This week's Initial Claims report showed a bounce in claims to 336K (slightly above consensus of 330K) from last week's very depressed level which itself was revised modestly higher to 323K. This still allowed the 4 week ma to fall to 330.5K, its lowest level since November 2007.

The NSA data showed Claims running at 279K, which once again is the lowest level seen since 2007 (see chart). The evidence continues to suggest that Claims are working their way lower during the most testing part of the year for the headline data. Another leg down to approach the 300K level looks increasingly possible in the months ahead, reinforcing the degree to which US employment is normalizing rapidly.

A year ago no emerging market would have wished to trade places with Spain, but with the market fretting about wide current account deficits the remarkable recovery in Spain's Trade Balance will be generating some envy this morning.

The June data showed a Trade Deficit of -€106 mln, which compares to a -€2,700 deficit in June 2012. The 12 month ma of the deficit has narrowed to -€1495 mln, its smallest level since July 1998. This compares to a reading of -€3409 in June 2012, -€4355 in June 2010 and -€8686 in June 2008 (see chart).

Although in part this improvement has been caused by slowing imports the major cause has been a very robust performance by Spain's export sector. July exports were no exception, with a total of €20.8 bln exported an increase of 10.5% YoY. This represents a record performance for July data, and the trailing 12 month ma has also reached a new all time high of €19.28 bln, which compares to a level of €18.19 bln a year go.

As we have explained before this sharp improvement in the trade balance not only benefits corporate earnings of exporters but has been a key factor in re-liquefying the financial system. Compared to 3 years ago €34.3 bln less has been required to meet Spain's 12 month trade deficit, a meaningful reduction that looks set to continue going forwards.

After yesterday's awful CAGED report for Brazilian job creation this morning's unemployment report will have come as something of a relief with the index falling from 6.00% to 5.60%, ahead of expectations for a drop to 5.80% (note Brazil's unemployment data is not seasonally adjusted and would be expected to fall at this time of year). This still represents an increase of 0.2% above the level of July 2012 and is the third consecutive month that the rate has been flat or higher on a YoY basis.

What this would seem to indicate is that the relationship between hiring and firing in Brazil has broken down, which is fairly typical for the early stages of a slowdown, particularly in an economy like Brazil where the regulatory and union hurdles to lay offs are prohibitive. Taking the data at face value (always a dangerous thing to do with official data) we have reached the point at which Brazil's employers are unwilling to add to their workforce but have not yet started to trim payrolls aggressively. While this delay may be good for personal incomes it tends to be quite bad for corporate profitability (and the fiscal balance) since it implies a level of over-employment is probably present in the private and public sectors.

We would not expect this equilibrium to be stable and either Brazil's economy will re-accelerate, leading to more hiring, or a more prolonged slowdown will start to cause some sizeable reductions in the country's workforce in the months ahead.

Link to Minutes http://www.federalreserve.gov/monetarypolicy/fomcminutes20130731.htm

Reading through the FOMC's July meeting minutes we were somewhat surprised that this anodyne set of comments provoked a brief flurry of turmoil in debt and equity markets, but by the time we had finished scanning the paragraphs for something exceptional the markets had apparently come to a similar conclusion.

It seems clear that the FOMC is edging towards a reduction of bond purchases and whether this comes in September or November matters little in the end. What was much more interesting to us was the determination shown in the minutes to ensure that a 2.00% inflation rate is achieved and maintained, with this being put forward as a policy goal to allow for a prolonged period of asset purchases and accommodation at the short end of the curve.

This would be all well and good if it were not for the fact that 2 weeks after the FOMC met the CPI rate did in fact increase to 2.00% (for the year ending in July). Admittedly this is a single month, and the trailing 6 and 12 month moving averages are 1.6% and 1.7%, while a measure such as the PCE Core PRice Index (which the FOMC has traditionally favored) remains much lower at 1.2%. Nevertheless the certainty shown by the FOMC that inflation could only be used as a cause for monetary stimulus rather than restraint:

"the Committee could provide guidance stating that it would not raise its target for the federal funds rate if the inflation rate was expected to run below a given level at a specific horizon. The latter enhancement to the forward guidance might be seen as reinforcing the message that the Committee was willing to defend its longer-term inflation goal from below as well as
from above."

We cannot help but feel that the FOMC risks repeating the mistake that it made with employment targeting with that of inflation. Setting a target is fine provided you have a reasonable chance of understanding when it will be met. The risk is growing that by early to mid 2014 the FOMC will either have to markedly change monetary policy or have to explain to the market why both its employment and inflation targets should not be viewed as rigid, which would run the risk of destroying the credibility of the organization at a time of leadership transition.

