BoJ says financial system maintains “stability on the whole”

Chris Scicluna
Emily Nicol

Wall St nudges higher as bond sell-off slows; markets relatively quiet in Asia
The S&P500 advanced a further 0.4% yesterday – a sixth consecutive gain that saw the index close only a fraction below last month’s record high. The advance came as Treasury yields pulled-back from the highs seen during Asian trading, with the 10Y UST closing at 1.65% – just slightly above the prior day’s US close. On a quiet day for data, the Fed’s latest Beige Book reported that economic activity had grown at a “modest to moderate rate”. However, several Districts noted that the pace of growth had slowed, constrained by supply chain disruptions, labour shortages and pandemic-related uncertainty. Employment growth was reported to have been dampened by a low labour supply, with firms reporting high turnover (consistent with last week’s JOLTS data) and robust wage growth. Reports of other input cost increases were widespread across industry sectors, driven by product scarcity resulting from supply chain bottlenecks. Many firms indicated that they had raised selling prices, suggesting a greater ability to pass along cost increases to customers amid strong demand. Expectations for future price growth varied with some expecting prices to remain high or increase further while others expected prices to moderate.

Since the close, US equity futures have traded a couple of tenths lower, while Treasury yields are little changed after initially pushing higher in Asian trading. On a quiet day for local data, it has been a mixed session for equity investors in Asia, with mostly only small moves in either direction. The main exceptions have been in Hong Kong and Japan. As we write, the Hang Seng is down 0.7%. Of note, shares in China Evergrande Group resumed trading and immediately fell more than 10%, with investors reacting to the company’s announcement late yesterday that it had failed to raise funds by divesting a controlling stake in Evergrande Property Services. Developments in Hong Kong seem to have weighed on Japanese stocks, where modest losses during the morning session have given way to larger losses after lunch, with the TOPIX closing down 1.3%. The weakness in Japanese stocks has tempered that seen earlier in the bond market, with the 10Y JGB yield having earlier edged up over 0.09% and so to its highest since April. In Japanese political news, ahead of the Lower House election at the end of this month, the latest polls indicate that the LDP is on track to retain its absolute majority, with one conducted by Kyodo News suggesting that it would win at least 233 of the 465 seats on offer (albeit down from the 276 held in the outgoing parliament). In contrast to the weakness in Hong Kong and Japan, China’s CSI300 is presently up 0.2% while most other major bourses are also trading very near yesterday’s closing levels.

In the Antipodes, the Aussie NAB quarterly business survey indicated a still very positive 12-month ahead outlook for business conditions, employment and capex. So, while longer-term AGCB yields are little changed, markets have continued to test the RBA by marching short-term bond yields higher, with the targeted April 2024 bond rising to a 12-month high of 0.18% – now 8bps above the RBA’s desired level. In New Zealand, the post CPI sell-off in bonds has continued, with the 10Y NZGB yield rising a further 6bps to 2.48% – now at its widest spread against USTs since 2017.

BoJ says financial system maintains “stability on the whole”, while continuing to highlight familiar risks
Today’s Japanese diary featured two reports from the BoJ – the semi-annual Financial System Report and the quarterly Senior Loan Officer Survey.

Beginning with the former, released just a short time ago, the BoJ has once again concluded that, despite the recent challenges posed by the Delta virus outbreak, Japan's financial system “has been maintaining stability on the whole”, with the financial intermediation function continuing to operate “smoothly” thanks to the soundness of financial institutions on the whole and the large–scale fiscal and monetary policy responses to the pandemic deployed in Japan and elsewhere. According to the results of the Bank’s macro stress testing, Japan's financial system is likely to remain highly robust even in the case of future resurgence of Covid-19 or an adjustment in global financial markets and emerging economies due to a rise in US long-term interest rates. However, the BoJ notes that in the event of a substantial and rapid adjustment in global financial markets, a deterioration in financial institutions' financial soundness could impair financial intermediation and so pose a risk of further downward pressure on the real economy.

