German IP weak as supply bottlenecks pinch

Emily Nicol

Wall Street hits new highs, but Asia-Pac equity markets flat to slightly weaker as focus turn to today’s US non-farm payroll report
Wall Street returned to its winning run yesterday, with the S&P500 drifting higher through the session before a late push saw the index close up 0.6% and so at a new record high. Following the previous day’s disappointing ADP report, a sharper than expected decline in continuing jobless claims provided some reassurance ahead of today’s non-farm payrolls report, while corporate earnings continued to impress. The bond market also exhibited a more positive tone, with the 10Y note weakening throughout the session to close at 1.22% – up 4bps on the day – with Fed Governor Waller noting that he was very optimistic about today’s July jobs report, as well as about prospects for that in August. However, the greenback was little changed.

Despite the positive backdrop provided by Wall Street – US futures are only a tenth weaker since the close – equity markets have traded flat at best in the Asia-Pacific region today. The greatest weakness is in Chinese markets, with the CSI300 presently down 0.5%. Ahead of this weekend’s international trade release, lingering concerns about regulatory actions, developments at the indebted Evergrande Group and rising new virus cases were probably at play (the latter exceeding 100 for the first time in six months). In Japan, where both wages and household spending data disappointed market expectations today, the TOPIX is more or less unchanged. The BoJ’s more reliable consumption indicator pointed to a lift in spending in June. However, sadly, Tokyo reported more than 5,000 new virus cases over the past day – a new record. PM Suga argued that this development was not linked to the Olympics, and optimistically that the prospect of spectators at the Paralympics would depend on the path of the virus.

Stocks were a touch firmer in Australia, even as New South Wales reported a record 291 new virus cases, and the state of Victoria back in lockdown for a sixth time. However, AGCB yields still inched higher, reflecting both weakness in USTs and comments made by RBA Governor Lowe. Lowe indicated that the Board saw little near-term benefit to be had in deferring its decision to taper its asset purchases from next month, suggesting that a more prolonged downturn would be required in order for the Bank to change this month’s policy decision. 

Japan’s consumer spending rebounds somewhat in June, but still contracts in Q2
With restrictions on trading easing somewhat across much of Japan in June – albeit, increasingly temporarily – today’s consumer spending indicators were inevitably less bleak than in May, while still confirming that private consumption likely declined in June.

Most importantly, the BoJ released its Consumption Activity Index for June, 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. Unsurprisingly the real index increased 2.7%M/M following an unrevised 3.7%M/M slump in May. In the detail, spending on durable goods declined a further 1.8%M/M following a 4.7%M/M decline in May. However, after declining over the previous two months, spending on non-durable goods increased 4.7%M/M. Spending on services, which had fallen 5.5%M/M in May, rebounded a meagre 2.0%M/M. Given that spending had surged more than 14%M/M last June following the initial first-wave slump, spending was down 0.4%Y/Y – down sharply from growth of almost 11%Y/Y in May. More importantly, the level of spending fell 1.2%Q/Q in Q2, led by a 3.1%Q/Q decline in spending on durable goods (spending on services fell 1.2%Q/Q). So the BoJ’s estimates suggest that the preliminary national accounts for Q2 – released on 16 August – will likely show a material decline in consumer spending during the quarter.

Today’s other consumer spending data came from the MIC’s monthly survey of household spending and incomes for June – data that does a much worse job of closely tracking the national accounts measure of private consumption. According to the survey, real household spending declined a further 3.2%M/M in June following a 2.1%M/M decline in May. So with spending having temporarily rebounded more than 12%M/M in June 2020 following the plunge associated with the first wave of the pandemic, spending in June this year fell 5.1%Y/Y – a result that was much weaker than consensus expectations. The measure of core spending, which excludes spending on volatile components such as housing and autos, declined a much smaller 0.9%M/M in June following a 1.8%M/M fall in May, but was still down 4.7%Y/Y. Nonetheless, despite declining throughout the quarter, the survey reports a 2.3%Q/Q rebound in core spending in Q2 – a result that is very unlikely to be replicated in the national accounts. Finally, the survey also reports a whopping 14.3%Y/Y decline in workers’ real household disposable income – a result that reflects the absence of government support payments that had boosted incomes by almost 19%Y/Y in June last year.

