After the major re-write of the FOMC statement at September meeting the text of this afternoon's release contains comparatively few changes, reflecting the fact that the decision to defer any reduction in bond purchases last month was always likely to be a multi-month affair. In addition the government shutdown meant somewhat less official data was available for perusal and those reports that were released were (even) less reliable than normal.

We have attached a red-lined version of the text (courtesy of Bloomberg ©) and as can be seen the majority of changes take place at the start of the communique. The outlook for the housing market was downgraded a little but perhaps the most interesting linguistic choice was to remove the controversial reference to the "tightening of financial conditions" as a risk to the recovery that was included last month.

There were three explanations offered by observers to the use of this term last month:

1. Ignorance

2. Conflation of Financial Conditions with the general level of interest rates (we note that the Chicago Fed's Financial Conditions Index contains a large input from underlying interest rates see link http://www.chicagofed.org/webpages/research/data/nfci/background.cfm ).

3. An implicit signal that the FOMC had been influenced by the (genuine) deterioration of financial conditions in a number of key emerging markets.

If we remove #1 as both impolite and highly unlikely given the large number of FRB staff who are paid to sit around looking at data, the remaining two explanations (which are not mutually exclusive) do offer an insight into the degree of the task that the FOMC has taken upon itself.

Over-emphasizing the significance of treasury yields removes the concept of a "benign" rise in interest rates, with no differentiation being made between a rise in treasury yields that steepens the curve and compresses credit spreads (even if nominal credit yields still rise), and one which is driven either by a sharp increase in short term yields and flattens the curve, or a rise of credit yields in which treasury yields either remain the same or actually decline. The first scenario is actually the typical back-drop for a strong economic recovery, the second for the period in which a central bank is adjusting policy to bring it into line with reality and the third a sign that monetary conditions are inappropriately tight. Under the Bernanke Doctrine instead we have a steadily strengthening economy with depression level treasury yields and relatively high credit spreads.

Regarding the influence of events within emerging markets we note that the extension of the FOMC's mandate into the international sphere arguably commenced in 2008 with the launch of the CBLS (a large scale provision of USD swap lines to a number of key EM central banks) and that this facility was used on a smaller scale in late 2011 to help the ECB control USD pricing at the height of the Eurocrisis. Nothing as dramatic took place over the summer months but the notion that the decision to maintain full bond purchases because of the stresses encountered in countries such as India and Brazil is somewhat surprising. Nevertheless the strains felt in financial conditions of emerging markets were clearly discussed in the truncated minutes of the September meeting and our assumption is that they were a factor in the decision to keep the current level of bond purchases in effect.

The removal of this language regarding financial conditions may therefore be an indication that the FOMC received some criticism over this issue or may instead reflect the fact that interest rates came back down in the US and most emerging markets have recovered a good portion of their summer losses. However, the fact that they did not choose to state that financial conditions have recovered but instead simply deleted the reference to them makes the former explanation a little more likely.

The rest of the text remains almost unchanged, with the promise that bond purchases will remain in place for a while longer and that the gap between tapering and an actual rise in interest rates will be lengthy. We continue to take issue with the latter, since we believe that the FOMC continues to underestimate both the speed with which employment conditions are improving and inflationary pressures are building. We do not doubt the honesty of the committee, merely its ability to accurately gauge the trajectory of an economic cycle which has consistently surprised it.

FOMC Statement Oct 30th 2013

The Lloyds Bank Commercial Business Barometer is a survey conducted with over 200 of the banks commercial customers tracking both current economic conditions and expectations. It is a diffusion index (in other words it records monthly improvement or deterioration rather than absolute levels) with the headline number representing the net percentage of positive or negative responses.

October saw the highest ever positive reading for the Current Conditions index at 63 (made up of 72% improving and 9% deteriorating), which represents another metric pointing to a robust UK recovery. This is the 14th consecutive positive reading and the 12 month ma of this metric has now reached 34, a level only surpassed during the initial "V" shaped rebound from the 2008/9 collapse.

Although this index tells us little about the absolute level of conditions we suspect these are fast approaching "normal" for many businesses and perhaps surpassing that in stronger areas of the economy. This clashes with the UK treasury market which still maintains a 10 year yield at a recessionary 2.56%, and monetary policy which combines a record low Base Rate with significant asset purchases.

Given the strong momentum in UK economic data we are starting to suspect that the UK treasury market could be the first to decouple itself from global markets by moving higher in response to strong economic data and that the BOE may be the first DM central bank to break with with the "Bernanke Doctrine" (we would expect the former to lead the latter) although it would probably take a clear upsurge in inflation data to cause the latter to take place.

Since the BLS employment report will not be released until the 2nd Friday of November this morning's ADP National Employment Report will perhaps have a little more time in the limelight than usual. The data showed an estimated 130K jobs added in October, below consensus expectations of 150K. However, given the natural volatility of this series and the fact that October activity will have had some impact from the Washington stand-off most observers will treat this as an in-line report (as can be seen by the limited response by US treasuries).

