In our Speculator Extra dated July 22nd we used a chart of the Citibank US
Economic Surprise index (CESIUSD Index for Bloomberg users) to demonstrate
the fact that there are typically several "data cycles" during each
economic cycle. By our count the fairly straightforward recovery of 2003-7
had no less than six separate multi-month gyrations from data that fell
consistently below consensus to above consensus (wee our earlier report for
a fuller discussion).
.
Back in late July the CESIUSD had fallen as low as -36 and we suggested
that it would have to fall well below -50 before the current cycle of
dismal data would have run its course. As can be seen on the attached chart
today's calculation is -64.3, which is the lowest reading since January
2009 and it would seem probable that the index will force its way lower
over the next few weeks as the remainder of July's official data is
released. Although this may seem like bad news it should be recognized that
since its creation in 2003 this index has been an excellent CONTRARY
indicator of future equity market performance, and indeed of future
economic surprises. Today's reading of -64 is already sufficient to qualify
for an extreme low reading, and as we said above, it is likely the final
reading will be somewhat lower. Although we very much doubt that the
December 2008 low of -140 will be troubled, in September 2004 the index
fell briefly below -100 despite the US economy having 3 more years of
expansion ahead of it. We do not doubt that the equity market will continue
to feel the pressure of any further poor data releases, particularly since
we have reached the point at which the relief engendered by that the robust
Q2 earnings has already been forgotten and replaced by angst over what is
reported in Q3 and Q4, but we appear to be much more than halfway through
this long corrective phase and our assumption continues to be that it will
be completed around the end of the current quarter. Should support at 1035 in
the SPX not hold we may yet see a new 2010 low recorded and our initial
correction target of 980 met, but as we have pointed out many times, the
ultimate depth of a corrective phase is actually a fairly trivial statistic.
Far more important is what happens after it is made, and to our eyes the
aftermath of the current correction should be a much more pleasant time for
equity investors than the last 4 months.
.
On this note we will sign off until after Labor Day. Should any readers
have important questions over this period of time they should be addressed
to my colleague Michael Aronstein.


(See attached file: D-CESIUSD_Index.gif) - D-CESIUSD_Index.gif

This would seem to be a very positive set of data from Moody's that underlines
the extent to which radically lower interest rates are easing the pressure on
US consumers' balance sheets. Judging by Moody's comments in this release July
was something of a breakthrough month in terms of delinquency trends, with
several metrics posting their best readings in the 20 month history of this
report. As we emphasized in today's "Speculator Extra" the message from credit
markets is certainly not consistent with the US falling into a deflationary
spiral.

As had been indicated by the NAHB Sentiment Index New Home Sales remained
very weak in July with reported sales falling to a new all time low of 276K
versus a consensus estimate of 300K. June's sales were scaled back on
revision to 315K to 330K. As spectacular as this data may appear we have
argued for several months that at the current levels of activity the
traditional seasonal adjustment to the data make no sense and that the
"raw" single month non-seasonally adjusted data is a better guide to
activity. This shows that sales were very weak at 25K, but not markedly
different from other recent data. The 6 month ma has tracked down to 30K
(360K annualized) and this is probably an accurate guide to the current
pace of home sales. This is still a dismal level of activity but not one
that is markedly different from what we have seen over the last two years.
Meanwhile the remaining public homebuilders would seem to have adjusted to
this new reality. Land is written down and now selectively acquired, new
home starts are at record lows, inventory levels at 40 year lows. As
disappointing as 2010 turned out to be for those (like ourselves) who hoped
for a recovery in the new home market the impact of this industry remaining
in the doldrums is much less than most suppose and the potential for
recovery remains in place later on this economic cycle.


(See attached file: D-NHSLNFS.gif)
(See attached file: D-HSMNTOT_Index.gif) - D-NHSLNFS.gif - D-HSMNTOT_Index.gif

The 2010 mortgage refinance boom continues to gather pace as this week's
MBA Refinance Index reached 4944.70, the highest reading since May 2009.
The importance of this development is hard to overstate. Although very few
refinancings will free up housing equity via a "cash out" transaction the
reduction of mortgage interest payments for a sizeable proportion of the
population will both help stabilize delinquency rates and also free up
funds for discretionary expenditure and savings. The MBS duration hedging
that this surge has created will also continue, keeping the buying pressure
intense at the long end of the treasury curve.
.
It is ironic that amidst calls for the FRB to "do something" it has
perhaps been lost on many that original "Credit Easing" policy has
succeeded beyond its wildest dreams in terms of both the pricing of housing
credit and its availability for traditional refinancings and the reduction
in Treasury yields across maturities.


