In any economic recovery the data needs to go through a process of becoming "less bad" before it can be considered "good", and it would appear that Italy has started to make the transition into the former category in recent months.

May's Industrial Orders are a good example of this, with the NSA index falling -1.1% YoY to 101.9 (2005 activity = 100). This is the second best (or least worst) YoY performance since November 2011 and caused the trailing 12 month ma to move up to -5.5%, which compares with the December 2012 level of -7.2%. We would hope to see Industrial Orders to start to grow again later in 2013. At their current level they are approximately -10% below their 2011 recovery high, and -20% below their 2008 cycle high. On the other hand they are 10% above their 2009 low, underlining that for the industrial sector this period of economic weakness has been much less destructive than the collapse of late 2008.

Spain's distressed domestic economy continues to be aided by a very powerful export surge which reached €20.9 bln in May, the second highest month on record and the highest for any May. This represents a 7.3% increase on May 2012 activity, which was itself a seasonal record, and the trailing 12 month ma has now reached a new high of €19.12, which compares to a prior cycle peak of just under €16 bln (see chart).

As well as generating corporate earnings and aiding employment this strong export performance has dramatically reduced Spain's long standing trade deficit. May saw a Trade Balance of a mere -€27.5 mln, the second best reading since the data starts in 1991. This took the 12 month ma up to -€1.71 bln, the smallest deficit since October 1998, and this compares with the pre-crisis levels of almost -€8.7 bln. Given Spain's difficulty in retaining bank deposits this massive reduction in the capital negative flows connected to trade has been of significant help in recent months, and if Spain is able to actually move into trade surplus in the months ahead (as Italy has already managed to do) then the positive flows from trade would start to aid the build up of domestic liquidity levels.

As we outlined in the summary of the current Weekly Speculator central banking has recently become dominated by a fetish of communication, in which the distinction between "walking the walk" and "talking the talk" has been become redundant.

We note two very differing views on this new style of central banking (which are central to what we like to term the "Bernanke Doctrine") were published this morning. Arguments in favor of communication were made by RBI Governor Subbarao in a speech to the European Economics and Financial Centre entitled "Central Banking in Emerging Economies Emerging Challenges" (see link):
http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/07EEFCSP072013.pdf

Readers should focus on Section V. in which Governor Subbarao outlines the case behind the use of "Communication as a Central Bank Tool". We are not convinced by the arguments made in this speech, which primarily rest on the few times that a central bank's comment coincided with a sharp (and beneficial) move in financial markets. We could list a myriad of times that helpful comments were made but ignored by cascading markets. Timing (and moderation) is everything with regards to creating credibility.

The opposite viewpoint is offered by Caroline Baum in the attached Bloomberg editorial "Masters of the Universe Don't Need Fed Hand Holding", which broadly echoes the arguments we made in our own research (see link): http://www.bloomberg.com/news/2013-07-17/masters-of-universe-don-t-need-fed-hand-holding.html

There is little doubt that we are currently in the minority at the present time, with many investors (particularly those concentrated in fixed income) exhorting central banks to be ever clearer in their message. Central bankers (who are increasingly drawn from the same narrow pool of academically trained individuals, rather as the French Civil Service came to rely almost exclusively on the closed world of the Enarques) seem only too happy to oblige, with the fetish of communication feeding into their own concept of heightened importance in the aftermath of the Lehman and Euro crises.

As we have already seen with QE3 this presupposes a level of control over markets that is clearly absent, even in those cases that the message is backed up by actual asset purchases. At some point in time the failure of this policy is likely to cause something of a crisis of credibility resulting in a backlash in central banking policy. Although we are unlikely to go back to the dark-ages of pre-1994 secrecy we would imagine that the world of central banking in 2020 will look as different to us as the limited policies used by central banks in 2006 does today.

This week's Initial Claims data erased the July 4th surge in Claims, with the headline index falling to 334K, below expectations of 345K and last week's level of 358K (revised down from 360K). The NSA report showed a large increase in Claims to 408.7K, which is typical for this time of year and once more represented the lowest level for the current week since 2007 (see chart).