The BoJ highlights three risks to the outlook that will be very familiar to readers of the Bank’s previous reports. The first risk is the possibility of an increase in credit costs, especially in sectors directly impacted by the pandemic, in the event of a delayed recovery. The Bank highlights the real estate sector as deserving of particular attention, together with highly leveraged borrowers more generally. The second risk highlighted is associated with the impact of possible future moves in global financial asset prices on banks’ investments, especially given the growing influence of NBFIs. Third, the BoJ again noted the risk flowing from a future destabilization of foreign currency funding due to a tightening of foreign currency funding markets. Finally, the Bank warns that even after the pandemic subsides, it is likely that the low interest rate environment and structural factors will continue to exert downward pressure on financial institutions' profits.

While the BoJ, in cooperation with the government, will play its part to ensure the stability of the financial system, it also advises financial institutions to strengthen their management of these three risks. In particular, adequate loan-loss provisioning based on the sustainability of borrowers' businesses and sound capital planning are viewed as key to institutions maintaining their financial soundness.

BoJ survey reports a smaller decline in business loan demand with a slight improvement expected in coming months as credit conditions continue to ease
The BoJ’s latest Senior Loan Officer Survey collected responses from Japan’s 50 largest banks between 9 September and 12 October, so spanning the removal of state of emergency conditions at the end of last month.

With respect to business lending, after reaching an 11-year low last quarter, the diffusion index (DI) measuring changes in the demand for loans improved 8pts to a still contractionary -3, with weaker demand continued to be reported on balance from all but medium-sized firms operating in the manufacturing sector. Amongst the few banks still reporting decreased demand, contributing factors including customers’ lack of sales and fixed investment and the increased availability of internal or alternative funding. Looking ahead, the DI for business loan demand over the next three months was 2, indicating that on net a very small number of banks expect an improvement in demand. Meanwhile, in smaller numbers than in the prior survey, on net banks reported that they had further eased credit standards on business loans. This easing was due to competition from other banks and banks’ own efforts to stimulate growth, as well as ‘other’ unspecified factors (the latter likely includes direct encouragement provided by government and BoJ support measures). Looking ahead, again in decreasing numbers, respondents expect to ease credit standards further over the next three months.

With respect to lending to households, the DI measuring changes in demand for loans increased just 1pt to 5. The DI measuring demand for consumer loans fell 4pts to 0, indicating no change since the prior period. However, the DI measuring demand for housing loans increased 4pts to 10, albeit still below the highs reached late last year. Looking ahead, the forecast DI for household loan demand was 3, indicating that demand might increase modestly over the next three months. As far as the supply of credit is concerned, as with the corporate sector, on balance banks eased their credit standards for household customers, albeit the DI declined slightly to 3 from 5 previously. Finally, a similar proportion of banks indicated that they expect to ease their credit standards further over the next three months.

UK public borrowing continues to trend well below OBR forecast suggesting scope for relaxation of fiscal plans ahead; CBI Industrial Trends Survey for October still to come
Every month this fiscal year UK public borrowing has significantly undershot the OBR’s forecast, and that remained the case with the September figures published this morning. In particular, net public sector borrowing excluding banks (PSNB ex) came in at £21.8bn last month, £7.0bn less than the same month a year ago and more than £4bn below the OBR’s forecast. The improvement from last year’s figure came predominantly on the revenue side as personal income tax receipts rebounded particularly vigorously in response to higher wage and jobs growth as GDP growth beat expectations. In addition, public spending also failed to rise quite as much as had been expected. Given the September figure, cumulative public sector net borrowing in the first six months of the fiscal year reached £108.1bn, little more than half the level in the first half of the last financial year and about 30% less than the OBR’s most recent forecast for the period. And currently, full-year borrowing looks on track to come in close to £200bn, some £34bn below the OBR’s forecast.