This keeps the 12 month ma almost unchanged at 172.1K, which remains about 18K below the average monthly level estimated by the BLS over the same period. We note that since its recalibration last year the ADP report has been consistently reporting lower numbers than the BLS. We do not ourselves favor one over the other from a methodological standpoint (they are both deeply flawed as real time signals, but more useful as longer term indicators of employment trends) but we would take into account the ADP reports consistent "under-reporting" of payroll gains when interpreting the data.

The after-effects of the government slowdown were clearly evident in the Conference Board Consumer Sentiment Index, which fell sharply to 71.2 in October from 80.2 in September (revised up from 79.7). Although this was somewhat lower than expectations of 75 given the clearly understandable cause of the decline it is hardly a cause for concern.

Indeed a similar wave of disgust followed the Fiscal Cliff debacle last January, when the index fell to 58.40 from 66.70. This didn't alter the trajectory of confidence which has been slowly building since the collapse of 2008/9 and by February the index had risen as high as 68. Given the transitory effect of the shutdown we would expect to see a similar rebound in confidence next month.

Perhaps the most interesting aspect of consumer confidence this cycle has been how muted it has been in the face of a strong bull market. October's poor reading was notable for taking place against the backdrop of the SPX forcing its way up to a new all time high (in January the SPX was recording a new six year high). Current levels of confidence are equivalent to that normally seen at the early stages of a bull market rather than the sort of giddy belief that accompanies major market tops.

The PBOC released its September 2013 balance sheet last night and although the data contains few surprises it acts as a reminder that credit growth continues to massively out-pace that of the monetary base. Total Assets grew by 226.5 bln CNY (0.73%), taking the annual growth rate down slightly to 7.43% from 8.02% last month. This represents something of a loosening from the static balance sheet of late 2012 but also a much tighter level of liquidity creation than we saw for much of the prior decade. In other words the PBOC has grown its balance sheet at very close to the stated target for GDP in recent months, perhaps a sign that the monetary base itself has become a key policy tool.

Of course credit growth can diverge from monetary growth for long periods of time (and in both directions as the FRB has discovered over the last five years). The official bank loan sector has been growing at over twice the pace of the central bank in recent months, while the shadow banking system has added an equivalent amount of credit into the system.

The two metrics we use to track this are the 12 month ma of total Social Financing compared to the size of the PBOC's balance sheet. This currently reads 4.99%, meaning that over the last 12 months total credit created has been equivalent to 60% of the PBOC's balance sheet (see chart). Although this is slightly lower than the readings seen in early 2013 it is still a remarkably high level, particularly since it follows the blowout readings of 2009/10.

We also track the ratio of the PBOC's balance sheet to total bank loans, and this fell to 0.4428 in September, the lowest level since October 2004. Of course nine years ago non-bank credit was a fraction of its current level, meaning that this ratio significantly underestimates the change in the relationship between total credit and total liquidity in the Chinese economy, although its direction remains an accurate reflection of the change in conditions.

Brazil's loan data for September hints at a moderation of lending by the State Sector banks, whose outstanding loans grew by 9.37 bln BRL (0.72%), the second slowest month since February 2012. Indeed for the first time in several quarters Private Sector bank lending grew by a larger amount, increasing 10.54 bln BRL (0.83%) but it is too early to be sure if this represents a change in the lending landscape or simply a one month blip.

Any slowdown by the state sector would be significant, since over the last couple of years this has been the dominant source of lending in the Brazilian economy, with a YoY growth rate of 26.5% compared to private sector lending growing at a 6.5% pace. As the attached chart shows this allowed the state sector to overtake private lending over the summer for the first time in modern history. We have voiced concern that this politically inspired growth has come at the cost of underwriting quality, with state banks apparently willing to extend credit in a manner that private banks had little appetite to match.

In terms of the sector breakdown there was little to report in the September data, once again Housing remains the most important driver of credit growth. Personal Credit grew by a modest 2.9 bln BRL (0.39%), while the delinquency rate of Personal Credit remained steady at 7.00%. With the unemployment rate now easing up and the credit growth rate slowing down we doubt whether much more progress will be made by delinquencies going forwards, and would not be surprised to see an up-tick in problem loans by the middle of next quarter.

The RBI acted in line with expectations last night, raising the REPO cut-off yield by 25 bp to 7.75%, its level between February and March this year, tightening monetary conditions for a local economy which is approaching stall speed. At the same time some relief was given to the financial sector, with the marginal standing facility rate (used by banks to access short term funding) dropped to 8.75% from 9.00%, which in turn eased some of the pressure on the local money market. Interbank rates now vary between 8.98% (overnight) and 9.22% (3 month) and while these levels are significantly higher than those prevailing earlier this year they also represent a big improvement from the "crisis" readings seen in August and early September.