The 4 weeks ma of Claims fell back to 346K from 351.3K, taking the data back below the key 350K level. Although we do not expect much more progress to be made in the remaining weeks of summer we are hopeful that the easier post Labor Day seasonal adjustments will allow the average to fall back to around 325K towards the end of 2013, signalling an increasingly healthy labor market.

June's China house price data shows the property market to be in full swing, which perhaps underlines the increasing determination of the administration and PBOC to restrain credit growth in this portion of the economy.

The NBS report (see link):
http://www.stats.gov.cn/english/statisticaldata/monthlydata/t20130718_402912245.htm

UK Unemployment Claimant data for June showed considerable progress being made with Claims falling -21.2K versus -8K expected, and May's data revised from -8.6K to -16.2K. This is the largest monthly drop in Claims since June 2010 and ties in with other data which suggests that the UK economy is now rebounding from its brush with recession in 2011/2 at a faster pace than most considered possible a few months ago.

Total Claims remain elevated at 1478K but we would be hopeful that they can now fall below the plateau around 1450K reached in late 2010. Readers should note that although this is almost twice the level of Claims seen pre-crisis it is far below the levels of the early 1980's and 1990's recessions, although changes in benefit entitlements over the last 30 year have played a large part in reducing Claimants. We remain hopeful that having experienced a deep and long lasting decline in activity the UK economy can now rebound appreciably in the months ahead.

The weekly MBA Mortgage Application data continues to show shrinking refinance activity while purchase mortgage applications remain resilient in the face of higher mortgage rates, although the data is still likely to be effected by the after effects of the July 4th holiday which makes this seasonally a very quiet part of the year for applications.

In terms of the report itself the Refinance Index fell again to 2351, the lowest reading since July 2011 and would seem likely to fall below 2000 in the weeks ahead. The Purchase Mortgage Index rose slightly to 202.70, causing its 10 week ma to dip to 209, compared to a reading of 213 in late May. This took the percentage of Refinancing Applications down to 62.9% of the total, the lowest since April 2011, although this metric is still well above what was seen in the housing boom of a decade ago.

In terms of the types of mortgages used ARMs bounced back to 7.2% this week in volume and 15.4% in terms of value, indicating that borrowers continue to migrate slowly towards this type of financing. With the 30 year mortgage at 4.48% and the 5/1 ARM at 3.53% there is a considerable incentive to take the risk of a variable rate mortgage and we would expect to see more use of ARMs in the weeks ahead.

The June Housing Start and Permit report at first sight shows a sudden drop in construction activity but on closer inspection the draw-down is entirely due to a freakish reduction in the multi-family housing portion of the report that we assume has more to do with the arcane methodology of the Census Bureau than any change in on the ground activity.

Total Housing Starts were estimated at 836K, the lowest since August 2012 and well below consensus of 960K while May's report was revised higher to 928K from 914K. However, Single Family Starts were almost unchanged at 591K (from 596K in May and the strongest June report since 2008) while Multi-Family starts were shown to have dropped -26.71% to 236K from 322K. The latter is simply not a credible piece of data given that a collapse in multi-family housing activity of this magnitude would not have gone unnoticed outside of the walls of the Census Bureau, while the Single Family data is shows the recent recovery in activity to be intact.

Permit data was similarly affected, with Total Permits estimated at 911K, well below consensus (1000K) and May's 985K (revised up from 974). Single Family Permits (the most important metric in the report) actually rose to 624K from 620K, reaching the highest level since June 2008. Multi-Family Permits collapsed -21.4% to 287K from 365K for their lowest reading since June 2012. Again we take comfort from the steady rise in the Single Family data.

Interestingly a separate set of data on Housing Under Construction shows no collapse in Multi Family activity (see chart). Total Housing Under Construction is estimated at 624K units (up from 621K in May), split evenly between Single Family (309K) and Multi Family (315K). As can be seen on the attached chart we have not seen overall construction dominated by Multi Family since the late 1960s and early 1970s when a massive surge in public housing projects heavily weighted the data to the Multi Family sector. Clearly the greatest opportunity for future growth now lies in the Single Family portion of the data, and there was nothing in this portion of the report to suggest that June was anything other than a continuation of the steady process of recovery.