(See attached file: D-MBAVREFI_Index.gif) - D-MBAVREFI_Index.gif

Weak existing sales data had been expected for July but the reported number
came in far short of expectations of 4.65mm at 3.83mm units, a 27.19% drop
in activity from June. This is actually the weakest number on record since
the total existing home data began in 1999, but for the Single Home data
the plunge to 3.37mm houses takes the activity all the way back to the
level seen in 1995 (even so this is far better than the new home data which
is below the level seen in 1970). On the surface this would seem to
indicate a total collapse in confidence in the existing home market but we
doubt that this is in fact the case. Although some purchase decisions may
have been deferred due to the pervading tone of gloom, the majority of this
report reflects the scale of distortion that the $8,000 tax credit wrought
on the housing market. In this sense it is "Cash for Clunkers Part 2"
although if anything housing was even more influenced by the government's
intervention. July's plunge suggests that very few incremental sales were
generated by this foolish policy, but this still means that sales should now
quickly rebound back up to the level seen before the policy was implemented
last year in the 4.00mm to 4.50mm range. This is sufficient to slowly work
through the massive overhang of foreclosed units over the coming months.
.
Some confidence for this view can be taken from the house price data in
today's report which showed the average price of an existing home
essentially unchanged despite the collapse in volume. This suggests that
the "clearing price" remains intact in most markets (as does other data
such as the Case Shiller index), which is an important part of rebuilding
confidence going forward. It should also be realized that the 30 year
mortgage rate has fallen by 75 bp since April, which translates into a
saving of around $1750 per annum on the average priced home. Although this
will not create the same sort of rush into the housing market as an
expiring tax credit the extreme affordability of US housing represents a
far more solid support going forwards.


(See attached file: D-EHSLSL_Index.gif)
(See attached file: M-EHSLAP_Index.gif) - D-EHSLSL_Index.gif -
M-EHSLAP_Index.gif

Last week's FRB Bank Lending survey suggested that credit granting
conditions for US corporations had eased considerably in recent months and
this is corroborated by the Fed's weekly H.8 report of Commercial Bank
balance sheets. Attached is a chart of the Commercial and Industrial (C&I)
loans held on the balance sheet of US Commercial Banks and as can be seen
at a glance the very steep run-off of credit's held seems to have halted in
recent weeks. The 13 week RoC has risen to a slightly negative 0.24%,
equivalent to a drop in credit of $12 bln over the course of a year. This
compares to the peak drop of just over $320 bln that was recorded between
February 2009 and February 2010 and therefore shows a significant easing of
credit conditions over the last 6 months.
.
Interestingly at the current level of $1,245 bln, total C&I loans held are
at the same level as April 2007, right at the start of the sub-prime
default cycle. In effect what has occurred is a cancelling of the blow off
LBO top that took place over the next 12 months as a series of large,
higher priced and bank-financed acquisitions ballooned total credit held by
$400 bln between April 2007 and October 2008. Going forward we would expect
this data series to move into positive territory on a 13 week basis by the
end of September and to see annual growth in the mid single digits by this
time next year. Should merger activity (a major use of C&I lending)
recover rapidly this estimate may prove to be on the conservative side. In
any case we would judge the credit crunch for this portion of the US
economy to have been completed, particularly since this data needs to be
considered in combination with the massive surge in corporate bond issuance
over the last 18 months.

(See attached file: W-ALCBCIL_Index.gif) - W-ALCBCIL_Index.gif

An interesting Chart of the Day that highlights the anomaly between the
Challenger Job Cuts data and Initial Claims. We made this point ourselves when
the July Challenger data was released a couple of weeks ago. As we wrote
earlier today there are good reasons to resist the obvious conclusion that a
rise in claims represents a significant deterioration in employment (copy of
chart is attached for non-bloomberg terminal users).