Brazil's CAGED monthly employment data showed a sharp deceleration in hiring activity in July with job gains of 41.5K falling far short of 100K consensus and last month's 123.8K report. This represents the worst July report since 2003 when Brazil was still climbing out of the millennial recession. Although it is possible that this report exaggerates the decline in hiring the 12 month ma has been deteriorating steadily for a number of quarters, falling to 47.2K in July, the lowest level since October 2009. One year ago the monthly index stood at 142K and the 12 month ma at 96.7K, meaning that nearly 50K less jobs a month (or 600K in total) have been created over this period.

It should be noted that during the recent period of poor economic performance Brazil's unemployment rate has continued to decline, reaching 4.9% last December before bouncing up to 5.9% in June. The deterioration in the CAGED suggests that unemployment may have bottomed, which would increase both economic and political pressures going forwards.

The July Existing Home Sales report should go a long way to soothing nerves regarding the US Housing market since it showed a combination of rising sales, tight inventory and rising prices. Total sales were estimated at 5.59mm SAAR, well above consensus of 5.15mm, while the June data was nudged lower to 5.06mm from 5.08mm. This represents a gain of 17.2% YoY and is the best sales data since March 2007, if one excludes the distortion from the 2009 tax credit program. In other words the existing home market is back to a level of activity seen right after the collapse of the sub-prime lending market. Single Family home sales were 4.76mm, a gain of 16.4% YoY (see chart).

As would be expected during the summer listing period inventory increased to 2.00mm homes, but this still represents the lowest July inventory level seen since 2002. Inventory as months of sales is now 5.1 homes, again representing a tight marketplace that in certain regions has become almost starved of product.
This tightening of inventory is shown in the price level, which kept close to June's very elevated level at $260.6K for a single family house a 9.95% increase YoY (see chart). Again this suggests no stress from rising mortgage rates is being transmitted to the existing home market.

The MBA application data for last week continues to show a sharp decline in re-finance activity and a much more modest drop on purchase mortgage applications. The Refinance Application Index fell sharply to 1979, the lowest level since April 2011 and taking the proportion of total applications down to 61.5%, also the lowest reading since April 2011.

The Purchase Mortgage Application Index rose slightly from 182.7 to 184.90, taking the trailing 10 week ma down to 198.9 its lowest level since March 2013. This represents a drop of 5.7% from peak activity, although this does not necessarily translate into less actual home buying, due to the fact that the index often includes multiple applications, the role of all-cash buying in the housing market and the use of differing seasonal adjustments for mortgage and housing sales data. The publication of Existing Home sales later this morning will give us some insight into the impact of rising rates.

Our sense is that the rise in rates may have given some buyers pause for thought, but this is likely to be overcome once it becomes obvious that home prices remain in a rising trend. Housing in most municipalities remains very affordable at current mortgage rates (and where it is least affordable demand is paradoxically the strongest).

We also note some stabilizing in mortgage rates even as the treasury market sell off to new levels. The Bankrate.com 30 year fixed rate is at 4.56%, slightly lower than its July 5th high at 4.64%, while the 5/1 ARM has actually dropped 24 bp to 3.40% over this period. Use of the ARM remains fairly muted at 6.3% by application and 14.3% by USD volume, although both metrics have risen considerably compared to their levels at the start of May (4.30% and 11.1% respectively). We continue to expect to see a much greater use of ARM products later in this housing cycle.

The summer of 2013 is starting to remind us a little of 2011, with attention increasingly drawn to an economic issue which had been staring market participants in the face for a number of years, but had been ignored since it did not impinge on investment returns.

In 2011 it was the unsustainable nature of the fiscal balance in a number of Eurozone countries and in 2013 it seems that the massive deterioration of current accounts in a number of key emerging markets has suddenly become the focus of the marketplace.

As in the case of the Eurocrisis (when the ECB catastrophically raised rates in both April and July 2011) the initial responses by a number of emerging market central banks has only served to undermine market confidence and exacerbate the economic pressures on the home front. We pointed out this similarity several weeks ago when countries such as Brazil, Indonesia and India started to follow a "currency first" monetary policy in the wake of the sharp devaluations that took place.

In the case of India the decision was made to deliberately constrict liquidity in the banking system by refraining from making large daily injections via the RBI Repo facility. These have shrunk from around 1000 bln INR ($15.6 bln) a day in June to an average of 387 bln ($6 bln) over the last 20 days. This has caused interbank and commercial paper rates to move sharply higher, with the 3 month interbank yield now 11.14%, 389 bp above the RBI's Repo rate.