It has been a difficult few weeks for holders of homebuilder equities as investors have fretted that the surge in US long dated yields (and consequently the 30 year fixed mortgage rate) would have substantially impacted the recovery in home sales. We have argued several times that these fears are likely to be misplaced given that even at 4.45% the 30 year mortgage rate is historically cheap, while the alternative of using ARM financing would still keep a mortgage rate well below 4%. Nevertheless the volatility in homebuilding equities has remained considerable and it is clear that a body of opinion has started to fear for the state of the housing market.

It is therefore just as well that today's NAHB Homebuilder sentiment survey came down decisively on our side of the argument, with the index jumping to 57 from 51, well above expectations and the best report since January 2006. Strong gains were seen in all sub-indexes with Present Sales (red) reaching 60 (the best since February 2006), Future Sales (blue) 67 (the strongest since October 2005) and Traffic 45 (the highest since November 2005).

In other words this is a very strong collection of data although readers should bear in mind that since the NAHB is a diffusion index, meaning that you cannot directly compare the data of today to that of 7 years ago. On the other hand what the report does show is that homebuilders feel substantially better about their prospects than they did 3 months ago when the 30 year mortgage rate was close to its record low. We continue to expect this to translate into strong home sales data and corporate reports in the upcoming quarterly earnings reports.

A very detailed article that can serve as a useful source of reference regarding China's shadow banking industry. Since we expect this to become a major preoccupation of market participants later in 2013 it is worth spending the time to understand the basics of what is taking place in China's shadow banking system.

www.bloomberg.com/news/2013-07-15/wealth-products-threaten-china-banks-on-ponzi-scheme-risk.html

The ZEW Investor Sentiment Poll continues to show only tepid enthusiasm for the current state of the German economy with July showing a +10.6% reading indicating a slight majority of those polled had a favorable viewpoint. From our perspective this keeps sentiment very much in the sweet spot as far as the local equity market is concerned, and the ZEW poll remains well below the sort of overwhelming positive consensus that would typically match a market top.

Tokyo Condominium Sales continued to improve in June, reaching 4888, a 22% gain on prior year activity and the strongest June report since 2010. This takes the trailing 12 month ma of sales up to 4096, the highest level since August 2008. Readers should note that pre-crisis activity was around 7000 units a month, meaning that there is plenty of room for further acceleration going forwards. We would hope to see the 12 month ma rise above the 4500 level in the coming months which we would view as a signal that a genuine rebound in sales activity is taking hold.

Interview centered on China with differing views on the meaning of China's GDP report.

www.bloomberg.com/video/china-slower-growth-new-normal-AsC0rWtSSBGn0srAJEUOWQ.html

Tracking China's large and disparate real estate market is made difficult by a lack of quality data with long track records (the latter is hardly a fault of the statisticians, more a reminder of the short history of market based economic exchange in that country) but it does seem clear that activity has re-accelerated substantially from the slowdown that took place in 2011 and 2012.

Attached is a chart of monthly activity estimated by the National Bureau of Statistics (NBS). Although we would not place much reliance on the accuracy of any particular number we would assume that it is at least indicative of trend, and we like the fact that it does fluctuate significantly over time, unlike the stage-managed Industrial Production, Retail and Fixed Asset data.

June data showed an increase in home sales (measured by floor-space) of 30.4% YoY. Although this is the weakest pace for 2013 (which has averaged 41% growth) it is still a very powerful rate of increase, and easily outstrips completed projects which grew 2.7% YoY. We do not find this resilience surprising since it reflects that surge in credit issuance that took place over the last 18 months and only starting moderating in the last few weeks. Given the deterioration in other economic metrics the buoyant real estate data underlines the extent that this has become the sole hot spot in the domestic economy.

Going forwards it will be interesting to track sales and completions and see if they start to react to a slowdown in credit issuance (assuming that one actually takes place). We would expect it to take several months for the full effect of a credit crunch to take hold, but note that in both the crisis of 2008 and the brief "macro-prudential" squeeze of 2011/12 sales activity did turn negative for several months.

The Advanced Retail Sales report is something of a misnomer, since these official estimates actually trail the release of actual (and hence more accurate) sales store data which is generally made available by the second or third day of the month. Nevertheless the data helps fill commentary and media pages despite the fact that its monthly fluctuations generally fall well within statistical error tolerance.