The equity market liked these steps, with the SENSEX rallying 1.74% to close at 20,929, its highest close since November 2010. Including these gains the index is only up 7.73% YTD in local terms, and down 3.96% for a USD investor, underlining the substantial under-performance of Indian equities in recent months.

International investors remain very patient with Indian equities, with YTD flows recovering over the summer to reach $15.7 bln, above their May peak. Interestingly bond investors are acting very differently with total YTD outflows hitting -$7.9 bln, by far the largest removal of foreign capital on record. We assume this discrepancy has been caused by the substantial losses in the INR, which are of course much more problematic for bondholders (with fixed yields) than equities. This removal of capital has acted to further tighten monetary conditions, with bond issuance slowing to a trickle in recent months.

India to our eyes remains vulnerable to further economic deterioration, with high inflation and large fiscal and trade deficits. We do not deny that some progress has been made in terms of restoring market confidence in recent weeks but the problems remain daunting and the corporate opportunities rather more limited than across most of the developed world.

Ireland's housing market continued to experience a strong rebound in prices in September with the National Residential Price Index rising 1.8% MoM, its largest monthly rise since August 2006. This is the sixth successive monthly price gain and takes the annual gain up to 3.6%, its highest level since late 2007. Of course the actual level of prices differs greatly from 6 years ago, with the index reaching 68.2 in September, almost exactly half its peak value in the last cycle.

The key Dublin market continues to set the pace for the rest of the country with prices gaining by a record 3.9% in September and 12.3% YoY, the fastest annual pace since April 2007. Again we would note that prices are only 49% of their prior cycle peak, but even so this is a very rapid pace of repair that indicates a strong resurgence of demand for housing in the nation's capital.

The US Pending Home Sales report showed a surprisingly steep decline in transactions with the seasonally adjusted index falling from 105.8 to 101.6 when consensus had called for a flat report. This takes the index back to its level in late 2012, which while disappointing as a monthly report still represents a reasonable level of overall activity (January 2001 activity = 100).

If there is any solace to take out of report it is that the collapse in activity took place in September, which is seasonally much less important than the prior 4 months, each of which saw Pending Sales record multi-year highs (ignoring tax credit distortion). Thus the number of "lost" transactions is far smaller than would have been the case with a 5% draw-down in July or August, although its effect on the seasonally adjusted headline is the same (see charts).

We would also note that monthly draw-downs of this magnitude are not unknown during strong housing markets with August 2003 seeing a similar decline (down 5.2 points to 108.1), again following a steep rise in mortgage rates (the 30 year mortgage rate rose from a then record low 4.90% in mid-June to 6.10% at the start of August). We therefore would not read too much into this data other than confirming the fact that higher rates did alter buyer behavior this summer, with perhaps some purchases being rushed through in an attempt to lock in rates that we feared to be rising further.

A decade ago the housing market was to accelerate into a bubble despite the fact that the 2003 low in mortgage rates was not surpassed again that cycle (it took the economic collapse of 2008/9 to achieve that) and our view remains that the stresses caused by rising rates will prove to be transitory this time around as well. There is nothing unusual about a housing cycle pushing against the twin headwinds of rising prices and interest rates, and while sharp moves in either can alter the trajectory of recovery (particularly over the short term) they do not typically force market activity to trend lower until housing affordability becomes truly problematic.

Since there was little new data released overnight worth commenting on we will revisit an issue that garnered an awful lot of attention a few months ago, but now seems to have slipped off radar screens, namely the very rapid build up of NYSE margin debt that has taken place since the start of this powerful bull market.

Readers may recall that over the spring and early summer a large number of stories were written, sparked largely by the simple fact that in April outstanding NYSE margin debt had risen to a new all time high, breaking above both the level seen in at the March 2000 ($279 bln) and July 2007 ($381 bln) highs, each of which took place against a peaking bull market. The fact that outstanding NYSE margin then went on to post a modest 2% decline in May led some to conclude that the top for debt was in place and that the US equity market was likely to suffer a significant decline within a number of weeks.

We were resistant to this view at the time, and pointed out that although NYSE Margin debt and the US equity market do tend to peak within weeks of each other (for obvious reasons) there is nothing unusual about a long bull market taking margin much higher than its prior peak. Indeed making a new high in margin has normally been nothing more than an intermediate step along the way (see attached long term chart).

A few months later we can see this pattern playing out in the US, and after the spring hiatus we note that the last 3 months have seen a rise in outstanding margin, with September's strong rally being partly fueled by a robust $18.3 bln increase (4.78%) to a new record high of $401.2 bln. No doubt this new record will make some queasy, with the mantra that this build up is unsustainable and that it undermines the credentials of this bull market.

We beg to differ. The rapid rise in margin debt is a logical outcome of both the robust equity market (which has good fundamental underpinnings) and the very generous monetary conditions kept in place by the FRB. The effect of the latter is twofold, with both the price and quantity of money being radically altered and as we argued in the summer the sustainability of a credit surge is ultimately dependent on both these factors.

