Japanese orders surprise on the upside

Chris Scicluna

Risk aversion evaporates, sending stocks higher across most of Asia; Aussie bond yields fall as Sydney virus outbreak worsens
The risk aversion that was evident during Friday’s Asian session proved short-lived, allowing European equities to erase most of Thursday’s heavy losses and the S&P500 to advance 1.1% to end the week at a fresh record high. At the same time, Treasury yields moved higher, with the 10Y UST closing up 7bps at 1.36% and so 11bps above the previous day’s intraday low. The recovery in risk sentiment was also evident in a rebound in both crude oil and industrial metals prices and a reduction in demand for the greenback, with sterling and the Antipodean dollars making especially solid gains.  

Against that background, even with US equity futures reopening a tenth or so weaker today, it has mostly been a positive start to the week in Asia-Pacific equity markets (a further slump in Vietnam being the main exception, as last week’s new pandemic restrictions appeared to weigh further on prices there). The largest rally has been in Japan where, after three days in the red, the TOPIX has rebounded more than 2%. Sentiment in Japan was perhaps supported by news of a larger-than-expected lift in core machinery orders in May (see below). Meanwhile, as we write, stocks have increased 1.2% in Mainland China, with investors perhaps also reacting to Friday’s late news of a stronger-than-expected lift in credit growth in June, as well as the PBoC’s announcement of a cut in Reserve Requirement Ratio effective from this Thursday (albeit the latter designed to allow banks to repay CNY1.1trn of MLF funding due to expire over the next month or so, as well as meet liquidity pressures created by coming tax flows).

While new pandemic restrictions took effect in Seoul today, a gain of 0.9% in the KOSPI has also ended a three-day losing streak in South Korea. In Australia the ASX200 rose 0.8%, thus failing to erase Friday’s losses, after officials in Sydney announced 112 new coronavirus cases today – now the largest outbreak of cases since the first wave of the pandemic. That news also weighed on the Aussie bond market, with the 10Y AGCB declining 4bps to 1.32%.  

Japan’s core machine orders increase solidly in May despite emergency conditions
As far as Japanese data are concerned, the focus today was the machinery orders report for May. The good news is that the report pointed to a pick-up in domestic demand for capital goods, despite the state of emergency conditions in place during the month, suggesting a degree of underlying optimism regarding the economy’s longer-term prospects. Total machinery orders increased a further 9.8%M/M – building on an 18.2%M/M increase in April – helped by a further 11.4%M/M lift in foreign orders (the latter now up a whopping 126%Y/Y). Importantly, after disappointing last month, the closely-followed measure of core private domestic orders (which excludes volatile items such as ships and capex by electricity companies) increased a larger-than-expected 7.8%M/M in May. While the 12.2%Y/Y increase in core orders in May owes mostly to base effects associated with the slump in orders at the onset of the pandemic, the level of core orders in May was only slightly below the average in the year leading up to the pandemic. In addition, the level of core orders over the first two months of Q2 is tracking almost 4% above the average through Q1, thus at this point exceeding the 2.5%Q/Q growth that machinery-producing firms had been forecast in the Cabinet Office’s survey.  

In the detail, orders from the domestic manufacturing sector increased 2.8%M/M in May and so were up a sturdy 37.9%Y/Y. This partially reflected a further recovery in shipbuilding orders, which had slumped to a two-year low in March. However, by far the largest increase was a surge in orders from the electrical machinery industry, which rose by over a third to the highest level since 2008. After declining 11%M/M in April, core orders from the non-manufacturing sector rebounded 10%M/M in May but were still down 4.7%Y/Y. Orders from the telecommunications sector increased to a five-month high, accounting for most of the growth seen during the month. Finally, government orders increased 3.1%M/M in May but were 23.2% below the unusually high level recorded a year earlier. 