June's report is no exception, with its 0.4% MoM rise falling below expectations of a 0.8% gain, while Retail Sales Less Auto and Gas actually fell -0.1% when it was expected to rise 0.4%. This will undoubtedly generate the conclusion that higher interest rates have somehow impacted general consumption, despite the fact that we saw no evidence of weakness in actual store sales, which were good enough to allow the S&P Retail Index to break out above 800 for the first time in its history and rise 7% in the first two weeks of July.

A more considered view of the data shows that Retail Sales have been in an obvious and steady uptrend for a number of years and June's report does nothing to suggest a top or reversal is anywhere close. In fact the YoY change of the official data actually rose in June to 5.7%, which is the strongest pace seen since April 2012 and well above the estimated change in GDP over the same period of time.

Evidence continues to build regarding the strength of the rebound in the UK domestic economy, which has always been closely linked to the strength of its housing market. July's Rightmove House Price index rose 4.8% YoY, the largest increase since June 2010. At an average £254K the average price of a home in the survey is now at its highest level while the trailing 12 month ma of £240K is slightly higher than the summer 2008 peak of £238K. With interest rates likely to remain low for a substantial period of time we would expect to see an acceleration of activity to match the rise in prices in the months ahead, together with a geographical broadening of the recovery outside of the Greater London area.

China's GDP report is the sort of "big data" that attracts far more scrutiny and commentary than is actually warranted by either its accuracy or illumination. If anything the published data has become representative of a new resolve to break with the policies of the prior administration, partly by being willing to both countenance and admit to a lower pace of growth. Thus the news that Q2 GDP slipped to 7.50% can best be taken as further evidence that a wind of change in blowing through the corridors of Beijing, if only because it as not deemed necessary to publish a higher number.

As we commented at the time the June trade data was published the export portion of the economy appears to be growing substantially less than published GDP, while housing construction and sales appear to be still somewhere in the double digits. Unfortunately it is upon the latter portion of the economy that the hammer blow of PBOC credit restriction is likely to fall, while it is far from clear that a stimulatory counterweight can be found for the industrial and export sectors.

The clear risk is that tighter credit markets will further restrict economic activity in the second half of the year, taking economic growth down to levels unseen since the short collapse of activity in late 2008 to early 2009. 5 years ago the credit spigot was opened to regenerate growth but this came at the cost of a massive mis-allocation of capital. This time around it seems more likely that other measures will be attempted with both fiscal stimulus and a change to the currency regime potential areas of activity.

Regarding the latter we did note that in the immediate aftermath of the release NBS Spokesman Sheng Laiyun did comment that the appreciation in the Yuan has started to hurt export competitiveness. It will not have gone unnoticed in Beijing that allowing their currency to appreciate against the USD has very different effects when the latter is itself appreciating against the vast majoity of global currencies. Should China's growth, and particularly its export sector, continue to falter we would not be surprised if currency management moves to the center of policy consideration.

The increasingly obvious weakness in India's industrial and consumer sectors calls for looser local monetary policy but the twin concerns of a large trade deficit and persistently high inflation (both of which feed into currency weakness) are substantial constraints on further RBI loosening moves.

June's trade data did at least show a sharp reduction in gold imports, with new tariffs slashing imports to $2.45 bln in June from $8.39 bln in May. Although it is possible that some of this activity has simply been replaced by smuggling, with a greater incentive for malfeasance having been created by the tighter policy, we believe that there has been a substantial drop gold imports, which no doubt helped feed into the metal's weakness in late June.

Other than that the sharp drop in gold overall import activity remained quite high at $36 bln, a 0.4% increase YoY. Exports on the other hand weakened by -4.6% YoY to $23.8 bln, taking the trade balance down to -$12 bln. Although this is a sharp improvement from May's massive -$20.1 bln deficit June is generally a stronger month for the trade balance, and YoY the deficit has widened from $11.2 in June 2012 although it is narrower than June 2011's record -$14.7 bln deficit.

However, the sharp depreciation in the INR during June means that in local terms the trade balance is in sharper deficit, reaching - 715 bln INR in June, a new record for this time of year and a widening of 85 bln INR (13.4%) from the June 2012 deficit. This suggests that the trade balance will remain a substantial policy constraint going forwards.