While the RBI welcomed this tightening it was less happy with the sharp move higher in long term yields and the spike in the 10 year sovereign yield to 9.24% on Monday caused a number of measures (including a small cash purchase of bonds) to be announced on Tuesday which initially took the yield back down to 8.30% before selling pressure resumed and took the yield back up to 8.4%.

None of the above has served the currency well, with the INR falling to a new all time low of 64.62 this morning before rallying to close at 64.03, compared to its early May spot rate of 54. Interestingly the current breakdown of the currency has not yet been accelerated by foreign investors selling equities, with YTD equity flows only dropping about $250 mm since July 15th and remaining strongly positive for the year at $12.19 bln. This helps explain the relative stability of the SENSEX, which has only fallen -7.83% in local prices. However, given that the USD loss is now -21.6% the patience of foreign equity investors cannot be assumed to continue if the currency experiences further losses.

Bond outflows have continued to deteriorate with the YTD withdrawal reaching a record -$4.54 bln, compared to -$2.88 bln on July 15th, making it quite likely that India's long term yields will resume their upward path, and exacerbating the pressure on the local financial sector, which is nursing substantial mark to market losses on bond holdings.

Ireland's Property Price index rose by 1.2% in July, matching June's increase and marking the 4th consecutive monthly gain and the 7 over the last 12 months. Since July 2012 prices have risen by 2.3%, their largest annual gain since November 2007. Of course prices are far lower today than six years ago and the index remains at 66.40 (Jan 2005=100) compared to 130.10, a drop of almost 50%.

As would be expected the key Dublin market is rebounding substantially faster than the rest of the country and July's 3.30% increase is the largest monthly gain since the data starts in 2005. The 12 month ma has moved up to 0.66%, equivalent to an annual gain of 8.0%, the largest move since May 2007. Of course the Dublin Price Index suffered even more than the national average, falling from a peak of 134.50 in February 2007 to a low of 57.30 last August. Even with the last year's gains the index remains at 62.20 but this also means that further sharp gains in prices can be anticipated.

The national market Ex-Dublin remains fairly static, with prices falling -0.1% MoM and still falling -1.4% over the course of the last year. However, given the strong rebound in Dublin prices we would expect the national market to follow its path to recovery over the coming months.

Japan's July trade report shows a continuing process of repair to an export sector which remains well below its prior cycle peak activity. Total Exports were ¥5.962 trln, a rise of 12.2% YoY but still -21.8% below the level seen in July 2008. Exports rose to all three major regions registered good growth with US exports growing 18.6%, China 9.5% and Europe 16.6% (See chart). The US once more was the largest market for exports at ¥1.105 trln, just above China's ¥1.104 trln. Exports to the EU are substantially smaller at ¥587 bln.

Meanwhile imports grew substantially faster reaching ¥6.985 trln, up 19.6% YoY and only -7.3% below peak imports seen in July 2008. Higher international fuel prices and a weaker currency would appear to be the drivers behind this surge in imports, although perhaps some can be attributed more positively to a recovery in domestic activity. Whatever the cause the effect has been to produce a large trade deficit of -¥1.023 trln in July, taking the 12 month trailing ma down to a record -¥780 bln (see chart). We would judge a deficit of this level to be sustainable (it does not approach the problematic deficits seen in a a number of EM economies), but it does mean that Japan has become substantially more reliant on international flows of capital in recent quarters and thus raises the stakes for the success of the Abenomic experiment.

One of the strange things about asset markets is that they are quite capable of ignoring a clear trend in data for a substantial period of time, particularly when it conflicts with the dominant narrative of a sector, country or region.

In the case of Indonesia for instance a marked deterioration in the Capital Account (see chart) went largely unnoticed in recent quarters since it was more than compensated for by investment flows into debt and equity markets. In the case of the latter Indonesia was a substantial beneficiary of investors falling out of love with the BRICs (particularly the first and last letter of the acronym), which led to substantial additional passive flows being directed to this market.

However 2013 has been a different story, with a number of EM currencies weakening substantially since the springtime. Over this period Indonesia's rupiah (IDR) has been associated with a more unfortunate moniker "The Fragile Five", which combines this currency with the 4 that we ourselves placed in a universe of vulnerable "carry" currencies - the INR, BRL, TRY and ZAR.