Commodity prices and the weaker yen continues to boost Japan’s goods PPI
In other Japanese news, the BoJ released the goods PPI for June, which surprised analysts to the upside for a fourth consecutive month. Not only was a further 0.6%M/M lift in the headline index 0.1ppt above the consensus expectation, but the previous month’s outcome was revised up 0.1ppt to 0.8%M/M as well. So the PPI increased 5.0%Y/Y – 0.2ppt above the consensus expectation, but down 0.1ppt from the more than 12-year high reached last month (now revised up to 5.1%Y/Y). Once again, higher prices for scrap and waste (up 3.9%M/M and 74.8%Y/Y) and utilities (up 1.0%M/M but down 3.6%Y/Y) contributed to this month’s outcome. However, the PPI for manufactured goods still increased a solid 0.5%M/M for a second consecutive month, albeit not enough to stop annual inflation from declining 0.2ppt to 5.3%Y/Y. The key drivers of the increase in prices for manufactured goods were very familiar: namely, a 3.0%M/M increase in the price of energy products (which are up 42%Y/Y) and a 6.3%M/M increase in lumber prices (now up almost 19%Y/Y). After increasing sharply in previous months, the price of non-ferrous metals fell 0.5%M/M but was still up almost 38%Y/Y.

As in recent months, the weakening of the yen is contributing to price increases at the producer level, especially for raw and intermediate materials. Measured in yen, import prices increased a further 1.7%M/M in June to the highest level since November 2018, and so were up almost 26%Y/Y. Even so, final producer goods prices increased just 0.4%M/M in May, with domestic prices rising just 0.3%M/M and the prices of imported goods rising 0.9%M/M. Consumer goods prices increased a somewhat larger 0.6%M/M – in part due to a 1.0%M/M lift in import prices – but base effects meant that annual inflation still declined 0.1ppt to 3.4%Y/Y. And of course, goods prices at the CPI level are inflating at nowhere near that rate, with firms either unable or unwilling to pass on the rise in input costs (at least at this stage).

BoJ policy meeting and updated Outlook Report the focus in Japan over the remainder of this week 
Looking ahead to the remainder of this week, the focus in Japan will be on the BoJ Board meeting that concludes on Friday. On this occasion the announcement regarding policy settings will be accompanied by an updated Outlook Report and the unveiling of more detail on the new ‘green’ funding support programme – likely to offer long-term funds at zero percent interest – that was announced at last month’s meeting (replacing a long-standing growth-focused measure that will be allowed to expire next year). The Bank’s key policy settings are likely to remain unchanged, notwithstanding the setback for the economy created by the extended wave of coronavirus cases, which is now also set to dampen further the economic benefits that might have been conferred by the Olympics. Indeed, recent comments by Governor Kuroda – drawing from observations in the latest Regional Economic Report – suggest that the Bank will continue to project a trend recovery of the economy as progress on vaccinations picks up, overseas economies continue to grow and assisted by supportive domestic monetary and fiscal policy settings (with further fiscal stimulus almost inevitable over coming months as PM Suga seeks to shore up support ahead of the forthcoming national election). 

As far as the Outlook Report is concerned, with the recent and near-term performance of the economy hampered by continued infections and restrictions on trading activity, the Board is likely to slightly revise down its forecast of GDP growth in FY21 (previously 4.0%), whilst boosting the outlook for at least FY22 (previously 2.4%). Even so, given developments in commodity prices – especially crude oil – and the yen, the Bank’s near-term inflation forecast is likely to be revised slightly higher, while the forecast for FY23 will likely continue to point to expected inflation that is only half of the Bank’s 2% long-term target.

As far as data are concerned, there are only a small number of Japanese releases due over the remainder of the week. On Wednesday, we will receive the final IP report for May – which disappointed expectations in the advance release – and the Reuters Tankan for July. On Thursday, METI’s Tertiary Industry Activity Index will cast light on activity in the services sector during May, with a repeat of the prior month’s 0.7%M/M decline likely given soft pandemic-impacted readings coming from the retail sector.

