 50.3.

Predictably, the manufacturing PMI continued to display greater resilience in July, pointing to an ongoing – albeit slower – expansion in activity. The headline manufacturing PMI fell just 0.2pts to 52.2, marking a five-month low, with the output index also declining 0.2pts to a six-month low of 50.5. Supply bottlenecks are likely still part of the explanation, with the supplier deliveries index barely improving from last month’s 14-month low. The new orders index fell 0.4pts to a six-month low of 51.5, while the new exports index fell 1.2pts to four-month low of 52.2. After reaching a post-pandemic high last month, the employment index also nudged down 0.3pts to 50.9. While the activity indicators in the sector were a little softer, the pricing indicators were markedly firmer. The input prices index jumped 3.1pts to 66.4 (the highest reading since September 2008) and output prices index increased 1.9pts to 53.5 (the highest reading since November 2018).

Turning to today’s other Japanese news, following on from last week’s national CPI report, today the BoJ released its analytical measures of underlying inflation that, unlike the regular measures of core inflation, are less-impacted by extreme relative price shifts such as the steep decline in mobile phone call charges that occurred in April. The trimmed mean inflation rate, which the BoJ regards as best correlated with the state of the economy, edged up 0.1ppt to 0.1%Y/Y in June – the highest reading since February 2020. This compares with the Bank’s preferred exclusion-based core measure (CPI excluding fresh food and energy), which was steady at -0.2%Y/Y. The weighted median and the modal increase in prices were both steady at 0.1%Y/Y, so also suggesting that the underlying inflation trend was fractionally positive.

Finally, after growing 65.2%Y/Y in May due to base effects associated with last year’s first wave of coronavirus cases, Japan’s national department store sales declined 1.6%Y/Y in June. With emergency trading restriction easing during the month, sales increased more than 50%M/M compared with May. However, the level of sales was over 22% lower than in June 2019. In the detail, spending on clothing and accessories fell 9.8%Y/Y in June, but sales of food increased 3.3%Y/Y.

Most focus in Japan this week will be on the Friday’s activity indicators for June
Aside from any pandemic-related dramas associated with the hosting of the Olympics, the focus over the remainder of the week will fall mainly on the key activity indicators for June (all released on Friday). Of particular interest will be the IP report, with the consensus – guided by firms’ own forecasts – expecting a 5%M/M rebound in output in June following an unexpectedly steep 6.5%M/M decline in May. The MIC’s household employment survey will also be of interest in light of the pandemic-induced softening seen in recent months. Given the easing of restrictions on trading in prefectures previously under state of emergency conditions – albeit only temporarily in the Tokyo area – retail sales data should report a rebound in spending in June. Data on housing starts and construction orders completes the docket. Earlier in the week, the only diary entries of note are the services PPI report for June and a speech by BoJ Governor Kuroda to the Japan National Press Club (both tomorrow).

Another quiet week for data in China, with Saturday’s official PMIs the focus
There were no major economic reports in China today and other than tomorrow’s corporate profit data there are no releases scheduled during the regular working week. However, Saturday will bring the release of the official PMI reports for July. According to Bloomberg’s survey, the consensus expects the manufacturing PMI to have edged down 0.1pts to 50.8. On this occasion, perhaps greater interest will fall on the non-manufacturing PMI, which fell to a four-month low of 53.5 in June. Bloomberg’s survey suggests that analysts also expect that index to decline 0.1pts to 53.4.