Regarding price, NYSE Broker call is the base rate for margin debt (borrowers will either pay a premium or receive a discount according to their credentials). Using this a a proxy for cost we can see that the total interest burden of current outstanding debt is $8.024 bln, less than a third of the July 2007 level of debt service at $26.695 and about 2.5 times less than the March 2000 level of $21.6 bln.

Regarding the quantity of money if we use M2 as a rough proxy we can see that the margin debt is currently 3.7% of total money stock, compared to 5.2% in July 2007 and 5.9% in March 2000 (we would see something similar if we used total bank deposits instead). In other words the current rapid build up of margin debt is actually quite sustainable, and moreover is likely to be sustained (which is not quite the same thing).

This is not to say we we welcome or applaud this process, but ultimately we are meant to be pragmatic observers (and participants) in the various investment cycles we encounter, and not fall into the moralist trap of bemoaning the perhaps less welcome consequences of a very powerful bull market.

Link:

www.bloomberg.com/video/bond-market-extremely-expensive-shaoul-says-oBBKkO3vRJa3vj1aum2eRA.html

Interview focuses on the relative value of the equity and bond market.

Attention towards Japan has become much more muted in recent months, in part because the torrid gains of early 2013 have been replaced by a duller range-bound market, but also because actual policy reform has proved more muted than some had hoped for.

We have always viewed the story differently, with monetary policy being the primary driver of our investment thesis together with an appreciation that Japan's primary motivation in following this reform is not economic but instead political. The country (or at least the newly elected administration) fears its economic irrelevance on the global scale is starting to become a diplomatic and even military handicap, a point made clear in the publication of its 2013 white paper on defense:
See link http://www.mod.go.jp/e/publ/w_paper/2013.html

For this reason we do not doubt the determination of the BoJ to see this policy through, and we are always great believers that given enough time monetary policy has extremely powerful effects. Fiscal reform and deregulation have a much spottier record, and while progress in either area would be a plus they are ultimately less important than the radical boost to domestic liquidity being undertaken by the BoJ.

One sign that this liquidity injection is having some effect is the turnaround in national CPI. This grew 1.1% YoY in September, the fastest annual pace since October 2008 (when soaring global oil prices rather than monetary policy were the catalyst). This compares with a -0.3% level a year ago, suggesting an important turning point in the inflationary cycle may have been delivered. The 12 month ma remains slightly negative at -0.1%, but this reflects data produced in late 2012 and early 2013. Monthly prices have increased every month since February and this slower moving metric can be expected to move into positive territory soon enough. Whether a trend towards higher prices can be sustained remains to be seen, but the fact that we have now moved into positive territory without any significant attention is an interesting development.

After the SHIBOR scare of early July China has had a relatively quiet summer, with most observers concluding that steady growth had resumed in the world's second largest economy. Our view over this period has been more nuanced; we recognized that the spike in concern was probably premature, but the scale of difficulty in navigating economic policy between the inflationary impulse of the local housing market, and the deflationary forces present elsewhere made it highly likely that China would be a source of market tension going forwards.

We therefore note with interest that both the local SHASHR index and offshore HSCEI index would appear to have de-coupled from the general recovery in emerging market equities in recent days, with both indexes falling below important support at their 50 day ma's. Interestingly this has been in part a response to another spike in money market rates, which have risen right up to the top of their normal range and are now threatening to break higher.

As was the case in July, the cause would appear to be a deliberate draining of liquidity from the REPO market by the PBOC. This follows the general pattern of the last two years in which credit has remained abundant (increasing in total by approximately $3 trn over the last 12 months) while actual liquidity available to the banking system has been much tighter.

It remains to be seen whether this episode will be allowed to proceed any further, or if the PBOC will start to add liquidity quickly to the money markets, but either way it is a reminder that China's capital markets remain in much more fragile state than those in the developed world.

Link to interview:

http://watch.bnn.ca/#clip1030291

Interview concentrates on equity and bond market comparing risk and opportunity in both.

We have always valued the weekly Initial claims report as giving a useful real-time snapshot of labor markets. It is therefore unfortunate that a combination of the government shutdown and computer problems in California (which is by far the largest state for this data) have served to distort reports since mid-September.

This week's report showed Claims of 350K, above estimations of 340K (for the reasons given above consensus was derived from an unusually wide dispersion of estimates), while last week's data was revised higher to 362K. This took the 4 week ma of Claims back up to 348.3, compared to a reading of 305K on September 27th, a number which was partially lowered by back-logged Californian claims which are now flooding the system. A sense of the scale of this issue is that during the summer California typically accounted for around 16% of total national Claims, and 13.6% of Claims for the week ending October 6th 2012, but supplied almost 24% in last week's report, suggesting that around 25-30K of total Claims were caused by the backlog.