CPI also looks to be at a worrying level, rising from 9.3% to 9.9% in June when expectations were for a flat report. Although good progress has been made in wholesale inflation in recent months CPI (a relatively new measure in India) remains stubbornly high, again worsening the outlook for further monetary easing.

Last night's economic data from India continues to indicate a sluggish industrial sector and a deteriorating trend for local car sales. The latter fell to 139K in June, a drop of 9% from June 2012 and the lowest June activity since 2009. The 12 month trailing ma of car sales has now fallen to 153K, down from 172K in July 2012 suggesting that a steady declining trend has been established. Since car sales surged by 70% from 2008 to 2012 (note there was no deep drawdown in 2008 car sales in India) the scope for a further sharp reduction in activity should not be underestimated.

Industrial Production data was no more encouraging with May seeing a -1.6% drop in activity YoY, the sharpest decline since June 2012. The trailing 12 month ma remains in low positive territory at 1.1%, indicating little or no growth taking place over the last year. We would expect that the recent rise in longer term rates and subsequent shutting of the corporate credit IPO market will serve to further depress industrial activity later this year.

China's Credit and Monetary Statistics for June were always likely to make for fascinating viewing and the data did not disappoint in this regard. At the level of Total Social Financing, 1040 bln CNY ($170 bln) of new credit was issued in June, making this the smallest aggregate increase since April 2012. However, the really interesting distinction was that between the regulated banking sector, which added a fairly generous 860.5 bln CNY ($140 bln) of new CNY loans to the system (this compares to a trailing 12 month ma of 702 bln CNY), and the "Shadow Banking" industry which added a mere 179 bln CNY ($29 bln). This is the smallest contribution from "Shadow Banking" since September 2011, when the industry actually contracted moderately, and has caused the trailing 12 month ma to drop to 809.65 bln CNY ($132 bln).

Within the bucket of shadow banking there are a number of different categories, which show very different levels of activity in June. As we had expected corporate bond issuance collapsed to 40 bln CNY, compared to the average issuance of 268 bln CNY over the prior 3 months. The little issuance that took place is likely to have been restricted to higher quality companies with the high yield market totally shut down over the last 60 days. Should bond issuance remain depressed over the summer we would expect this to translate into lower corporate activity and a higher risk of delinquency.

By comparison Trust loans issuance (which we would loosely term "wealth management" products) continued to be fairly active at 112.2 bln CNY, a faster pace than May's 99.2 bln pace but significantly slower than the February-April 3 month average of 269 bln CNY. This suggests that the PBOC has yet to really get this area of financing under control, which is not surprising given that the violent squeeze on money markets only really took effect towards the end of June.

Where this squeeze is apparent in the data is in Bankers' Acceptance Bills, which withdrew -263.6 bln CNY as banks sought to access liquidity from any available source. We would expect this to rebound back into positive territory in July given the recent normalizing of money market rates.

At the level of Money Supply this month's data showed M1 growth to have slowed to 9.1% YoY, the weakest growth since December 2012 and M2 to slip to 14.0% YoY. This keeps the spread between M1 and M2 at -4.9%, once more indicating that credit growth outpacing more narrow liquidity in China's economy.

Overall this report is in line with our expectations, and keeps the risk of a credit crunch later in 2013 at a fairly high level. We remain concerned that market participants are paying much too little attention to this risk at the current time.

Indonesia's central bank surprised market participants by raising the base rate to 6.50% from 6.00%, versus the 25 bp hike that had generally been expected. This continues the steady tightening of domestic monetary policy that has been the general response of emerging market central banks to the sharp deterioration of foreign investor flows. We note that although Indonesia's currency (IDR) has been relatively stable in recent weeks compared to its emerging market peers it has been in a steady downtrend for several months moving from 8500 in August 2011 to almost 10000 today, a decline of -17.6%. Given that the country's FX reserves fell sharply by -7.05 bln (-6.71%) in June it seems clear that the central bank has been aggressively intervening to manage the pace of decline in recent weeks. The larger than expected move in rates can therefore be seen as an additional attempt to stabilize the currency without relying too greatly on reserves.