China’s credit expansion picks up in June; PBoC cuts RRR but CNY1.1trn of MLF loans set to expire
There were no economic reports of note in China today. However, ahead of the key data to come later this week, today the market had the opportunity to digest the slightly stronger-than-expected credit and money growth data released late on Friday, which were followed immediately by a cut in the PBoC’s reserve requirement ratio (RRR). Indicative of the PBoC’s desire that banks support the economy in the face of continued pandemic-restraints on growth and upward pressures on input costs, aggregate financing grew CNY3.67trn in June, which was the most since January and around CNY0.2trn more than in June last year. As a result, annual growth in the total stock of aggregate financing stabilized at the 15-month low of 11.0%Y/Y reported in May. Bank lending grew CNY2.12trn, which was the most since March. This was also CNY0.3trn more than in June last year, causing annual growth in the stock of loans to edge up to 12.6%Y/Y. With regard to the monetary aggregates, growth in M1 eased a further 0.6ppts to 5.5%Y/Y but growth in M2 increased 0.3ppts to 8.6%Y/Y – a rate that is drawing closer to China’s target for nominal GDP growth this year. 

Turning to the PBoC’s policy move, with CPI inflation remaining quiescent, the Bank announced that it would cut the RRR by 0.5ppt – lowering the average across all banks to 8.9% – effective from 15 July, citing the aims of supporting the real economy – especially “small and micro enterprises” impacted by increasingly high commodity prices – and ensuring that “overall financing costs are stable with a slight decrease”. That said, it is important to note that MLF loans amounting to a total of CNY1.1trn will be allowed to mature on 15 July and 17 August – thus soaking up much of this additional liquidity – while the PBoC also anticipates a liquidity gap associated with tax payments due in mid-to-late July. As a result, despite the RRR cut, the PBoC characterized overall banking system liquidity as “basically stable” following this decision.

Trade data to come in China tomorrow, followed by the remaining key activity indicators and the Q2 GDP report on Thursday
Looking ahead, this week’s important economic diary begins tomorrow with the release of trade data for June. With base effects becoming less pronounced, both export and import growth are expected to have slowed to still flattering rates of around 23%Y/Y and 30%Y/Y respectively. Thursday will bring the release of China’s key domestic activity indicators for June and the first estimate of GDP growth in Q2. Given recent disappointing PMI readings, Bloomberg’s survey indicates that the market expects China’s economy to have grown at a subpar pace of 1.0%Q/Q – albeit up from just 0.6%Q/Q in Q1 – while less pronounced base effects associated with last year’s poor start means that annual growth is expected to slow to 8.0%Y/Y from 18.3%Y/Y previously. The monthly activity data for June – especially retail sales – will be analysed closely to determine momentum heading into Q3.

Lagarde signals new ECB forward policy guidance next week; euro area IP and final inflation due this week
While she presented the conclusions of the ECB’s strategic policy review last week, President Lagarde suggested that the new 2% inflation target would not change the Governing Council’s reaction function. However, with that message having been coolly received by the markets, in an interview with Bloomberg, she changed tone last night. In particular, she made clear that next week’s monetary policy meeting would bring new forward guidance, underscoring the need for policy to maintain favourable financing conditions for some time to help meet the new target. It remains to be seen, however, whether that updated guidance will bring with it news on the calibration of the ECB’s policy tools, including the near-term pace of PEPP purchases. And while feasible, it seems unlikely that it will offer detail on the nature of the asset purchase programme to succeed the PEPP next year – ideally, such a programme would retain the extra flexibility afforded by the PEPP to continue to address market fragmentation risks in future.

While other members of the Governing Council might give their own takes on the implications of the strategic policy review this week, it should be relatively uneventful for euro area economic news, with arguably the most noteworthy data being Wednesday’s release of euro area industrial production figures for May. Despite the weakness recorded in the largest three member states, aggregate euro area IP is expected to have moved broadly sideways, supported by a surge in output from Spain. Final inflation figures will also be published throughout the week, with German and French figures due tomorrow, Spanish numbers due Wednesday, Italian data due Thursday and aggregate euro area numbers on Friday. These are expected to confirm the modest drop in the preliminary headline estimate of euro area CPI to 1.9%Y/Y, with the core rate unchanged on the month at 0.9%Y/Y. Finally, Friday will also bring euro area trade data for May car registrations numbers for June.