Japan’s labour cash earnings decline 0.1%Y/Y in June, much weaker than expectations
Today also saw the MHLW release the preliminary Monthly Labour Survey for June. Despite declining 2.0%Y/Y in June last year, total labour cash earnings (per employee) declined a further 0.1%Y/Y – a result that was much weaker than the consensus estimate that flattering base effects would lead to growth of 1.1%Y/Y. This year’s decline owed to continued weakness in summer bonus earnings, which fell 2.3%Y/Y. By contrast, contracted earnings increased 1.3%Y/Y – albeit down from 1.8%Y/Y last month – largely thanks to an 18.3%Y/Y rebound in overtime earnings following a 24.6%Y/Y decline a year earlier. The increase in overtime earnings reflects the recovery in overtime hours worked, which increased by 2.1%M/M and 18.8%Y/Y in June. Regular earnings increased just 0.3%Y/Y, which was 0.1ppts slower than in June last year. After accounting for inflation, real wages declined 0.4%Y/Y.

Elsewhere in the survey, total hours worked increased a seasonally-adjusted 2.4%M/M in June – this following a 4.5%M/M slump in May – and were up 2.7%Y/Y. After declining last month for the first time since May last year, regular employment was steady in June but thanks to base effects grew 1.6%Y/Y. Employment in the manufacturing sector declined 0.2%M/M and 1.2%Y/Y. By contrast, reflecting demand created by the pandemic, employment in the medical, healthcare and welfare sector increased 2.9%Y/Y. According to the preliminary breakdown – which is often substantially revised – growth in the number of full-time employees picked up 0.4ppts to 1.5%Y/Y. Meanwhile, growth in the number of part-time employees – which had withstood the worst of the first wave of the pandemic – increased 1.6%Y/Y following a 1.5%Y/Y decline a year earlier. 

Japan’s coincident and leading indexes advance in June
In other Japanese news, the Cabinet Office released its preliminary business indicators for June. Notwithstanding current downward pressures on activity due to the pandemic, both the coincident and leading indexes improved during the month. The coincident index increased 1.9pts to 94.0. And while it remained 1.3pts below the 18-month high struck back in April, an “improving” assessment was pronounced for a fourth consecutive month. Meanwhile, the leading index increased 1.5pts to 104.8, exceeding the prior April high to mark the best reading since February 2014. 

German production disappointed in June as supply bottlenecks appear to weigh
As we flagged the downside risks yesterday in light of the weaker German turnover data, this morning’s industrial production figures had a disappointing end to the second quarter. In particular, production falling for the third consecutive month and by a steeper 1.3%M/M in June (having been expected to rise ½%M/M), to leave it down 0.5%Q/Q in Q2 and still 6.8% lower than the pre-pandemic level.

The weakness in part reflected construction activity, which declined for the fourth consecutive month (-2.6%M/M). But manufacturing output also remained fragile (-0.9%M/M), as ongoing supply constraints seemingly continued to weigh. For example, production of motor vehicles fell for the sixth consecutive month (-0.9%M/M), to leave it still some 29% lower than the pre-pandemic level, while machinery and equipment output fell a sharp 6.6%M/M in June to leave the level some 8½% lower than February 2020. Overall, production of capital goods fell 2.9%M/M in June to be down 4.6%Q/Q in Q2, with output of intermediate goods down 0.9%M/M, but up 0.6%Q/Q.

In contrast, production of consumer goods continued to recover, with growth of 3.4%M/M in June leaving it almost 2½% higher over the second quarter as a whole. Of course, with recent growth in orders having far outpaced production, and backlogs of work sky-high, output in Germany’s other manufacturing sub-sectors should return to firm growth as soon as supply bottlenecks - particularly in semiconductors - ease. 

Italian and Spanish industrial output figures are also due for release shortly and forecast to have risen between ½-1%M/M in June.

Report on UK jobs flags record rise in starting salaries due to a lack of candidates
The REC/KPMG report on UK jobs today continued to signal reduced spare capacity in the labour market at the start of Q3. According to the survey, recruitment continued to rise sharply in July – the indices for both permanent and temporary appointments remained close to series highs – as demand for employment was sky high due to the easing of restrictions and ongoing recovery in economic activity. However, recruitment consultants continued to flag a notable rise in vacancies due to a shortage of candidates, underpinned in part by concerns over job security and a lack of European workers due to Brexit. As such, today’s survey suggested that starting salaries were rising at their fastest pace in the 24-year history. 