Friday saw the publication of Indonesia's Q2 Current Account data after its market closed with the deficit reaching -$9.8 bln, or 4.4% of GDP. This marked a record deficit and was substantially wider than the -$8.17 bln deficit of Q2 2012 (see chart). To compound the pressure a substantial sell off in the BRL to 2.39 served as a "body punch" to the EM carry complex.

Last night's session showed the damage to investor psyche with a massive -5.58% decline in the local JCI index and a further -1.68% decline in the IDR, creating a loss of over 7% for a USD holder of Indonesian equities. Pressure was also felt in the bond market where the 10 year yield reached 8.37%, its highest level since March 2011. This represents a substantial tightening of local monetary conditions as we had anticipated at the time the central bank chose to raise rates in June. The rapid transition of Indonesia from a market darling to a source of investment woe risks sparking a substantial outflow of investment capital, with obvious implications for currency and asset markets.

Although the headlines have been drawn to the almost unanimous participation of China's cities in a rising price trend over the last year (69 out of 70 cities saw prices rise for affordable new homes over this period) the more current monthly price change data is a little less positive and does offer some evidence that a recent tightening of credit standards may be having some effect.

New home data showed prices rising in 63 out of 70 cities, the lowest number since January 2013 although still a large majority. 5 Cities saw prices fall, again the highest since January. This data has deteriorated from 68 and 1 in March, when the first wave of credit tightening took place (see chart).

For the Existing Home market the declining trend is a little more pronounced. Although on an annual basis 68 cities saw rising prices and 2 falling prices on a monthly basis the number of rising price cities was 55 and falling price cities 8 (see chart). This is the worst data since January 2013 when 51 cities had rising monthly prices and 7 falling prices and is a marked deterioration from March when 67 cities had rising prices and only 1 falling prices.

Of course this trend of weakening prices is only present in a small minority of cities, but it is a growing trend and it would be wrong to present this data as showing no effect from credit tightening. In fact this creeping deterioration is in line with our own concept of a delayed response to credit tightening, with no clear effects being obvious to most observers until late 2013 or early 2014,

It is interesting to note that not only have long term US interest rates moved above their July 2013 high but the middle of the curve has steepened further as part of this move. Attached is an update of our yield curve chart which slices the overall curve into 4 segments, 1-2 year (blue), 2-5 year (green) 5-10 year (purple) and 10-30 year (black).

It is the middle two segments which have expanded in recent days with the 2-5 year spread widening to 124.4 bp, the highest level since June 2011 and the 5-10 year segment which is now 125.4 bp wide, the highest reading since August 9th, 2011. As was the case back in May and June a widening of these portions of the curve can be expected to cause maximum duress to a large number of bondholders although it is possible that some managers took advantage of the lull in the last few weeks to re-position themselves less aggressively.

At the very short end of the curve the 1-2 year spread has widened modestly to 22.9 bp, indicating the market still prices in very little FOMC tightening for the next 2 years. At the long end the 10-30 year spread has contracted back to 102.2 bp, which is still wider than the 97.2 low recorded on January 5th.

Although the 5.1 point drop in the University of Michigan Sentiment index will probably generate some headlines on a slow summer Friday it is a fairly typical reaction to a soggy equity market and does no real damage to the trend of improving sentiment. Indeed the trailing 12 month ma of the poll reached 79.7 in August, its best reading since March 2008. We would expect this trend to continue to move higher in the months ahead even if interest and mortgage rates break higher.

The July US Housing Start and Permit report was almost exactly in line with estimates showing the June drop to be an aberrant report caused by the volatile multi-family portion of the survey. Although this report cannot be classed as a "surprise" it should be remembered that the Homebuilding sector had sold off by over 20% since May before yesterday's 7.7% reversal in the S15HOME index following the release of strong NAHB data. This suggests that the market has priced in far more deterioration in homebuilding and sales than has actually taken place in response to the move higher in mortgage rates.

July Housing Starts were estimated at 896K (consensus 900K) and were split between 591K Single Family Starts (compared to 604K in June and 593K in April before the increase in mortgage rates) and 305K Multi-family Starts (242K in June, 259K in April). This means that Single Family Starts are running over 15% above their level of a year ago. June data was revised slightly higher from 836K to 846K.

Total Permits were estimated at 943K (945K consensus) split between 613K Single Family Permits (625K in June, 614K in April) and 330K Multi Family (330K and 391K). Single Family Permit data tends to be the most reliable single number in the report and shows no deterioration over the last 4 months.