+------------------------------------------------------------------------------+

‘Mis-Categorized’ Initial Claims Cloud Job Market: Chart of Day
2010-08-19 17:10:12.77 GMT


By Shobhana Chandra
Aug. 19 (Bloomberg) -- Applications for unemployment
insurance and planned jobs cuts have diverged, according to data
compiled by Bloomberg News. The latest widening of the gap may
be due to the extension of jobless benefits at the end of July,
said economist Raymond Stone.
The CHART OF THE DAY shows how first-time jobless claims
are climbing while planned firings figures from Chicago-based
Challenger, Gray & Christmas Inc. have been falling, leading to
the biggest gap since records began in 1998.
The extension of benefits at the end of July may be
prompting Americans whose assistance ran out to file new claims,
making the labor market appear more dismal than it is, said
Stone. These “mis-categorized” claims should have been
applications for other types of unemployment insurance, Stone
said in a note.
“Looking at the most recent data, I don’t want to conclude
the world is falling apart,” Stone, managing director and chief
economist at Stone & McCarthy Research Associates in Skillman,
New Jersey, said in an interview. “Looking at it over the last
year, there was significant improvement in the labor market and
that improvement ended sometime in the last quarter.”
President Barack Obama on July 22 signed into law a measure
restoring jobless benefits to 2.5 million people. Claims have
climbed in each of the past three weeks, reaching 500,000 in the
week ended Aug. 14, the Labor Department said today in
Washington. Those who’ve used up traditional benefits and are
now collecting emergency and extended payments rose by 309,334
million to 5.59 million in the week ended July 31.

For Related News and Information:
U.S. economy stories: NI USECO <GO>
News on consumer spending: TNI US CONS <GO>
Top stories on the economy: TOP ECO <GO>
Bloomberg news on the labor market: TNI US LABOR BN <GO>
Charts home page: GRAPH <GO>

--Editors: Vince Golle, Carlos Torres

To contact the reporter on this story:
Shobhana Chandra in Washington at +1-202-624-1888 or
[email protected]

To contact the editor responsible for this story:
Christopher Wellisz at +1-202-624-1862 or [email protected]
- challengerinitial.gif

At a time that many data-points are suggesting a moderation of activity it
is striking that transportation companies have not reported any slowdown in
activity and that this week's rail traffic data continues to suggest a very
rapid rebound in the amount of goods being moved around the country. Since
this is a very volatile and seasonal data series care must be taken in
interpretation, but the smooth rise of the 52 week ma reflects the pace of
repair that has taken rail freight volumes back to where they were in 2005
and the 52 week RoC of at 20.82% compares favorably with that seen in the
last recovery. As we commented earlier today when discussing the Philly Fed
data the deterioration in SENTIMENT amongst industrialists seems to be much
greater than the actual reduction in ACTUAL ACTIVITY, and this is a very
important distinction to be made when analyzing the data.

(See attached file: D-RAILTOTL_Index.gif) - D-RAILTOTL_Index.gif

The 30 year bond yield continues fall back rapidly both in absolute terms
and relative to the 10 year note yield. The 30 year bond yield has fallen
another 9 bp this morning to 3.63% bringing the 30 - 10 year spread down to
107 bp, 21 bp below its peak on August 11th. As a result the price of the
30 year treasury future has continued to outstrip that of the 10 year (see
attached), with the ratio of these two instruments now at 1.068. We see
this market activity continuing for a number of sessions before this
frenetic bond rally has run its course (our rough target for the 30 year
yield remains 3.25%), and since the benchmark 30 year GSE mortgage is
priced off the 30 year bond the savings passed on to consumers could end up
being significant, drawing yet more activity into the refinancing arena.

(See attached file: D-USGG30_Index.gif)
(See attached file: W-US1_Comdty.gif) - D-USGG30_Index.gif - W-US1_Comdty.gif

August's Philadephia Fed report is a poor piece of data that suggests that the
pace of improvement in local manufacturing activity has moderated considerably.
The overall index (black) fell back into negative territory at -7.7 as did New
Orders at -7.10. Although both numbers are only slightly negative (the Philly
Fed stressed this point) we would not want to see a downwards spiral in
activity develop over the coming months are are therefore relieved that future
expectations remained quite positve in both metrics. Interestingly the
Inventory sub-index shrank much than New Orders, more reaching -11.60,
suggesting that manufacturers have been very quick to scale back production.
This does not seem to have come at the expense of Employment with the index
effectively neutral at -2.70. We would draw some comfort from the fact that the
Philly Fed has a history of being much more volatile than other PMI series and
has generated a number of false signals in the past, but data such as this will
further undermine the fragile confidence of the equity market at the current
time.
.
Perhaps the most interesting insight of this report came on the short
conference call that followed the data release. According to the Philly Fed the
main cause of weaker data was not a deterioration in actual DEMAND for goods
but instead a "growing uncertainty" (we said at the time that it was unhelpful
of Chairman Bernanke to pronounce the current situation as "unusually
uncertain") linked to a combination of emploment costs and tax structure. This
echoes our own thoughts that a sense of reality and economic disciplne being
imposed upon the current administration by the upcoming mid-term elections
would be a major boost to both investor confidence and actual economic
activity. - phillyfedaug2010.gif