So, at next week’s Budget and Spending Review announcement, the OBR will revise down its projection for public borrowing. However, with the Government having asked the OBR to base its economic forecasts on GDP data that were published before the most recent significant upwards revisions, and the OBR unlikely to revise its pessimistic view of the likely level of scarring from the pandemic, the fiscal projections are unlikely to suggest the full scope for relaxation of fiscal plans until next year’s Budget, when the Chancellor is likely to offer the prospect of some politically motivated giveaways ahead of the next election.

Still to come this morning, ahead of Friday's flash PMIs, the CBI's latest quarterly industrial trends survey will provide an update on output, orders, employment and investment intentions in the manufacturing sector.

French business confidence boosted by the strongest services confidence since 2000. Euro area consumer confidence index due later today
This morning’s French INSEE business survey surprised on the upside, suggesting a more favourable outlook at the start of Q4 that might also be reflected in tomorrow’s flash PMIs. In particular, the headline confidence index rose 2pts to 113 in October, matching the multi-year high reached in June, well above the pre-crisis reading and significantly higher than the long-run average. While the assessment of the business climate remains well above the long-run average across the main subsectors, the improvement in October was principally driven by the services sector with increased optimism regarding the outlook to the highest since 2000. Conditions reportedly remained stable in manufacturing, although therefore firms continued to report disruption to past and expected future production due to supply constraints.

Looking ahead, today brings the release of the Commission's preliminary euro area consumer confidence index for October. While households are likely to have remained broadly upbeat about economic conditions at the start of Q4, they might well express some concerns about their financial situation on the back of the anticipated increase in household energy bills over the near term.

Today’s US diary features existing home sales, the Philly Fed’s factory survey and the Conference Board’s leading index; corporate reporting continues with Intel and AT&T
This week’s flow of US housing-related data continues today with the release of news on existing home sales. Daiwa America’s Mike Moran expects a 3.7%M/M lift in sales in September on the back of the jump in pending home sales reported in August. Today will also bring the Conference Board’s leading index for September. This will likely post its 17th increase in the last 18 months, with positive contributions from ISM new orders, the leading credit index, and the slope of the yield curve offsetting negative contributions from the manufacturing workweek and orders for consumer goods. Following Monday’s soft IP report, indications of more recent developments in the factory sector will come from the Philly Fed’s manufacturing survey for October, while weekly jobless claims will also be of interest following last week’s low reading. Today’s Fed speaking diary includes a speech by Fed Governor Waller, who earlier this week aired his concerns about upside risks to the inflation outlook. Finally, the corporate reporting season will continue with today’s report by Intel of particular interest given problems in the semiconductor industry.

Australia’s quarterly NAB business survey suggests that firms maintain a positive 12-month outlook despite recent disruptions
On the data front, the focus in Australia today was the release of the quarterly edition of the NAB’s business survey for Q3, which provides additional detail – including regarding firms’ near-term expectations – not found in the monthly survey. As suggested by the monthly survey, current business confidence and business conditions fell sharply compared with the exceptionally high levels reached in Q2, prior to the Delta virus outbreak that began in New South Wales. And with the latest survey conducted from 17 August to 9 September – well in advance of the re-opening roadmaps that were set out by the state governments of New South Wales and Victoria – firms remained cautious about the near-term outlook. That said, while the three-month ahead business conditions index stood at just 8 – below the current reading of 13 – this remains a better-than-average assessment of business conditions. Moreover, firms were more optimistic about business conditions over the coming 12 months, with that index standing at 19 – down from 33 in Q2 but still a very positive outlook by historic standards. Importantly, the survey also suggested a positive outlook for employment, with the three-month ahead index standing at 12 and the 12-month index at 30 – the latter just 9pts below the record Q2 reading. The 12-month outlook for capex also remained very positive, with the relevant index standing at 26. Despite the impact of the virus outbreak on activity, the survey continued to point to upward pressure on costs and selling prices. While labour cost pressures eased somewhat, purchase costs, final product prices and retail prices all nudged all strengthened from Q2 levels that were already at decade highs. 

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