Houses Under Construction rose to a new cycle high of 636K, up from 623K in June and 607K in April. Given that this metric should (at least theoretically) have the most influence on actual current activity this breakout is significant and should correlate to stronger demand for employment and materials.

While the emerging market complex has been troubled in recent quarters by deteriorating trade and current account balances the opposite has been true of the Eurozone. This morning saw the publication of amalgamated June data (much of which had already been released by individual countries). This showed a Trade Balance of €14.86 bln, the third highest on record while the trailing 12 month ma moved up to €11.29 bln, an all time high for this metric, which was at -€2.12 bln two years ago. The Current Account surplus was somewhat larger at €16.9 bln. Which also moved the trailing 12 month ma up to a new all time high of €16.4 bln.

It is hard to exaggerate the importance to these robust Capital Account flows during the period in which foreign investors have been generally unwilling to hold European financial assets and they have also served to counteract the contraction of the ECB's balance sheet. The very robust trade position has also been an important factor in allowing Europe's corporate sector to perform somewhat better than its aggregate economic data in recent quarters.

Earlier today the July CPI report was released at the same time as the explosive Initial Claims report (we make no apology for concentrating on the latter in real time). Although CPI was in line with expectations at 2.0%, as was "core" CPI at 1.7%, and therefore will not have surprised the market it is still worth considering the possibility that we are close to a turning point in the inflationary cycle.

Almost 5 years ago at the time QE (or to be accurate CE) was introduced the few who noticed we dominated by "inflation hawks" who complained vociferously about monetary debasement. With several years of low to negative inflationary reports the link between overly generous monetary policy and a build up in inflationary pressures has become largely discredited, and to the extent inflation is a target for the US (and other central banks following the Bernanke Doctrine) it is because there is "not enough" of it present in the economy.

It is therefore interesting to note the stabilizing of CPI shown in this month's report, with the trailing 12 month ma bottoming at 1.70% over the last 4 months and now hinting at a move higher. We would not be surprised to now see a series of higher than expected reports going forwards.

Meanwhile US money supply growth continues to motor higher. M1 is growing at 11.6% YoY and has increased by almost 80% from its level at the start of Credit Easing, reaching $2.52 trln this week. M2 growth is currently 6.6% YoY, well above both the growth rate of GDP and that of CPI. Since September 2008 M2 has grown by approximately $3 trln, or 38%. Over this 5 year period the amount of media attention devoted to M2 has dropped off considerably (see chart) with monthly stories falling from between 800-1000 in the 2008-2010 period to around 400 stories a month today (see chart). We suspect we may be entering a period of greater discussion of both CPI and the influence of monetary growth upon it.

The last few weeks have been tough for home-building equities, which have been aggressively sold in response to the move higher by US interest rates. The release of the August NAHB Homebuilder Sentiment index has therefore come as relief since it suggests that conditions have continued to improve in the new home market even as interest rates have moved higher.

The Overall index (black) rose to 59 in August, the strongest reading since November 2005 and indicating a comfortable majority of builders surveyed have seen an improvement in conditions over the last month. The Present Sales index (red) rose to 63, the best level seen since January 2006 while Future Sales (blue) at 69 were the best since October 2005. Traffic (green) was static at 45, again keeping the trend intact whereby modest readings in this metric lead to a higher level of sales being generated. We note that following the release of the report the S15HOME index recovered from a sharp -3% loss and is now unchanged on the day but we suspect we will still need to see the New Home Sales data surpass or at least meet expectations to put a firm floor under this area of the market.

The Initial Claims report for W/E August 10th estimated Claims to have been 320K, well below expectations for 335K which matched last week's revised level. This substantial drop in Claims represents the lowest level recorded since October 2007 and continues the recent string of improving data from this report. The 4 week ma of claims fell to 332K, which is the lowest level since November 2007.

As the NSA chart shows this improvement in Claims has come at what is seasonally the toughest part of the year for the headline data and there is some reason to believe that an even sharper recovery in headline Claims may take place after Labor Day. Although the market continues to regard the BLS monthly Non-Farm report as the more senior data we have noticed that Claims data has started to get a little more respect in recent weeks, with the current very strong report causing a break-out at the long end of the US treasury curve to take place. Given that over time all US Labor statistics tend to converge it makes sense that the weekly (and we would argue historical more reliable trend indicator)is finally getting some respect.

The UK Retail Sales report for July continued the string of strong economic data with Total Sales Ex Autos rising 1.1% MoM (0.6% consensus) and 3.1% YoY (2.7% consensus). In addition the June report was nudged higher to a 0.3% monthly increase in activity.