The weekly unemployment claims data has been notably week throughout the
summer of 2010 and although this probably reflects a reluctance of
employers to aggressively rehire (as evidenced by several PMI employment
sub-indexes) this does not necessarily mean that employment has started to
deteriorate meaningfully. As the attached long term chart shows initial
claims data tends to be extremely noisy in general but particularly so in
the early stages of a recovery in employment. This is probably partly a
reflection of the "jerkiness" of re-employment decisions but also
symptomatic of the limitations of data collection in the first place. This
survey is anything but a simple direct measurement of employment claims but
is instead an extrapolation from numerous regional surveys that is subject to
heavy seasonal and general adjustment which inevitably leads to significant
reporting errors being introduced. For instance, each of the circles shows
a period of multiple weeks in which initial claims were reported to surge
during the early stages of an economic recovery for a number of weeks
before falling back into their declining trend. Interestingly, in each of
these cases the Continuing Claims data did not confirm the deterioration in
employment, something that is also true of recent reports.
.
Clearly we would be more comfortable if initial claims started to fall back
rapidly, but in the absence of other anecdotal data surrounding corporate
lay-offs we do not see private sector employment deteriorating
meaningfully. We are less sanguine about the prospects for a significant
re-hiring wave than we were several months ago but our hope would be that
growing corporate confidence in the recovery (we note a substantial spike in
merger activity this week) together with a sense that the worst of this
administration's interventionist instincts are being curtailed could still
lead to a substantial improvement in employment over the coming months.


(See attached file: M-INJCSP_Index.gif) - M-INJCSP_Index.gif

The rapid increase in re-financing activity is finally starting to get some
mainstream financial media attention. See below for an example from Dow Jones
Newswires:
--------------------------------------------------------------------------------
=DJ Mortgage Bonds Hit As Refinancing Finally Picks Up

By Prabha Natarajan
Of DOW JONES NEWSWIRES

As we had expected the plunge in long term US interest rates has sparked
something of a scramble to refinance home mortgages. This would seem to
have been an obvious consequence but judging by this week's report from
Fannie Mae's internal economists
http://www.fanniemae.com/media/economics/index.jhtml?p=Media&s=Economics+%26+
it will have come as a surprise to at least some players in this
marketplace. As reluctant taxpayer-owners of this institution we can only
hope that their mortgage hedging desk conducts its own independent
analysis.
.
In any case, as the attached chart shows the MBA Refinancing index has
soared to 4676.70 this week, the highest reading since April 2009 and well
into boom territory above the 4000 level. Even the 10 week ma of this index
has reached 3877, indicating a steady wave of refinancing activity that
will have markedly changed the hedging assumptions of MBS holders. This
continues to be a major factor behind the massive rush into long dated
treasuries, and is likely to cause yields to substantially overshoot to the
downside (something that arguably has already occurred). Interestingly, this
activity is limited to refinancing, purchase activity remains very muted
even though the affordability of homes has become extremely attractive
following the fall in mortgage rates. This is not as surprising as it may
appear. The decision to purchase a home is dependent on a myriad of
factors, price and affordability only being one (important) issue.
Refinancing, on the other hand, invariably makes sense given that the fees
involved are dwarfed by the savings offered. As can be seen on the attached
chart, refinancing activity typically dominates mortgage issuance during
refinance booms and the current ratio of 81.4% is broadly similar to that
seen in 2008 and in the 2002-3 period. However, even without boosting purchases
the collapse in rates is still helping a large number of home-owners lock in
rates and free up more disposable income for consumption and/or savings.
AS a result the transfer of wealth from the nation's savers to its consumers
continues apace, and with the former participating quite willingly in the
process by pouring money into bond related investments. Later this decade the
difference between preserving capital and preserving purchasing power is
likely to become painfully apparent, but in the meantime these flows are at
least acting a stimulus for future economic activity.




(See attached file: D-MBAVREFI_Index.gif) - D-MBAVREFI_Index.gif

An interesting Bloomberg "Chart of the Day" which mirrors some of our own
concerns about the popularity of US Treasuries. Copy of Chart is attached for
non-Bloomberg terminal users.