Johnson to confirm lifting of most English coronavirus restrictions; UK inflation and labour market data the highlights this week 
Despite the current significant uptrend in the number of new coronavirus cases, UK PM Johnson will later today confirm his intention to relax most remaining coronavirus restrictions – predominantly related to large gatherings – from 19 July. Meanwhile, there will be several top-tier UK data releases this week, with June inflation figures due on Wednesday and the latest labour market report on Thursday. Having jumped above the 2.0% target in May for the first time in almost two years, we expect the headline CPI rate to have moved sideways at 2.1%Y/Y in June, with a moderation in non-energy goods inflation likely to be offset by higher services and energy prices. Indeed, given recent developments in oil markets, we see the risks skewed to the upside. Against this backdrop, however, core inflation might well have edged slightly lower from the near-two-year high of 2.0%Y/Y reached in May.

With the government’s Job Retention Scheme still in full operation in May and the economy continuing to return to some form of post-lockdown normality, we expect to see a further tightening in labour market conditions, including a further notable increase in payrolls and vacancies. The unemployment rate is expected to have moved sideways in the three months to May – although it is worth noting that recent unemployment, employment and inactivity figures will be revised slightly due to methodological changes (the unemployment rate will be nudged up between 0.1-0.2ppt and employment rate revised down by 0.3ppt). Meanwhile, growth in average labour earnings seems highly likely to rise above 6½%Y/Y, supported in part by base and composition effects. Ahead of this will see the BRC’s latest retail sales monitor for June published tomorrow. At the BoE, meanwhile, tomorrow the Bank will publish its latest Financial Stability Report with Thursday bringing its quarterly Credit Conditions and Bank Liabilities surveys.

Inflation the early focus in the US, before attention turns towards activity indicators later in the week; Fed Chair Powell’s semi-annual testimony also of note, while banks report Q2 earnings 
While there are no major economic reports due in the US today, there are a number of important data releases and events over the remainder of this week. Initially the focus will be on inflation, starting tomorrow with the CPI report for June. Daiwa America’s Mike Moran expects another solid 0.5%M/M lift in the headline CPI, leaving annual inflation close to last month’s 5.0%Y/Y pace. With the economy continuing to reopen, he expects further price normalization and robust demand to drive a 0.4%M/M lift in the core index, which should raise annual inflation to a new high of 4.0%Y/Y. While the CPI will dominate attention, tomorrow will also bring the release of federal budget data and the latest NFIB small business survey. On Wednesday, Mike expects the PPI to mimic the CPI, with headline and core prices lifting by 0.5%M/M and 0.4%M/M respectively. Whatever these inflation reports reveal, Fed Chair Powell will have the opportunity to comment when he presents the first leg of his semi-annual testimony to the House Financial Services Committee later Wednesday morning (and again on Thursday, when he testifies before the Senate Banking Committee). The Fed will also release its latest Beige Book of anecdotal reports on Wednesday.

From Thursday onwards, attention turns mainly to indicators of activity. Most interest that day will centre on the IP report for June. Mike estimates only a modest 0.4%M/M lift in activity this month, with labour market data pointing to a relatively soft outcome in the manufacturing sector (mining and utility output are likely to be much stronger, however). Further indications regarding the trend in manufacturing activity will be provided by the release of Philadelphia and New York Fed manufacturing surveys for July, while data on trade prices for June is also scheduled for release. On Friday, the focus turns mostly to the consumer with the release of the advance retail sales report for June and the preliminary findings of the University of Michigan’s consumer survey for July. Mike forecasts that a drop in auto sales will result in a 0.3%M/M decline in total retail spending, but he expects ex-auto spending to have nudged up 0.2%M/M. Meanwhile, he expects that a strengthening labour market and rising stock market will lift the University of Michigan’s consumer confidence index by 4.5pts to 90.0, which if realized would be a post-pandemic high. News on developments in business inventories during May will complete the week’s economic diary.