German ifo ahead today, and a busy week of euro area data to follow, including flash Q2 GDP and July inflation and account of the ECB Gov Co meeting on the strategic review
A very busy week ahead for euro area data kicks off today with the German ifo business survey for July. Judging from Friday’s flash PMIs, this will report firm growth momentum at the start of Q3. The week’s most noteworthy data, however, come on Friday with the flash Q2 GDP and July inflation figures. We anticipate a moderate rebound in euro area GDP in Q2 following the modest contraction (-0.3%Q/Q) in Q1, with growth of 1.2%Q/Q to leave output up almost 13%Y/Y but still 3.9% below the pre-pandemic level. In addition, Germany is likely to have more than fully reversed its 1.8%Q/Q contraction in Q1 and Spain is also likely to have grown by a touch above 2.0%Q/Q. We expect growth of close to 1.0%Q/Q in France and Italy, where GDP moved broadly sideways in Q1. In terms of inflation, we forecast the headline rate to rise just 0.1ppt to the ECB’s 2.0% target in July, due to principally to higher energy prices. But with services inflation still subdued and non-energy goods inflation having likely eased back after a jump in June, core inflation is likely to slip back further from 0.9%Y/Y in June.

Among the other euro area data due this week, July sentiment survey results include the Commission’s business and consumer confidence indicators on Thursday. Having risen for five consecutive months and to a 21-year high in June, the headline euro area economic sentiment index is likely to have fallen back somewhat, albeit remaining at an elevated level. In addition, euro area bank lending figures are due on Tuesday, while French, German and euro area labour market data are due on Tuesday, Thursday and Friday respectively. And beyond the data, Thursday will bring publication of the account of the ECB’s special policy meeting of 7-8 July when the Governing Council agreed its strategic policy review conclusions. All decisions, including the setting of a symmetric 2% inflation target, were unanimous. But the account might shine light on the debate on issues that are still unresolved, including the purpose and effectiveness of the asset purchases and likely PEPP pace into the autumn and beyond.

Speech by MPC’s Vlieghe most notable in the UK today, with July retail surveys to come this week
A relatively quiet week for UK economic news kicks off today with a speech by BoE MPC member Gertjan Vlieghe. With a focus on the drivers of low interest rates, this might provide insight into how he will vote at the August monetary policy meeting, which will be his last as an external member on the Committee but where splits seem likely to emerge on whether to maintain the current asset purchase target or bring the QE programme to an early end. Data due include the CBI’s latest distributive trades survey tomorrow, which will provide an update on retail sector activity at the start of Q2 following the moderate growth in June reported in Friday’s official retail sales figures. The BRC’s shop price index for July – due Wednesday – will be watched for any signs of upwards price pressures on the High Street.

An extremely busy week ahead in the US, with a Fed meeting, key data and a huge amount of corporate reporting
This week’s US economic diary is packed with important data and events. Naturally, a key focus will be Wednesday’s FOMC meeting. There is little prospect of any change in policy settings and the post-meeting statement is likely to contain little change in tone from that issued in June, with the economy maintaining good forward momentum and further upside inflation prices surely to be dismissed as temporary. Therefore, most interest will centre Chair Powell’s post-meeting press conference, where reporters will doubtless seek information on whether the committee has made any progress in plans for an eventual tapering of the QE programme. Daiwa America’s Mike Moran expects Powell to remain very non-committal on a taper start date – perhaps especially so in light of the recent increase in local coronavirus cases – while it also seems unlikely that the committee will have reached an agreement on whether to taper MBS purchases ahead of Treasuries.

Turning to this week’s data flow, the diary begins today with news on new home sales in June and the Dallas Fed’s manufacturing survey for July. As far as home sales are concerned, following four-months of decline, Mike expects a solid 7.3%M/M rebound this month. Tomorrow will bring both the Conference Board’s consumer survey for July and the advance durable goods orders report for June. Given the weakening seen in the University of Michigan’s survey amidst upside surprises to inflation, the former will almost certainly backtrack from last month’s post-pandemic high. However, durable goods orders are likely to have firmed, not least due to a lift in aircraft orders. The Richmond Fed’s manufacturing survey and the S&P/Corelogic and FHFA home prices indexes round out tomorrow’s diary.