+------------------------------------------------------------------------------+

U.S. Bonds Resemble Internet Bubble, Citi Says: Chart of Day
2010-08-17 13:02:46.390 GMT


By David Wilson
Aug. 17 (Bloomberg) -- U.S. bonds may be just as vulnerable
to a plunge as stocks were a decade ago, when the Internet
bubble burst, according to Tobias Levkovich, Citigroup Inc.’s
chief U.S. equity strategist.
The CHART OF THE DAY depicts how an index of monthly
returns on 10-year Treasury notes since 2000, as compiled by
Ryan Labs, compares with a total-return version of the Standard
& Poor’s 500 Index from 1990 through 2005. The latter gauge
peaked in August 2000 and tumbled 38 percent in the next two
years.
“The similarities should cause anxiety,” Levkovich wrote
yesterday in a report with a comparable chart. He calculated
that the 10-year note had a 0.87 correlation with the S&P 500 of
a decade earlier, which meant its performance followed much the
same pattern.
Another parallel, he wrote, is that investors are moving
into bond mutual funds in the same way that they “poured cash
excessively into stock funds back in 2000.”
About $561 billion has flowed into bond funds since the
beginning of last year, according to data from the Investment
Company Institute. Stock funds, by contrast, had a $42 billion
outflow during the period.
To measure the relationship between the 10-year note and
the S&P 500, Levkovich used what’s known as the coefficient of
determination. This figure can be between 0 and 1. The higher
the number, the more closely one data series mirrors another.

(To save a copy of the chart, click here.)

For Related News and Information:
U.S. bond strategy: TNI USB STRATEGY <GO>
Bond market top stories: TOP BON <GO>
Stock market top stories: TOP STK <GO>
Charts home page: GRAPH <GO>

--Editors: James Greiff, Steven Gittelson

To contact the reporter on this story:
David Wilson in New York at +1-212-617-2248 or
[email protected]

To contact the editor responsible for this story:
James Greiff at +1-212-617-5801 or [email protected]
- 10yearspxchart.gif

PNC, Regions Break $3.1 Billion Logjam of Bad Loans (Update1)

This appears to be an important data-point in the Commercial Real Estate cycle
since it marks some of the first large sales of "whole" (ie non-securitized)
loans by US Commercial Banks to genuine third parties. Although prices obtained
for loans were somewhat below their carried value (between 14% and 27%
according to this article) this is still far higher than the doomsday forecasts
being issued this time last year. With over $1,550 bln of Commercial RE loans
still sitting on Commercial Bank balance sheets we would expect a significant
amount of whole-loan turnover in the coming months and the capital freed up by
transaction should eventually form part of the fuel for the next lending cycle.

 

We have written a great deal about the volatility of data in recent weeks
and the fact that it has been about the only positive argument left to make
does not make it any less true or important to grasp. This morning's
publication of Industrial Production and Capacity Utilization help
demonstrate why we have spent much time pointing out that official data
tends to fluctuate substantially from month to month (we often refer to it
as "drunken sailor" data) while keeping its trend intact over a period of
months.
.
According to the Federal Reserve, US Industrial Production grew by a very
substantial 1.0% in July after falling -0.1% in June (revised down from
0.1%), while Capacity Utilization rose strongly to 74.8%. We assure readers
that nothing of the sort occurred over this 60 day period (it would have
been reflected in numerous corporate public statements around earnings
season if it had), but there is still good reason to pay attention to the
clear trend established in both data series. As the attached chart shows,
both Industrial Production and Capacity Utilization have recovered rapidly
in recent months and remain in well defined, powerful uptrends. This has
been already signalled by PMI reports for July and today's report merely
puts the official data back into line with more reliable metrics. This is
not to say that it is irrelevant. The downturn in official economic data
has been the main factor in undermining support for the equity market and
creating the crescendo of flows into fixed income. A series of stronger
economic reports would therefore be expected to have a meaningful impact on
these flows but given the momentum that has been established in both
markets individual positive blips may still be ignored.


(See attached file: D-IP_Index.gif) - D-IP_Index.gif

As had been indicated by yesterday's NAHB sentiment survey, homebuilding
activity in the US remains at its multi-decade low. Headline housing starts
came in at 546K below consensus 560K but ahead of June's revised data of
537K (original report was 549K). Building Permits (which we prefer) came in
at 565K, below consensus 580K and last month's revised 583K. Single Family
permits (see attached) fell to 416K, the lowest reading since April 2009.
The misses are not statistically meaningful and merely confirm that
remarkably little building activity is taking place in 2010. It is clear
that our original hopes for a building recovery this year were misplaced
and we would not now expect to see a meaningful uptick in activity until
sales show a consistent improvement over a period of months. Given the
seasonal nature of the US hosuing market it is hard to see this occurring
prior to next springtime.