Interestingly even with the impact of California and the Federal shutdown (no estimate was provided at the impact of the latter) the 4 week ma has only backed up to its level in July. Since both these issues will only have a temporary effect on the data this still suggests that a marked improvement in Claims took place over the summer, although perhaps not quite as significant as the giddy data released in early September. We will not have a reliable read on Claims data for a number of weeks but we would expect to see Claims settle somewhere between 300K and 320K sooner or later.

We would remind readers that this improvement has not been reflected in the relatively poor non-farm payroll data released since July, suggesting that some degree of catch-up is due by the latter. Of course the October non-farm payroll report will have to adjust for the Washington hiatus but sooner or later we would expect to see some significant upside employment reports.

http://blogs.wsj.com/economics/2013/10/23/dont-put-too-much-stock-in-one-jobs-report/

A very sensible piece that outlines the degree and sources of volatility in this over-watched data series. Well worth reading as a general reference piece.

The Brazilian Consumer Confidence index fell to 111.70 in October, a 2.5 point drop from its September level despite the recovery in the local equity market. As can be seen on the attached chart this keeps confidence towards the low end of its recent range, although it remains over 3 points higher than its July 2013 low of 108.3, which coincided with the abrupt sell off at the start of summer.

However, even that July reading could hardly be seen as the sort of deeply pessimistic reading that marks the end of a bear market. Even allowing for the natural optimism of Brazilian consumers we would expect confidence to be comfortably below 100 at the down point of an economic and market cycle, and we note that this measure was breached between October 2008 and April 2009, with the low point being 94.9 recorded in November and December.

The reason for the resilience of confidence is not hard to fathom, since the local government has done everything within its power to ensure that the pain of Brazil's economic slowdown has been felt by the corporate and investment sectors rather than Brazil's consumers. Unemployment has remained very low (partly because of Brazil's rigid labor laws that make lay-offs very difficult) and credit has continued to be freely available (aided by the generosity of the state controlled banks late into the economic cycle). Thus although confidence has lost the buoyancy of the boom years it remains far above a recessionary level.

Our view is that this is unlikely to remain true throughout the remainder of the down cycle, and that at some point significant pain will be felt by Brazil's consumers, and will be reflected by a sharply lower confidence reading. Paradoxically this outcome would signal better news for investors, since a few months of low confidence readings would be consistent with the bottoming of the down cycle. As it is we are not there yet and we would avoid the temptation to step back into Brazilian equities (particularly those focussed on local demand) at the current time.

UK mortgage approvals for September totaled 42.99K, well above expectations of 39.5K and the strongest single month for transactions since December 2009. This represents a 39.6% YoY increase in activity for September's single month data, and while this may overstate the underlying trend of improvement the 12 month ma has now recovered to reach 35.19K, its highest level since October 2010.

However, this does not tell the entire story; because home prices (particularly in London) have recovered meaningfully in recent quarters the value of approved transaction actually broke out to a 5½ year high in September of £6.666 bln, underlining the significance of this recovery to both the UK consumer and banking sectors. The 12 month ma of this metric rose to £5.456 bln, the highest level seen since July 2010, but if September's breakout can be sustained this metric will start to climb strongly into the end of the year.

One of the few silver linings to the Washington shutdown was the fact that we were saved the release of much of the government economic data but this morning saw the return of a dark cloud in the form of the September non-farm payroll report.

This data series has in recent months shown no obvious sign of improvement in contrast to a host of other employment metrics from both the public and private sector that suggested (at least through September) that the last 6 months have seen a notable uptick in labor demand. Unfortunately, the non-farm payroll report remains the "daddy of the data", setting the mood of the market (at least over the short term) and the terms of analysis within the Federal Reserve, despite the fact that there is no evidence that it supplies a more accurate reflection of current conditions than alternative measures such as Initial Claims.

The September BLS report estimated Total Additions to Payrolls at 148K, below expectations of 180K. August data was revised higher to 193K from 169K while the weak July report was revised lower from 104K to a scarcely credible 89K. Including net revisions of +9K this takes the data to within 25K of the consensus view, which is of course well within the error tolerance of this data. In other words whatever the immediate effect on the market's psychological make up there is little conclusion to draw from the data.

Private Sector Payrolls were estimated to have risen by only 126K, compared to 180K consensus. Hidden in this "miss" is the fact that the Public Sector has ceased to be a drag on overall employment - a notable change from the first four years of this recovery. Revisions to the last two months were -18K, taking the overall picture a little lower. On the other hand the trailing 12 month ma actually rose slightly as the poor September 2012 data dropped out of the calculation, with this metric now 191K. As can be seen on the attached chart there has been remarkably little change to the annual pace of job gains over the last three years, which is as good an argument as any for paying somewhat less attention to the monthly reports.