Although Indonesia's economy seems to be in much better shape that of Brazil (see earlier note) the substantial rise in local bond yields and now the short end of the curve represents an unwelcome tightening of domestic economic conditions. Should foreign investors continue to withdraw capital from this sphere the danger is that an unwelcome spiral of lower currency rates requires a stiff monetary policy response even as asset prices and economic activity come under pressure.

Estimating Initial Claims over a holiday period is always a tricky process for the BLS and so this week's surge to 360K (compared to consensus expectations of 340K) is well within the error tolerance of the data. We would expect to see this metric move back down to its recent range below 350K once the holiday distortion is completed and in any case the trailing 4 week ma was not greatly affected rising to 351.8K.

What was perhaps a little more interesting was the fact that the NSA report came in at 384.8K, which is the lowest reading for this calendar period since 2006 (see NSA chart). This is perhaps the best way to track the current improvement in Claims data. Until recently the NSA report was running ahead of all data since 2008 (note that Claims only started to surge in the second half of that year) but by now moving beyond the 2007 data, when the economy was stalling at peak activity and employment Claims data is starting to suggest that we are entering a much more positive employment environment.

The fact that last night's decision to raise the SELIC to 8.50% was widely anticipated by the market does not make it any wiser. We warned in May that the move towards higher rates underestimated the underlying weakness of the economy and capital markets and since the May 28th decision to raise the SELIC from 7.50% to 8.00% the IBOV index has fallen from 56,036 to 45,483 (-18.8%) while the BRL has gone from 2.075 to 2.265 against the USD, a decline of almost exactly -10%.

Although we would not expect a significant immediate response to the latest hike it will only serve to make a bad situation worse for the local economy. We also see the decision of the central bank to avoid any change of language since the May 28th statement as a sign that they are more concerned about inflationary pressures than a domestic recession, issuing the terse sentence that

"The Committee evaluates that this decision will contribute to set inflation into decline and ensure that this trend persists in the upcoming year."

as the only guidance for its shift towards higher rates. It is particularly interesting that the Committee refrained from linking rising interest rates to the need to defend the weakening currency, despite the fact that it has been aggressively intervening since the start of June.

Looking ahead we would still expect to see the worsening conditions in the domestic economy cause the central bank to change policy later this year. Unfortunately this suggests that we have yet to see the low in either the local equity, bond or currency markets for the current bear market.

The fact that the July 4th holiday fell in the middle of last week makes this morning's MBA report rather less reliable than normal. Unsurprisingly the Refinance Applications Index fell sharply to 2454, a drop of -4.43% from last week and taking the index back to its July 2011 level. The Purchase Mortgage Application Index also fell -3.12% to 201.70 taking its 10 week trailing ma down to 210.75. However, when one considers that the holiday caused the NSA data to fall -23.16% we would not conclude that a meaningful drop in activity took place last week unless it were confirmed by future reports.

Similarly there was a substantial drop in ARM usage last week, falling from 7.5% to 6.5%. Given the wide spread that still exists between the 30 year fixed and 5/1 ARM it seems likely that this drop is a statistical blip rather than a reversal of trend and we still expect to see substantially more ARM usage take place over the coming months.

China's Trade Data for June suggests that the export driven portion of the economy continues to experience sluggish activity while imports are running substantially below the official estimate of GDP growth.

Total Exports were reported at $174.32 bln, a drop of -3.1% YoY. For the second month running exports to Hong Kong were sharply lower, dropping by 7% YoY to $25.7 bln. This shows that the recent crackdown on false invoicing has had some effect, but it should be noted that this level of activity is still 9% higher than that reported in 2011 and we suspect that there is still considerable statistical fluff in the Hong Kong report. Since Hong Kong represents $24.7 bln (91%) of the entire Trade Balance of $27.12 bln there is reason to conclude that China's true trade position is substantially less buoyant than reported.

Imports on the other hand have been sluggish for several months and June's total of $147.19 bln represented a drop of -0.7% YoY. It should be noted that the 12 month ma of the YoY change is now 4.8%, and this is a reasonable estimate of the underlying pace of activity in the portion of the Chinese economy that has not been driven by the explosion of domestic credit.