(See attached file: D-NHSPA1_Index.gif) - D-NHSPA1_Index.gif

The NAHB Sentiment Index continued its recent dismal run in August by falling
to 13 (from 14 in July). Sales fell slightly to 14 (15) while Future Sales
showed greater deterioration falling to 18 from 21. This keeps sentiment firmly
within the "box of depression" that has contained readings for the last 3
years. The recent significant outperformance by the North East region also
reversed with the regional index coming in at 18, sharply down from 24 in July.
Today's data suggests that both Housing Start and New Home sales data for July
will be weak data points, although this is already reflected in low consensus
forecasts and investor sentiment towards this group and is therefore unlikely
to have significant market impact upon release. - nahbaug10.gif

The long end of the US treasury curve continues to draw in capital, causing
yields to drop rapidly down to levels seen at the height of the 2008
crisis. The 10 year note yield has fallen to 2.62% this morning and is
closing in on our target of 2.50% with enough momentum behind it to suggest
that the final yield recorded in this move may be somewhat lower. Meanwhile
the 30 year bond has finally begun to draw its own capital flows. We had
commented last week that the spread between the 10 and 30 year note had
reached a record of over 128 bp and at this level a 30 year bond's yield
was over 40% greater than that paid to a 10 year note holder. This disparity
seemed unlikely to remain in place and as can be seen on the attached chart the
30 year bond yield has fallen sharply in recent days. We would expect to
see this instrument continue to benefit from inflows for the remainder of
this move, indeed the existing spread of 116 bp is still greater than
anything seen prior to the current bond rally, indicating that the 30 year bond
yield has the potential to fall considerably if bond inflows continue at their
current pace.
.
This would make life interesting since the 30 year bond has far greater
price sensitivity than the 10 year note to the same move in yield. As the
attached chart of the underlying futures' prices shows, even though the 10
year note yield has fallen considerably further in the current move, the 30
year bond future (US1) has actually increased in price by significantly more
than the 10 year note future (TY1). Indeed the ratio of these 2 future prices
has risen above 1.05 in recent days and the only other time this has happened
over the last 15 years are the LTCM crisis of 1998 and the post-Lehman crisis of
2008. As can be seen on the attached 28 year chart, towards the end of
Treasury rallies the price of the US1 future tends to considerably outrun
the TY1 (shown by a peak being formed by the blue ratio line), only for
this outperformance to abruptly reverse as the crisis abates and treasury
yields unwind their overshoot.
.
Assuming that we have not just entered a deflationary spiral that sees
Japan style yields in place for several years we would expect to see a
similar pattern later in 2010. In other words gains in the 30 year bond
future could be considerable over the short term, but would be followed by
a punishing "give-back" similar to that seen in 2009. Thus our reading of
the equity and bond charts are that we have entered the terminal phase of
this massive reallocation and that while price adjustment may still be
considerable the odds of an important top in the bond market and low in the
US equity market being recorded in the next few weeks continue to grow.


(See attached file: D-USGG30_Index.gif)

(See attached file: W-US1_Comdty.gif) - D-USGG30_Index.gif - W-US1_Comdty.gif

Consumer confidence continues to be a dreary reflection of the public's
unwillingness to believe in a recovery. The overall University of Michigan
index rose to 69.6 in August (from 67.8) but this still keeps confidence at a
very low level and well below that seen earlier this year. As we have commented
before, the relevance of this index for future consumer activity is far lower
than is generally supposed and the main use of this data is as a contrary
indicator when it reaches an extreme. However, at the current time this data
does have some interesting political implications.
.
With the mid-term elections now only 3 months away and Congress in summer
recess (maximizing politicians direct contact with their electorate) this data
is actually more of a problem for the current administration than capital
markets. Consumer confidence is a very poor predictor of the direction of an
economy, but as George Bush Snr. discovered in 1992, a lack of confidence in
recovery can have very significant electoral implications (this index was in
the mid 70's during the summer of 1992). Since our sense is that the market
would welcome a substantial re-balancing of Congress and the Senate and a
return to political gridlock, this may have some important investment
implications and it will be interesting to see if market action starts to be
affected by the polling data that will start to dominate the political
newswires after the Labor Day holiday. - unimichaug10.gif

