As economic data continues meanders between Okay and underwhelming, it is hard to envisage how BoJ will take a step back from their mammoth QE program and fight with 10yr JGBs. Yet as bond markets remain under pressure, if central banks do embark on tightening, it will prove an almighty test for BoJ to support their JGB in a falling market.
Producer prices remains steady at 2% YoY, with PPI MoM stalling at 0% for the 2nd month running. Unless we see a tick or two higher next month then we can expect the YoY read to drift to 2%. With CPI also remaining steady at the minor amount of 0.4% YoY, we can be sure that reflationary forces are far from here and monetary stimulus will be here to remain for some time ahead.
With machinery orders contracting a further -3.6% on Monday, there had been hopes for machinery tool orders to pick up some of the slack. Rising by 10.1% in May, the index delivered and revives some hope for capex going forward. Now at 31.1% YoY, it does provide some support for growth and takes off some of the damage from the dire machine orders. By our estimates, machinery tool orders at 0.6% MoM suggests CAPEX of 0.3% QoQ. If this trend continues growth will face severe headwinds in the quarters ahead.
Whilst BoJ continue their debatable narrative of improved growth prospects, we also note there is evidence they believe their own outlook. Money supply (M2) has steadied at 8.7trn Yen, which is almost exactly on the long-term trend. Additionally, M2 has now contracted by -4.5% YoY which suggests they are more confident that the economy is able to support itself whilst they focus on keeping the 10yr JGBs at ‘around’ 0%.
Yet it is this battle with yields that BoJ are more likely to meet their match. Last year they announced they will keep the 10yr JGB yield close to zero, yet the trend has only risen since and last week moved above 0.1%. This may sound miniscule on a relative basis to other yields, but when you imagine the amount of bond purchasing they must do to keep it this low, then it isn’t hard to see the wheels fall off somewhere. In the past two weeks traders have assumed the central banks are coordinating the beginning a (minor) hike trajectory, which has scared investors out of bonds and their yields soaring higher. That is, all but CHF and JPY bond yields. Perhaps the interesting trade will be if BoJ thrown in the towel and let the markets decide where yields should be, in which case the bond markets could indeed collapse and send yields above 0.5%. We doubt the BoJ are ready to do that just yet, especially whilst they still have confidence their own growth trajectory may be achieved. Yet it is something to consider as we approach 2018 if leading indicators do not pick up because, overall, they point to headwinds for growth and lack of reflation.
Next up we have industrial production and capacity utilisation. IP threw another warning signal for growth by contracting -3.3% in May, its lowest rate since 2011. This dragged the YoY read to 5% and, although this may fall further due to three monthly contractions in 5 months. Whilst PMI data suggests support ahead for growth at 52.4, it’s unlikely to carry the burden of other weak leading indicators such as Capex and machinery tool orders. Coincident indicators such as Industrial Production are only just starting to underline this point. Therefor we think the battle between BoJ and yields may be the bigger story for 2018 unless leading indicators pick up soon, in tandem.