It is also interesting to note that the clear trend of improving Unemployment remains in effect, with the data falling to 7.2%, helped by a 133K gain on the Household Survey (the Participation Rate was unchanged at 63.2%). This takes this metric a little closer to the FOMC target of 6.5%, although we note that the committee has sought to distance itself from rigidly responding to this guideline in recent meetings.

In the normal course of a year we would expect better data to be released during Q4, which has significant seasonal tailwinds helping the report. This time around we will have the distortion from the shutdown to contend with, making the October and November reports even more of a lottery than normal. Our advice would be to simply move on from today's report and assume nothing major has changed, with perhaps the most important effect being that the bond market may have bought itself a little more time.

China continues to experience a broad housing boom which is unsurprising given that credit metrics continue to suggest a very rabid build up of private sector indebtedness.

September's data showed New Affordable Home Prices rose in 65 out of 70 surveyed cities (falling slightly from 66 last month), with only 2 cities experiencing falling MoM prices (unchanged). Existing Home prices rose in 63 cities (up from 58 last month) and fell in only 4 (5 last month), which is the strongest data seen since April at the start of the brief crackdown in shadow banking.

It is not just the consistency of the data that is remarkable but also the rate at which prices are increasing. Beijing (16%), Shanghai (17%), Shenzen (20%) and Guangzhou (20%) all experienced very sharp annual price increases in markets that were already fully priced a year ago. It remains to be seen at what point the PBOC will feel forced to react to this situation, but the fact that other portions of the Chinese economy (most obviously exports) would appear to be growing well under the GDP target rate, the temptation to allow a buoyant real estate market to continue to carry the strain would seem to be winning the policy argument.

Link:

www.bloomberg.com/video/s-p-500-can-hit-1-800-by-end-of-the-year-shaoul-Af81HuE6TkiUT9OX368xdA.html

Interview concentrates on US equity and bond market.

September's NAR report on Existing Home Sales showed a stabilizing of the housing market following the strong recovery of activity over the last two years. Total Sales were estimated at 5.29mm units almost exactly matching expectations, with August revised slightly lower to 5.39mm from 5.48mm units. This still keeps activity over 15% above its level of a year ago, while the trailing 12 month ma has risen to 5.06mm, its highest level since November 2007.

Activity in Single Family homes matched the overall picture with sales of 4.68mm representing a 10.9% YoY change, and the 12 month ma also reaching a 6 year high at 4.47mm units. In other words a strong trend of recovery has taken hold which has lifted the overall market back to a level equivalent to that of the healthy pre-boom housing market at the start of this century.

One slight change is the state of inventory which registered its first YoY rise in over two years. The rise was a modest 3.7% and at 1.96mm units overall inventory remains very low. However, it does now look as if the inventory cycle has finally bottomed with the 12 month ma flattening out at 1.82 mm units, the lowest level for this metric since December 2001. It should be noted that a rising inventory from a low level is quite normal for a strong existing home market, particularly if it reflects a willingness of homeowners (or lenders) to list houses that have seen prices recover back to where they can be sold for an acceptable sum. Indeed given that activity in certain markets has been held back by the availability of units it would not be a surprise in inventory and sales start to be positively correlated going forwards. Much later on inventory may become a sign of a housing market in over-supply, but we are nowhere near the sort of metrics seen at the peak of the last two housing booms.

Over the last few years the Bank of Israel has had close informal ties to the FRB thanks to the fact that its Governor Stanley Fischer had served as the doctoral supervisor to Ben Bernanke. Strangely enough their succession has also been tied by history, since in both cases an internal female candidate that they preferred (we state this without hard proof in the case of Chairman Bernanke favoring Janet Yellen) seemed about to be passed up in favor of a political insider with close links to the President/Prime Minister.

Most readers will be aware of the ill-fated candidacy of Larry Summers but in Israel's case things got somewhat messier as Jacob Frenkel (a prior incumbent of this post) was nominated and then forced to withdraw due to a personal issue that had not been disclosed prior to his nomination, and was then followed by Leonardo Leiderman whose candidacy lasted a matter of days. Finally this weekend Karnit Flug has been nominated for a post that it now seems certain she will fill on a permanent basis having served as Deputy Governor under Stanley Fischer and interim governor during the selection process.

This means that Israel's monetary policy can be expected to remain on its particular course, which could be described as "Swiss", in that it seeks to target the currency rate as a primary policy aim in the same manner with which the SNB has kept the CHF/EUR cross rate above 1.20. Rather like Switzerland Israel was fortunate not to feel the full blow of the 2008 collapse domestically, and was similarly only tangentially affected be the Eurocrisis, but its central bank reacted as if it was the epicenter.

The result has been a strong domestic economy in recent years, but one that is becoming mired by growing asset inflation in the form of its property market. Despite the risks caused by this issue the BOI has continued to target a weaker shekel by purchasing significant amounts of FX in recent months, causing money supply to accelerate. September's data showed M1 growing by 3% MoM, the fastest single month since April 2012. Annual growth is now 14.1%, and the 12 month ma of growth has reached 11.5%, the highest level since December 2010.