This morning's publication of Advance Retail Sales estimates allows both
sides of the economic argument to make a point. Those looking for evidence
of a slowdown will note that the headline number came in at 0.4%, missing
the consensus estimate of 0.5% and that sales ex-gasoline fell -0.1%. But
this month's data was pulled downwards by the upward revision to June's data
where sales are now estimated at -0.3% from the original -0.5% (it is not
allways appreciated that the actual data is a cummulative series of total
sales and that the monthly change is derived from this). From our
perspective this keeps the steady improvement in retail demand in place
while confirming that the rapid pace originally reported in late 2009 and
early 2010 almost certainly overstated actual activity. As the attached
chart shows the 6 month ma of sales (red) continues to snake higher while the
annual change (blue) of 5.5% still compares favorably with the early stages of
the last 2 economic recoveries even though CPI is considerably lower in 2010
than in either 1993 or 2003 (this matters since this data is expressed in
nominal dollars).


(See attached file: D-RSTATOTL_Index.gif) - D-RSTATOTL_Index.gif

We noted yesterday that Chinese M2 growth ground to a halt in July but even so
one would not expect to see a drop in mortgage activity of 98% in a major city.
Assuming that this story is correct (there is no obvious reason to doubt its
veracity other than its surprising content) the Shanghai mortgage market
effectively shut down in July. This shows the downside of China's authoritarian
version of market forces, it is hard to think of a more destructive force then
totally removing credit overnight from an extended real estate market. We
continue to expect the Chinese RE market to experience a very hard landing and
for this to spill over into other financial prices.

An interesting story to have come out Japan this morning. Apaprently it is not
just the FRB which is reaching its capitulation
point.

--------------------------------------------------------------------------------
DJ Japan Trade Ministry Announces Emergency Strong Yen Survey-Nikkei

TOKYO (Dow Jones)--Japan's Ministry of Economy, Trade and Industry announced
Wednesday it will conduct an emergency survey of approximately 200 companies to
assess how the recently strong yen has affected their operations, the Nikkei
business daily reported on its online edition Wednesday.
The news comes as the dollar dropped to a 15-year low against the yen
Wednesday at Y84.72, a development that is likely to increase concerns among
Japanese exporters. A strong yen makes Japanese products more expensive
overseas and eats into revenue sent back to Japan.
The trade ministry's survey will question firms on how the recently strong
yen has impacted upon management issues related to exports, as well as sounding
out how companies intend to deal with the effects of the strong yen going
forward, according to the Nikkei.
Meanwhile, Minister of Economy, Trade and Industry Masayuki Naoshima said
Wednesday that while the government and Bank of Japan are of the same mind on
the strong yen problem, they have a difference of perspective on the issue,
according to the business daily. The remarks come after the central bank
concluded a regular policy meeting Tuesday at which it refrained from taking
any additional easing measures that analysts say would be one way to try tocurb
yen strength.
"The recent yen strength may exert a big impact on the Japanese economy, even
in the medium- to long-term," the Nikkei reported Naoshima as saying. Japanese
companies are subject to major foreign exchange risk, necessitating
consideration of whether present conditions are fair, Naoshima said, according
to the Nikkei.
But echoing analysts' comments, Naoshima suggested unilateral intervention
may be difficult for now. "While there could be a big effect if international
coordinated intervention were possible, it would be rather difficult for Japan
to intervene on its own," Naoshima said, according to the Nikkei.

In our recent Speculator Extra "Stat's Don't Kill Markets" we pointed out
that the MBA Refi index had forced its way up to the 4000 level and that
this typically meant that some sort of monetary or financial market episode
could be expected to occur (we denoted this with a "?" on the chart at the
time).
.
Yesterday's shift in emotional tone by the FOMC, together with its decision
to abandon any notion of a monetary exit strategy certainly fits the
description of a "monetary episode", while with a little patience a
financial one may also be supplied. As we stated yesterday the FOMC's mood
is often an excellent contrary indicator, particularly when a shift in tone is
forced upon it by market prices. After a good night's sleep reflecting on this
we feel reasonably confident in our belief that we are now entering the terminal
phase of this corrective move for the equity market and corresponding rush
into fixed income.
.
With regards to the latter, the relationship between the 30 year bond and 10
year note continues to fascinate us, not just because the spread continues
to blow out to new records (it is now almost 15% wider than at any prior
point in history) but also because the 30 year bond has so far stubbornly
refused to "confirm" the deflationary impulse by falling to a new 2010 low.
The crushing of the 10 year (and other intermediate duration) treasury
yield has the look of forced market action by a combination of MBS holders
(we note that the Refi index remained just below 4,000 this week) and those
playing the shape of the yield curve. Quite where this ends in terms of
yields and equity prices is open to conjecture. 3 weeks ago we estimated
(or guessed) that the 2 year note would reach 50 bp, the 10 year 2.50% and
the SPX as low as 980. The first two assumptions remain in place (indeed
the 2 year note this morning reached 49 bp) but we would hope that the SPX
could potentially find support in the 1030-1060 range. However, we would stress
that the final extreme readings are far less important that the shift in
sentiment and portfolio allocations that brings them about. The elimination of
economic hope may be depressing to witness but paradoxically can be a strong
foundation for future equity market performance.