Overall this report underlines the significant policy dilemma facing the Chinese administration and central bank. The great motor of the last 15 years has been export activity, but there is little likelihood of this returning to form anytime soon. In recent quarters this growth has been partially substituted by credit fueled land and real estate speculation, together with the attendant financial services (both official and "shadow"). In belatedly seeking to reign in the excesses present in this portion of the economy the risk is that the underlying weakness in other areas becomes more obvious.

We will confess to largely ignoring Venezuela's economic data but this country is an important destination for emerging market bond investors making up over 4.8% of the EMBI benchmark index for the 7th largest holding by country. Given our general concerns about emerging market credit in general we were interested to note that Venezuela's CPI rose by 4.3% for the month of June, taking the YoY increase up to 37.3%, its highest level since February 2003. This compares to a CPI rate of 21.20% in June 2012 and looking at the history of this measure (see attached chart) a rise above 40% would bring into play the danger of a hyper-inflationary episode.

Such an eventuality would create a substantially elevated risk of default for USD credits, since the value of the local currency earnings used to service or repay the debt would be likely to depreciate rapidly. With the benchmark 12¾% 2022 still trading just above par (down from a peak of $122.5 in February but above its level of a year ago) it does not appear that the bond market has started to price in the dangers of an inflationary spiral taking hold.

The early evidence suggests that the massive increase of Japan's Monetary Base via BoJ asset purchases is having a measurable effect on broader monetary aggregates. Last night saw the publication of June data for M1, M2 and M3, each of which moved significantly higher.

M1 grew by 0.32% to ¥532 trln in what is typically a down month for this aggregate, causing the YoY growth to move up to 5.1% from 4.4%, the highest level since December 2011 when the BoJ's response to the tsunami was about to tail off. Although that short increase in liquidity was helpful, it had little effect on broader monetary aggregates, suggesting that the new liquidity provided caused little capital formation further down the food chain from deposit accounts.

The current episode feels somewhat different, since this time there has been a marked pick up in the pace of M2. This grew by 0.62% in June making this the 7th positive month out of the last 8. This has taken the YoY growth rate up to 3.8%, which is the fastest pace of growth since June 1999. Consensus was for a more modest 3.4% growth rate, suggesting that there has been rather more "leakage" of liquidity into the real economy than most observers had expected.

It also means that the current period of QE has now exceeded that of 2002-3 when a similar surge in monetary base only generated a maximum M2 growth rate of 3.7% in March 2002. M1 by comparison soared by 32.6% in the 12 months ending April 2002 before collapsing as the BoJ removed liquidity before it had time to take hold. It is important to note that this time the BoJ has a popular mandate for its current policy and the full support of the current administration, making a sudden about turn in policy far less likely to take place.

As the attached chart shows, during Japan's boom years M2 grew between 8% and 12% before collapsing precipitously between 1990 and 1992. We would not expect to see a return to this sort of pace (partly because CPI is much lower at the current time), but a move above the post 1992 high of 5.0% (recorded in February 1998) would seem to be an achievable target. If this were to occur it would be meaningful evidence that credit formation and the economic activity that is associated with it has finally begun to take root in Japan.

Over the weekend the PBOC released its May update to its balance sheet data. As we had expected this showed a modest increase of 0.45% for the month, taking the balance sheet up to a new record of 30.214 trln CNY (approximately $4.9 trln), up 6.48% YoY. This is the fastest pace of increase since January 2012, but still far slower than the gains seen during the great export boom of 2002-8 or the initial post crisis period of 2009-11.

At the current rate the PBOC's balance sheet is growing a little slower than GDP, but significantly slower than overall credit. Bank credit alone has been growing by around 15% over the last year, and this has taken the ratio of the PBOC's balance sheet to bank credit down to 0.4495, the lowest ratio since April 2005 (see chart). This underlines the effective tightening of underlying liquidity conditions that has taken place over the last few quarters even as credit has continued to flow freely.

Of course bank lending is only part of the story, as we have highlighted before "shadow banking" has become a much more powerful force in China since the post-crisis loosening of monetary conditions. As can be seen on the attached charts over the last 12 months, Total Social Financing has averaged 3.92% of the PBOC's balance sheet, meaning that cumulatively, credit equivalent to 64.2% of the total PBOC has been issued over this period. As remarkable as this statistic is, it is actually slightly lower than during the period of massive bank lending following the 2008 collapse in a activity.