As can be seen on the attached chart this takes the index of activity up to a new record high of 104.7 (2010 = 100) which constitutes a breakout from the congested range which has contained the index since it registered its prior cycle peak in 2008. Although we would always caution relying on a single month's data to draw conclusion the trailing 12 month ma has also risen to a new all time high of 102.2, compared to a level of 100.6 in July 2012. This at least demonstrates that a clear trend of improving retail sales has been established although it will take a few months to be sure of the strength of the recovery. Meanwhile the UK Gilt market seems to believe in the power of the recovery, with the 10 year yield moving up to 2.68% this morning, its highest level since 2011 (see chart).

The Indonesian Rupiah (IDR) has been one of the poorest performing currencies in recent weeks, dropping approximately -5.5% between May and August. Over this period the local central bank has raised interest rates while a series of currency interventions have been used to stem the slide. The release of July's FX reserves this morning shows the extent of this intervention, with the total falling by -$5.42 bln (-5.53%) to $92.67 bln. This follows a -$7.05 bln decline in June and means that since the start of 2012 FX reserves have fallen by -$16.11 bln, or -14.8%.

At their current level reserves are back to their November 2010 level and although this is far from a reserves crisis a drop of this magnitude can be expected to have a marked effect on local liquidity. This together with the increase in interest rates will have created substantially less friendly monetary conditions for the local economy, the effects of which can be expected to show up in economic and corporate data later in 2013.

Over the course of the last few weeks we have seen a number of studies comparing the level of NYSE Margin Debt Outstanding to that of the SPX index. The general argument being made in these studies is that the last two equity market peaks in 2000 and 2007 were accompanied by record amounts of outstanding margin debt and that given that the latter has just recorded a new all time high a reliable signal has been generated for the end of the current bull market.

We do not find this argument to be convincing, since it is lacking in both historical scale and an understanding of the relationship between the level of credit, the cost of credit and the value of the underlying asset being purchased.

Regarding the issue of timescale we have attached a chart that looks at the relationship between margin credit and the SPX index going back 50 years. As can be seen although peaks in the SPX index generally do coincide with peaks in NYSE margin debt there can be long periods of time during bull markets in which both measures push far into "blue sky" territory. This was true of the 1982 - 1987 bull run over which time the SPX approximately doubled in value while margin debt almost tripled and also the 1993 - 2000 period when the index increased from 440 to 1550 while margin debt increased from $61 bln to $279 bln.
Therefore the fact that both margin debt and the SPX have both recorded all time highs in recent weeks in itself tells us nothing about the future trajectory of either measures.

In order to look forward into the future we would suggest it makes sense to consider the value of the asset being leveraged and also the cost of servicing the debt. Regarding the former we would suggest that the EPS of the SPX index is a reasonable proxy for its "value" and we have attached a chart showing the ratio of NYSE Margin Debt to Total EPS of the SPX index (where the data goes back to 1993).

As can be seen there is a fairly constant range of values between 10,000 and 20,000 for this metric. For a brief period in the early 1990's the ratio was below 10,000 (meaning there was very little margin debt being used relative to SPX earnings) and in early 2009, when SPX earnings briefly collapsed the ratio shot up to 32.8K (we have deliberately cut off most of this spike to keep the scale relevant). Both the 2000 and 2007 peaks in the ratio came in at almost exactly 20,000 compared to the current reading just below 14,000. This would suggest that even if SPX earnings were to remain constant margin debt could be increased by about 40% before it reached the equivalent levels seen in 2000 and 2007.

Regarding the cost of debt service the divergence between 2013 and the prior two peaks is even more striking. Margin debt is typically priced off the Broker Call rate (BLR index on Bloomberg), which itself is priced off the FDTR. Its current yield of 2.00% compares with a 20 year average of 4.89%, a peak 2000 level of 8.25% and a peak 2007 level of 7.00%. We have attached a chart showing the cost of debt service using Broker Call which shows that the current cost of debt service is $7.53 bln, compared to the July 2007 peak of $26.70 bln and the March 2000 peak of $21.59 bln. Current debt service costs (in nominal terms) compare to November 2004 and May 1997 underlying the extreme affordability of the debt service burden.

Our expectation therefore is that margin debt expansion will remain in place until corporate earnings falter and/or the FRB finally starts to hike the FDTR by a significant amount. We do not expect to see either of these take place for a number of quarters making the current attention on margin debt considerably premature.