By allowing money supply to increase at this pace late in an economic cycle the central bank now risks feeding inflationary pressures. We would expect the local equity market to be a "benign" victim, since historically there has been a strong relationship between M1 and the level of the TA-100 index (see chart). Less palatable would be a further leg higher for local property prices, or any outcrop of inflation at the level of consumer prices. Presently CPI remains at a placid 1.30%, but it topped 4% for much of 2011 sparking some significant social unrest.

Thus although Israel's size makes it a fairly trivial participant in the global economy it does have certain characteristics that make it worthy of attention in tracking a potential transition to a phase of higher inflation globally.

It is interesting to note that the release of China's economic statistics for September, together with its Q3 GDP report has generated few top level headlines this morning, suggesting that the agonizing over the state of the world's second largest economy has subsided for the time being. Of course part of the reason for the lack of news is the lack of surprise contained in much of this data, which seemingly never changes much from month to month.

Overall GDP was estimated at 7.8%, in line with expectations and this was also true of Industrial Production at 10.2%. Retail Sales were a little weaker than expectations at 12.3% and Fixed Asset Expenditure also just missed at 20.2%, but this was essentially an "in line" set of data that showed a modest rebound in activity taking place over the summer.

As we have noted before it seems highly likely that the export sector of the economy is growing much slower than the official GDP report, meaning that if today's data is to be believed other portions of the Chinese economy must be outperforming. This would certainly appear to be the case for real estate, where the total area of residential real estate sold increased by 23.9% YoY in September. Although this is the slowest increase since December it is clearly still a rapid pace of change that suggests that mortgage credit remains freely available.

Given the lack of clarity regarding the data perhaps the most useful statistic released last night was the simple Entrepreneur Confidence Index. This survey came in at 119.5, slightly higher than the Q2 reading of 117. Over the 15 year history of this index readings of around 120 have been consistent with a "normal" period of expansion, 130 and above with a boom and anything below 110 a more problematic set of circumstances. This seems about right for the state of China today, with the PBOC still navigating the currents between the risks of an inflationary bubble in real estate and the deflationary outcome of bringing it to an end. None of this in our opinion makes China an attractive destination for investment capital, but it does also suggest that its economy is not an imminent risk for global markets either.

At the time the September "taper faker" FOMC statement was released we noted the surprising inclusion of language regarding a deterioration of financial conditions when none appeared to have occurred in the US. As the minutes of the meeting made clearer when they were released three weeks later, this seemed to be linked to conditions in emerging markets rather than the US, which may be a controversial widening of the FOMC's policy remit but at least absolves them from the charge of ignorance.

Since mid September US Financial Conditions (as measured by the Bloomberg US Financial Conditions index) have continued to improve, with the index actually registering a new all time high of 1.58 on Wednesday (5 years and one day after the index made its record low at -12.67), before falling back slightly to 1.47 this morning. Perhaps more importantly these readings are not the product of a brief blip, since the trailing 10 week ma has now reached an all time high of 1.34, while the 52 week ma is 1.04, the first time this measure has averaged over +1 for an entire year.

In our opinion the length of time that conditions have remained strongly positive is perhaps more important than the level itself, since it generally takes some time for financial conditions to start to filter through to actual economic activity. Perhaps even more striking is the fact that all of this is taking place against a backdrop of domestic monetary policy that is arguably even looser than was in place in the immediate aftermath of the Lehman collapse. We say this since the initial burst of "Credit Easing" had a substantial portion diverted to global markets via the CBLS facility, whereas all of QE3 has been deployed within US Treasury and MBS markets.

As the attached chart makes clear, prior periods of strong financial conditions have typically been matched either by FOMC tightening moves, rather than the emergency conditions kept in place today. Given that we foresee no speedy change to FRB policy we would expect the BFCIUS to move higher from their current level, with the most likely catalysts being a higher SPX index, lower VIX (which remains somewhat elevated at 13.48) and a tighter Baa/10 Year treasury spread.

We do wonder if it is possible that an "upside crisis" +2 reading could actually be registered, which would mean that conditions were 2 standard deviations better than normal. We have hitherto thought that this was an impossibility but we would have said the same about a -12 reading in early 2008 and yet one was recorded exactly 5 years ago.

We have commented several times on the substantial improvement of Current Account data in a number of key Euro-zone economies, and it therefore should come as little surprise that the aggregate data shows a very impressive rate of improvement.

The August aggregate Euro-Area Current Account (SA) reached €17.4 bln, a record for this calendar month, taking the 12 month ma up to €16.1 bln which is also a record. This means that over the last 12 months the total Current Account surplus reached €193 bln, which represents a key source of private sector liquidity both in the form of export earnings and investment capital (the balance has been strongly positive in the Goods, Services and Income sub-categories).