Finally, it is worth noting that the Q2 earnings season moves up a gear this week. Amongst the 21 S&P500 companies reporting earnings, the focus will be on the bank sector with JP Morgan Chase, Goldman Sachs, Bank of America, Citigroup, Wells Fargo and Morgan Stanley reporting this week.

Aussie economic data continues to point to considerable economic momentum
Aside from monitoring the evolution of the coronavirus outbreak in Sydney, the focus in Australia over the first part of the week will be on the latest developments in business and consumer sentiment, with the NAB Business Survey released tomorrow and the Westpac survey of consumer confidence to follow on Wednesday. Given the recent outbreak of coronavirus cases, especially in Sydney, it would be surprising if both business and consumer sentiment has not taken a significant backward step, especially with the former having portrayed key activity indicators at a record high in May. However, both are likely to continue to point to a robust near-term outlook for the economy.

Most interest this week will centre on Thursday’s Labour Force report for June, which will set the baseline for the updated forecasts that the RBA must compile for next month’s Board meeting and Statement on Monetary Policy. After posting a whopping 115k increase last month – the latest of a long line of large upside surprises – the market is forecasting a relatively modest 20k increase in employment in June, even with job advertising levels setting new highs. As a result, after an unusually sharp decline last month, the consensus expects the unemployment rate to have remained at 5.1% in June. As RBA Governor Lowe explained last week, he expects that the unemployment rate will need to at least move into the low 4s to generate the 3%-plus annual wage inflation that he expects will be required to sustain CPI inflation comfortably within the Bank’s 2-3% target range. So further progress in reducing the unemployment rate would increase the likelihood of an earlier policy tightening if later followed by a lift in wage and CPI inflation from current undesirably low levels.

Kiwi consumer spending rebound continues in June
According to Statistics New Zealand, the total value of spending at retail stores – as measured by electronic payment systems – increased a further 0.9%M/M in June, building on a 1.7%M/M increase in May and a 4.5%M/M increase in April. As a result, following a 2.5%Q/Q contraction in Q1, spending rebounded 5.7%Q/Q in Q2, while the level of spending in June was 4.0% higher than a year earlier. Excluding spending on autos and fuel, the core measure of sales grew 0.6%M/M in June and 5.6%Q/Q in Q2, led by a further rebound in spending in the hospitality sector (which had been hindered by short-lived restrictions in Q1). 

RBNZ policy review and the Q2 CPI the key events in New Zealand over the remainder of this week
At its last meeting in May the RBNZ surprised the market by dropping its earlier uber-dovish rhetoric and acknowledging that some policy tightening would likely be necessary from the second half of next year. Since then a plethora of strong economic reports and extremely elevated inflation indicators have caused the market to leap frog the RBNZ’s outlook, with the four major domestic banks now all calling for policy tightening to begin in November this year. With that in mind, Wednesday’s RBNZ policy review holds more interest than might otherwise have been the case, with the focus being on whether the Bank attempts to lean against the call for such early policy tightening. While we doubt that the RBNZ would presently see the need to tighten as soon as November – after all, at least for now it still has a QE programme in place – it will also be mindful that this coming Friday’s Q2 CPI report could have a decisive impact on both its own and market opinion. And so ahead of the release of updated economic forecasts at the next meeting in August, this week’s post-meeting statement may well prove decidedly non-committal. As far as the CPI is concerned, according to Bloomberg’s survey, the consensus expects a 0.7%Q/Q increase in prices to lift annual inflation to 2.7%Y/Y from 1.5%Y/Y previously, as last year’s pandemic-induced decline in prices drops out of the calculation. Any upside surprise would increase the likelihood of inflation topping 3%Y/Y in Q3 at a time when other indicators of price pressures, including labour shortages, are flashing red.

Aside from the RBNZ and the CPI, this week’s other remaining diary entries include tomorrow’s REINZ housing report for June and Friday’s manufacturing PMI for June.

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