UK economic data continues to run well ahead of consensus with the July Unemployment Claimant Count falling by -29.2K, compared to expectations of a -15K decline. In addition June's report was revised lower from -21.2K to -29.4K, increasing the sense that a marked improvement in hiring has taken place. This data takes the 12 month ma of Claims down to -12.05K, which is the sharpest rate of improvement since January 2011, but still a little below the peak rate of improvement seen in late 2010. On the other hand Total Claimants are now 1441K, which is the lowest data seen since February 2009 indicating that for this metric at least the UK economy has improved beyond the level seen in the 2009/10 rebound.

If 2011 was the year of the Euro-crisis then 2013 is shaping up to be the year of "Euro-repair", with strong equity market returns being matched by much healthier peripheral sovereign credit markets. Indeed it is noticeable that although Spanish and Italian yields rose sharply in the May/June fixed income sell off, they have recovered the majority of their losses since the start of July. This is in stark contrast to the vast majority of global sovereign yields, including that of the emerging market complex.

This would appear to justify our conclusion made several weeks ago that the acceleration of economic activity within developed economy complex means that credit risk is very low but interest rate risk a (literally) rising threat. Safe haven credits such as the US, German and Switzerland benefit from credit risk but are undermined by interest rate risk, while the obverse is true of peripheral Europe, which are currently the only true "credit" bonds in the sovereign universe.

Since yields bottomed in early May the performance of German, French, Italian and Spanish Yields has been as follows:

May Low:

Germany 1.16%
France 1.66%
Italy 3.76%
Spain 4.04%

June Peak

Germany 1.80% (+74bp from May low)
France 2.45% (+79bp)
Italy 4.85% (+109 bp)
Spain 5.07% (+103 bp)

Current

Germany 1.80% (down -2 bp from June peak)
France 2.32% (down -13 bp)
Italy 4.15% (down -70 bp)
Spain 4.45% (down -62 bp)

In early May the German Bund traded at a spread of -260 bp to Italy and -288 to Spain. Today these spreads are -235 bp and -265 bp respectively. These still represent very attractive additional yields for those needing to clip coupons and we would not be surprised to see flows continue to benefit peripheral credits and penalize the safety trade where the yields on offer do not adequately compensate for the risk of negative total returns. Looking ahead a few weeks a German 10 year yield above 2.00% coinciding with an Italian yield below 4.00% does not look to be outlandish.

German investors are finally showing some appreciation of their local economic conditions with the ZEW Investor Sentiment poll seeing a sharp increase in both the Current and Expectations survey. The Current index rose to 18.3 from 10.6 in August, a sharp increase from last month's reading of 10.6 and just above the level of a year ago. Future Expectations were somewhat stronger, rising from 36.3 in July, which is a considerable improvement from the -25.5% reading seen in August 2012.

In our experience the former is the more useful index to follow since historically it has been a useful timing device for the DAX index with high readings in 2007 (88.7 in June) and 2011 (91.5 in May) marking important peaks in the index while important lows have coincided with almost universally negative sentiment (-96.1% in March 2003, -86.2 in February 2009. As with all indicators its record is not perfect, and the March 2000 poll only registered +21.6%, despite coming on the eve of the market's peak but we still regard it as a useful poll to follow.

At its current level the Current Conditions poll is registering only modest acceptance of positive conditions, which generally can be seen to be a bullish signal for the local equity index (provided the sentiment trend is improving). It would typically take a number of months for sentiment to rise to the sort of problematic levels that we would associate with a major market top, which would allow ample time for the DAX index to register a series of new highs well above that seen in May (8557.86).

Our view remains that perhaps the most surprising outcome this quarter will be European returns leading a strong overall quarter for developed markets, which would be an outcome that very few investors were set up to benefit from 6 weeks ago.

If the last note of India showed the argument for continued tight fiscal and monetary policy the simultaneous release of Industrial Production data (for June) and Car Sales (July) shows the deterioration on local activity that has in part been brought about by this tightening.

Industrial Production was estimated to have fallen by -2.2% YoY, double the expected -1.1% draw-down in activity, while May's report was revised sharply lower from -1.6% to -2.8%. It should be noted that this report pre-dates the significant tightening in monetary policy which took place in July and that India's interbank rates have risen by around 250 bp to between 10.30% (overnight) and 10.75% (3 month) since the end of June which can only be expected to have taken a further toll on activity. The 12 month trailing ma of Industrial Production remains modestly positive at 1.0%, underlining that there is little margin for further deterioration.