Non-farm payrolls the focus in the US today – job growth should be strong, but how strong is uncertain
The focus in the US today will clearly be on the July employment report, which will likely be awaited somewhat nervously in light of the soft ADP employment reading seen midweek. Daiwa America’s Mike Moran still expects the BLS to report a strong 750k lift in non-farm payrolls, building on the 850k gain reported in June. Mike’s forecast is somewhat below the consensus forecast – which has come down to 870k according to Bloomberg – with recent soft ISM employment readings and the ADP report hinting that employers may be having difficulty matching workers to the record job openings on offer. Even so, he expects the unemployment rate to decline 0.2ppt to 5.7% (as does the consensus). The final wholesale trade report and consumer credit data for June are also due but will likely be drowned out by the payrolls report.

RBA SMP and Governor Lowe’s testimony provides no great surprises; Lowe indicators QE taper deferment considered but rejected as offering little immediate benefit
After surprising many people earlier this week, the focus in Australia today was back on the RBA with the Bank releasing its quarterly Statement on Monetary Policy (SMP) – providing greater detail on the Bank’s economic outlook – and Governor Lowe giving his (online) semi-annual testimony to the House of Representatives Standing Committee on Economics.

Beginning with the SMP, given the expected contraction of the economy in the current quarter due to lockdowns, especially in Sydney, the new baseline outlook is for GDP growth of 4% this year (on a Q4 to Q4 basis), down from the 5¼% forecast made back in May. Thereafter, the Bank now expects growth of 4% next year – revised up a ¼ppt – while the first forecast for the full 2023 year envisages growth of 2½%. The new forecasts assume that the cash rate follows market pricing (with other elements of the Bank’s stimulus as decided last month); a constant effective trade-weighted exchange (TWI) of 62 and Brent crude at $70/bbl. Despite the weaker near-term outlook for activity, given progress made in the first half of this year, the Bank still expects the unemployment rate to end this year at 5%. Thereafter, the unemployment rate is forecast to decline to 4¼% by the end of next year – ¼ppts lower than forecast previously – with a further decline to 4% expected by the end of 2023 (a level last seen briefly in 2008, prior to the GFC). 

However, in the Bank’s opinion, this will only be sufficient to generate a gradual uplift in inflation. The Bank’s expects trimmed mean inflation to end this year at 1¾%Y/Y – ¼ppt firmer than forecast previously – and to remain at that level at the end of next year. Thereafter, inflation is forecast to begin trending higher, rising to 2%Y/Y in June 2023 and 2¼%Y/Y by the end of 2023. Given the Bank’s commitment not to raise the cash rate until actual inflation is sustainably within the target range – and as Lowe reiterated today, simply sneaking across the 2% line for a quarter or two will not be enough – these forecasts make clear why the Bank still does not expect to raise the cash rate before 2024. However, the Bank’s scenario analysis makes clear that it is open to considering other possibilities. For example, the SMP depicts an upside scenario in which the virus is brought under control more quickly, leading to more rapid growth in consumption and services exports. In this scenario, the unemployment rate declines below 3½ per cent, leading to a brisk rebound in wages growth, and inflation picks up to around 2¾ per cent by the end of 2023.

Turning to Lowe’s testimony, his formal statement highlighted five mains themes from the SMP: (1) the Australian economy has bounced back quicker and stronger than was earlier expected; (2) the recovery has been interrupted by outbreaks of the highly infectious Delta strain of the coronavirus, especially in New South Wales; (3) the economy is expected to bounce back quickly once the restrictions ease; (4) we have not seen the same upside surprises in wages and prices that we have experienced in jobs and output, and that it will take some time for inflation to be sustainably in the 2 to 3% target range; and (5) the RBA's package of monetary policy measures is providing substantial support to the Australian economy in the face of lockdowns and the expected resumption of the economic expansion. In addition, Lowe explained that at this week’s meeting the Board had considered deferring its decision to taper assets purchases. However, given that the Board expects a return to strong growth next year, it considered that any additional bond purchases would only have a very small effect right now when the support is needed most, and that fiscal policy is the more appropriate instrument for providing support in response to a temporary and localised hit to income. However, as indicated earlier this week, Lowe noted that the Board will keep the situation under review and are prepared to act in response to further bad news on the health front that affects the outlook for the economy over the year ahead. 

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