A ray of hope
10 July 2018
The headline sentiment reading of the latest Tankan report for large manufacturers, a closely watched temperature gauge of corporate Japan, weakened again the second quarter. This comes hot on the heels of a dip in the new orders PMI index in June and a 0.2% m/m contraction in the May industrial production data. Does this mean that the shock contraction in Q1 activity is about to morph into a more persistent slowdown?
We are certainly seeing firms re-calibrate expectations about the strength of the external environment. May export data were lacklustre, while Japan’s new export orders reading weakened noticeably in June to 48.9, from 51.1 in May (see Chart 8). However, while the global trade cycle may be losing some steam we do not expect a more meaningful downturn, as developed market demand should remain healthy. Even more encouragingly for Japan, we are seeing better trends in the bellwether tech sector. New export order readings from Korea and Taiwan rebounded sharply in June, pointing to resilience in the semiconductor cycle. A hiccup in tech demand led to weak production and an unsightly inventory build in Japan in Q1. Better end demand should reverse some of that shock. Another external threat to corporate Japan comes from an escalation of the protectionist measures originating from the US and China. Sentiment in the steel and non-ferrous metal industries edged lower in the June Tankan after a collapse in sentiment in March in the aftermath of an announcement of US tariffs targeting these sectors. However, other industries may not have fully adjusted given the survey was conducted in early June before the latest change in US trade rhetoric and actions. In conclusion, we think the impact from developments overseas is more a reflection of corporate Japan’s frail confidence than material changes to the risks around their outlook.
The story regarding the domestic economy is more intriguing. We have long bemoaned the slow pace of growth enhancing reforms and the limited opportunities for corporate investment in domestic growth. There are tentative signs that progress is being made to tackle this key issue. A major positive surprise in the latest Tankan report came from fixed investment plans for the coming fiscal year, which were revised to 7.9% y/y, the highest reading since 1983. The reading reflected a broadening out of optimism to the non-manufacturing (11.2% y/y) and small manufacturing (7.6% y/y) sectors, boding well for a more persistent capex revival. Of course, there has been false dawns in the past here – with firms noticeably failing to realise upbeat capex plans in the early years of Abe’s premiership. However, we are more optimistic this time. The need for labour and energy saving investment remains in place. More encouragingly still, we witnessed the first upward revision in corporate growth expectations for four years in the Cabinet Office’s recently published annual Survey of Corporate Behaviour (see Chart 9). The emergence of domestic growth opportunities offer a ray of hope for a sustainable revival in activity. However, it has taken much longer than most would have hoped and will all be for nothing if the external environment deteriorates meaningfully or the ageing global cycle is brought to an end by a policy or political shock.