India's official car sales data for July suggests that local industrial activity will remain under pressure. Total Car Sales were 131K, a drop of -7.4% YoY and the lowest July sales since 2009. The 12 month ma of car sales dropped to 152K, which is -11.1% below the July 2012 level of this metric at 171K. Again given the continued tight monetary policy we would expect to see a further down-shift in activity in August's report.

India's trade report for July showed some improvement from the yawning gap of early 2013 with sharply lower oil imports down -8.2% YoY (India's crude prices are driven by Brent pricing) contributing to a -6.2% YoY drop in total imports to $38.16 bln. We would imagine that the recent tightening of regulations on gold imports will have also contributed significantly to this report, although it should be recognized that to some extent shutting off official channels means that some of the the prior official imports has been shifted into smuggling which of course will not be picked up in the report.

Exports grew by 11.64% YoY to reach 25.83 bln although it should be recognized that this still keeps activity below its July 2011 level. The Trade Balance was -$12.27 bln, which compares to the record July deficit of -17.48 bln seen in 2012. This takes the trailing 12 month ma of the deficit up to -$16.5 bln which remains an alarmingly high figure. Following the release of the report the Finance Minister announced plans to curb certain "non essential" imports including gold, silver and also curbs on crude oil. Although we understand the impetus for this policy we would be concerned that the activity will shift outside of official channels, which will result in improved official data but far less relief to the underlying capital flows.

India's CPI report was also released last night (as was industrial production and car sales which will be dealt with separately). CPI remains stubbornly high at 9.64%, which was marginally below expectations of 9.71% but still unacceptably high. The trailing 12 month ma of this relatively new metric (the data starts in January 2012) is 10.02%, which is one of the highest levels anywhere in the emerging market complex. Although India's Wholesale Inflation metric has improved substantially in recent months we are yet to see any evidence of this moving down the to retail prices.

Tokyo Condominium Sales experienced their best July sales since 2007 with 5306 units sold, an increase of 31.6% from July 2012. This takes the trailing 12 month ma of sales up to 4202 units, the highest level since July 2008. It would appear that a meaningful recovery in sales activity has taken place in the capital cities housing market, and although the extent to which this will develop into a broader national recovery remains open to question we do take encouragement from this trend.

China's broad economic activity reports show little impact from the recent credit shrinkage, which given their statistical inertia and the time lag for credit restrictions to take effect is not surprising.

Industrial Production (which we suspect is a heavily massaged data series) rose from 8.9% to 9.7% YoY, beating expectations of 8.9% growth. The YTD cumulative increase (see chart) is now 9.4%, up from 9.3% in June, which compares to growth of 10.3% in July 2012. Fixed Asset Investment growth remains much stronger at 20.1%, in line with expectations and just above its July 2012 level of 20.4%. Retail Sales were the only category to disappoint, increasing by 13.2% YoY, below expectations of 13.5% and June's growth rate of 13.3%. The YTD cumulative growth rate remained at 12.8% and this is somewhat below the July 2012 pace of 14.2% growth. We would not draw too many conclusions from this set of data and would continue to rely on corporate data points to judge Chinese activity.

Given our concerns about credit shrinkage we are also now returning to the real estate sector. Longer term readers may recognize the attached chart which we used in 2011 to track the difference between real estate sales (red) and completions (black). Although it is premature to expect much change in activity it helps to start looking at metrics such as these a little early. As can be seen real estate sales appear to be very healthy, up 27% YoY in terms of the Square Meters of real estate sold. This is well ahead of the pace of Real Estate Completions, which lag at 4.6% above the July 2012 level. In large part this mismatch is a correction of the period from mid 2011 to late 2012 when Completions ran far head of sales. Again the data shows no effect from credit shrinkage on either metric, which is unsurprising but no guarantee that this will remain the case in the months ahead.

China's monetary aggregates are much more sensitive to bank credit than other forms of financing and this means that at a time of great divergence between these two measures the usefulness of following money supply is somewhat diminished.

Even so it is a worthwhile exercise to keep an eye on monetary growth, which remains quite healthy at the level of M2 and acceptable for the more narrow categary of M1. M2 growth in July reached 14.5% YoY, above expectations of 14.0% and (unsurprisingly) close to the pace of bank credit growth at 14.3%. M1 growth bounced slightly to 9.70%, which keeps the spread between these two measures at -4.80%. As a reminder a negative spread implies credit growth is faster than liquidity growth, which has been the case in China for a number of quarters. In summary the July report shows little change from recent conditions, which makes sense given the stability of bank financing over recent months.