What is different this time around, is the expanded role of "shadow banking" (which we define as Total Social Financing - Total New Bank Loans). This has averaged 2.95% over the last 12 months, or a cumulative 35.35% of the PBOC's balance sheet. This is substantially higher than the prior peak of this metric seen in March 2010 when it registered 2.53% (30.36% cumulative) which helps explain the increasingly aggressive stance of the PBOC to shadow banking activity.

Our view remains that the deterioration in Chinese liquidity and credit conditions represents the most important macro trend for investors to follow at the present time and June's monetary and credit reports will be unusually interesting sets of data.

Japan's June Bank Loan and Deposit report shows a modest pick-up in lending activity and a more robust increase in deposits. This combination will be familiar to anyone who tracked the equivalent metrics in the US post 2009, since it generally takes a while until the new liquidity that has pooled in the financial system finds its way into new credit.

Although the blame for this lag is generally placed at the feet of the bankers, who are accused of refusing to lend, in our experience sluggish loan demand is at least as responsible. In part this is a product of understandable lag between an injection of liquidity and a consequent build up in confidence to consume, but also a reflection of the fact that with liquidity abundant lending is less required for the initial build up in personal and corporate sector activity since cash at hand is a viable alternative.

Certainly in Japan's case the latter is readily available, with June's report showing Total Deposits and CD's increasing 0.8% to ¥592.7 trln, a new record and an increase of 4.1% YoY, which is the fastest pace of growth since June 1999. This suggests that the massive increase of the monetary base is at least starting to affect private sector bank balances. Lending activity is growing more slowly, with June's data taking outstanding Bank Loans (ex trusts) up to ¥403.6 trln, an increase of 2.2% YoY.

As can be seen on the attached chart this takes the ratio of Deposits/Bank Loans up to 1.47, a new all time high (the equivalent ratio in the US is 1.285, up from 0.97 in late 2007). This ratio can be interpreted as the "latent potential" of the banking system to provide credit although as we discussed above it can take some time until its force becomes apparent in an economic cycle. In Japan's case, however, it should be noted that loan activity itself is far lower than it was 15 years ago, suggesting that there is little need for the private sector to deleverage, which means in turn that the lag between the build up of deposits and a pick up in lending may be somewhat shorter than was experienced in the US.

This morning's BLS report, and the fact that it was released on a relatively de-populated post holiday Friday, has led to a severe case of "belly ache" in the US Yield curve, with the 5 year Treasury yield rising by 13.6 bp to 1.55%. In looking at the yield curve in recent weeks we have consistently argued that this area forms the most dangerous portion of the curve, since post QE2 it has become dominated by leveraged trades attempting to benefit from the generosity of the FRB and even though QE3 targeted the long end of the curve this remained the case in recent months.

As our segmented chart of the US Yield curve shows, it is the 2-5 year portion of the curve (green) which has undergone the vast majority of the widening in recent weeks, with this spread moving from 55 bp in mid-May to 116.5 bp at the time of writing. This represents the widest spread seen since April 2012, just before the return of the Eurocrisis saw a flood of capital move back into "safe haven" treasury markets. By comparison the short end of the curve represented by the 1-2 year spread (blue) remains very tight at 24.3 bp, demonstrating that the market understands that the FOMC has no intention of raising the FDTR for a considerable period of time.

The long end of the curve has moved substantially higher in terms of actual yields, but its relationship to the middle of the curve is almost unchanged, with the 5-10 year (purple) spread range-bound at 112.5 bp. At the ultra-long end there has even been some compression with the 10-30 year spread (black) falling to 95.8 bp, its tightest level since November 2011 (when MF Global's liquidation was distorting all treasury yields).

Meanwhile this morning saw a significant change in the long end of US yields with the 30 year swap rate (see separate chart) moving back into positive territory for the first time since January 2009. The existence of a negative swap at the long end of the curve has been one of the great anomalies of this long period of ultra-low yields and we suspect this is further evidence of hurried liquidation of large long dated portfolios. We note that the negative swap spread started starting narrowing rapidly a couple of months ago, pre-dating the sharp move higher in long dated yields, and we would imagine that its move into positive territory implies more pain ahead for long dated bond holders.