Wednesday will bring the release of advance merchandise trade and inventory data for June. Mike expects the trade deficit to have narrowed slightly to $87bn, thanks to a pullback in imports from above-trend levels in May. These reports will help analysts fine-tune their estimates for Thursday’s release of the advance national accounts for Q2. Ahead of this week’s final indicators, Mike expects that GDP likely advanced a very solid 8.0%AR, led by strong growth in consumption and a moderate advance in business capex. Net exports should be close to neutral after three quarters of decline, but residential construction and perhaps inventories will weigh on growth. Pending home sales data for June will also be released on Thursday.

On Friday, the personal income and spending report for June will spell out the monthly profile of income, spending and the core PCE deflator that will be implicit in the GDP report. Mike expects only modest increases in both income and spending, whereas a 0.6%Q/Q increase the core PCE deflator will likely send the Fed’s preferred core inflation metric to a new high of 3.7%Y/Y. Also of note on Friday is the Employment Cost Index for Q2. Amidst reports of rising wage pressures, Mike expects a second consecutive 0.9%Q/Q increase in employee compensation, which compares with the 0.7%Q/Q average seen in the year prior to the pandemic. The Chicago PMI for July and finalized results of the University of Michigan survey for July complete the week’s economic diary.

Finally, as if a Fed meeting and a busy economic diary were not enough for the market to digest, this week will also bring earnings reports from more than a third of the companies in the S&P500. If the results so far this seasons is any guide, these reports should provide a degree of support to the stock market.

Inflation week ahead in Australia with Wednesday’s CPI the key focus; developments in the virus outbreak will also be monitored closely
Were it not for the current virus outbreak, which has clearly compromised the near-term economic outlook, this week’s diary of key inflation reports would have the potential to lead to some significant repricing of the Australia rates market. Most interest will centre on Wednesday’s CPI report, with the consensus expecting a 0.7%Q/Q increase in the headline index to lift annual inflation to 3.7%Y/Y. This almost 13-year high reflects the 1.9%Q/Q plunge in the CPI in Q2 last year, which was due in part to temporary government policy measures to support the economy during the first wave of the pandemic. Therefore, more interest will centre on the analytical core measures favoured by the RBA. In particular, the consensus forecast of a 0.5%Q/Q lift in the trimmed mean would point to underlying momentum that is still inconsistent with the RBA’s goal of moving inflation comfortably inside the 2-3% target range (annual trimmed mean inflation would remain below the band at 1.6%Y/Y, albeit up from 1.1%Y/Y in Q1). Given the performance of the economy prior to the virus outbreak and the pattern of surprises elsewhere – including in New Zealand – the balance of risks would appear weighted towards a somewhat stronger outcome. However, at least for now, it is doubtful that the market would respond strongly to such a surprise with around half of the Australian population currently subject to lockdown restrictions.

As far as the rest of the week’s diary is concerned, data on trade prices and the PPI for Q2 will follow on Thursday and Friday respectively while the RBA will also release private sector credit data for June on Friday. While RBA Deputy Governor Debelle will speak via web to a FX market US audience tomorrow, the speech is unlikely to break new ground given the proximity of the next RBA Board meeting.

Kiwi exports hit record high in June; sentiment data and building approvals still to come this week
New Zealand’s recorded a trade surplus of NZ$261mn in June. Exports surged more than 9%M/M to a record high and were up 17.1%Y/Y, with dairy exports rising 31.3%Y/Y and so accounting for close to half of that growth. Imports increased 2.6%M/M and were up 23.5%Y/Y, with passenger motor car imports rebounding more than 176%Y/Y and imports of crude oil rising more than 129%Y/Y. Imports of plant and machinery increased a very encouraging 19.3%Y/Y – indicative of the capacity pressures facing the economy – and imports of consumer goods increased 18.9%Y/Y.

Looking ahead, the focus over the remainder of the week will be on Thursday’s ANZ Business Outlook survey for July – especially on the inflation indicators – with news on consumer confidence and building approvals to follow on Friday.

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