This compares to deficits of €123 bln in the 12 months ending June 2009, and €50.4 bln in the 12 months ending February 2011, swings of €316 bln and €143 bln respectively. In other words the sums involved are large enough to matter even in an economic area as large as the Eurozone. Gains have also been well dispersed with only France showing little sign of improvement over the last three years.

We believe that the improvement in Current Account data has been largely overlooked by market participants, just as the substantial deterioration in emerging market data went unnoticed until currencies dislocated at the end of the second quarter. We would expect rather more attention going forwards as the strong equity market performance of most Eurozone markets starts to generate more interest on the part of investors.

The NAHB Homebuilder Sentiment Survey experienced a modest pullback in October from 57 (revised down from 58) to 55, but remains at a level which is consistent with improving overall activity in the housing market. To put this in perspective the NAHB index was at 41 in October 2012 and remained at this level as recently as April, and the fact that it has remained elevated above 50 during the important summer period despite the fact that interest rates have remained elevated suggests that the recovery in activity has staying power.

The mild deterioration in the headline index was spread across all three sub indexes with each declining by 2 points to 58 for Present Sales, 62 for Future Sales and 44 for Traffic. All of these readings remain comfortably above their level of a year ago and although expectations have dampened a little since the height of summer there is nothing in this data to hint at a substantial reduction in either activity or expectations.

Tokyo Condominium Sales contracts increased substantially in September, with the 4986 reading marking a 113% increase on the level of a year ago. We would caution that in part this surge is caused by a move to beat the upcoming increase in consumption taxes next April but we suspect that a good portion of this improvement marks a genuine willingness to re-enter the housing market after several years of modest activity.

September's report takes the trailing 12 month ma up to 3581 units, compared to 3009 a year ago, making this the strongest 12 months for sales since November 2007. On the other hand we would note that a decade ago sales averaged over 6000 and we assume would have been much higher at the end of the 1980's boom (the data only starts on 2001). Nevertheless we take encouragement from the turn in activity and would expect it to at least partially survive the implementation of increased taxes next year.

Yesterday we commented on surprisingly strong UK inflationary data and made the point that the BOE had moved in line with the FOMC in emphasizing the equal importance of monitoring employment when setting monetary policy.

Although these comments were intended to sooth the local gilt market we see a similar pattern emerging whereby much stronger employment statistics are released at precisely the point at which the central bank has elevated their policy influence. The September unemployment report showed the total Claimant Count falling by -41.7K, the largest monthly fall since 1997, while the August data was revised from -32.6K to -41.6K, making this a very strong report. The 12 month ma shows an average of -18.5K falling off the Claimant Count, the fastest rate of decline since July 1998.

The overall level of unemployment remains elevated at 1351, but it is back to its level in August 2009 and now falling quite sharply. Interestingly there is not much difference between the current level and the readings seen back in 1998, although the employment picture went on to improve considerably over the next decade with the count bottoming below 800K in 2008 (see chart). What we would say is that the speed of improvement is starting to undermine the concept of an "emergency", while yesterday's inflation data showed that there are some risks of an upside breakout in prices in the months ahead. Whether this will be enough to stir either the BOE or the gilt market remains to be seen but a good fundamental argument can now be made in favor of substantially higher local interest rates.

EU Car Sales posted a 5.4% annual increase during the seasonally important month of September (typically the third strongest month in the calendar). The narrower 15 country pre-2004 EU (which makes up the vast majority of activity) also posted a 5.4% gain, with sales reaching 1.10 mm units. This compares with a September 2007 reading of 1.304 mm. The 12 month ma of sales is currently 0.912 mm units, which compares to a pre crisis average of 1.2mm units, indicating that activity remains about 75% of normal at the current time.

As would be expected there is a divergence of activity in the major countries. German sales were roughly flat (-1.2%), but never suffered a deep draw-down in either 2008 or 2011 making this unremarkable. France actually saw sales move up to a record in 2010 thanks to a series of post-Lehman emergency incentives, before a fairly steep decline set in during the 2011 Euro-crisis. It would appear that sales are currently bottoming with September posting a modest 3.4% increase.

The other three markets all suffered much more disruption in recent years. In the case of the UK the bulk of the damage took place 5 years ago and we are now finally seeing the sort of strong rebound in activity that the US has enjoyed in recent quarters, with September (a very important month for UK sales) posting a 12.1% increase (we commented about this strong data earlier this month).

Car sales in both Spain and Italy suffered greatly in 2011, and as a result are still in the process of hammering out a bottom. In Spain's case incentives helped push September sales up 28.5%, but even so at 45.2K they are less than half of their level in September 2007. For Italy sales continued to decline by a modest -2.9% and over the last 12 months have averaged around 55% of their pre-crisis levels. We would expect to see Italy start to post annual sales gains in the coming months, with the deep draw-down in activity allowing for several quarters of growth once the turn is in place.