(See attached file: D-MBAVREFI_Index.gif)
(See attached file: D-USGG30_Index.gif) - D-MBAVREFI_Index.gif -
D-USGG30_Index.gif

Chinese monetary growth continued to abate rapidly in July with total M2
increasing by a mere 17.84 CNY (0.03%) the smallest nominal increase since
October 2005 and the smallest percentage increase since the unusual monthly
drop recorded in October 2004. This takes the YoY growth rate down to
17.64% and the 3 month annualized rate to just over 10%. The latter is well
below the current rate of industrial and retail sales growth which suggests
that Chinese monetary policy is starting to exert meaningful pressure on
the non-housing portions of the economy. Interestingly actual new loan
growth has not declined by the same degree, with total new loans at 532.8
Bln CNY. Although this was well below expectations of 600 bln it is in line
with the level of loan growth in March 2010 when M2 grew by a much more
robust 1400 bln (2.20%). This may be indicative of the fact that credit is
now being used almost entirely to prop up fixed asset markets (both housing
and industrial investment) and is no longer seeping into the general
financial economy. This would clearly not be a plus for local financial
asset prices as it would imply a significantly less monetary excess is
being created for the same level of loan growth.
.
Despite some of this morning's headlines, thus far there is little evidence
of distress outside of the local equity and property markets. Retail
activity for instance remains robust, and although we note that July's
sales missed consensus estimates, as the attached chart shows 2010 sales to
date have increased considerably ahead of the last 5 years average
activity. July's small drop from June is also seasonally normal. Therefore
to the extent that Chinese monetary authorities are focussed on domestic
consumer activity rather than financial asset markets (since bankers and
realtors rarely mount the barricades this would appear to be a reasonable
assumption) we would argue that there is rather less pressure to loosen
polices in the immediate future than some commentators suppose. As a result
we would remain concerned that pressure on Chinese financial asset prices
will remain in place for the next few months with potential negative
consequences for other international markets closely linked by economic
ties and investor sentiment.


(See attached file: D-CNMSM2_Index.gif) - D-CNMSM2_Index.gif

Today's FOMC statement contains an unusual degree of public hand-wringing
as the FRB, ignoring the message of their own recent Beige Book report,
fully reflect the sharp down-tick in sentiment that has accompanied recent
poor US economic data releases. Attached is a side-by-side comparison of
today's statement with that issued in June and without resorting to
linguistics, the sheer AMOUNT of text that has been changed is highly
unusual and indicates a change of heart within this body, as does the fact
that pretty much every statement represents a downgrade of prior
expectations. Since we hold the FRB to be as good a contrary indicator as
consumer or investment sentiment (anybody doubting this should read the
FOMC minutes for the mid-2007 or late-2000 meetings) we are quite happy
with this development, even though it will no doubt cause a redoubling of
negative commentary.
.
As to their policy remedy, the purchase of Treasury securities with MBS run
off (see earlier comment today) is about the mildest action that could be
taken while protecting the FRB from the charge of indifference. As the
attached chart shows, MBS holdings have recently been moderating due to
refinancing pay-offs but not by a degree sufficient to change anything.
Furthermore, the actual 30 year mortgage rate paid by consumers has
plummeted in the 5 months since the FRB stopped purchasing MBS, meaning
that mortgage rates are hardly a cause for concern at present. We would
therefore describe today's action to be a "non-solution to a non-problem"
and suspect that the FOMC understands this to be the case. The same is
obviously true for nominal treasury yields and indeed the entire spectrum
of investment grade credit.
.
As to the real problem of a sub-par (but recovering) US economy, only
time and an abatement of punitive legislative activity can be expected to
heal. Monetary policy is already extremely accommodative. Keeping that
FRB's balance sheet at approximately $2,054 Bln (as the supplementary
release mandates) will achieve little in terms of accelerating recovery but
will certainly increase the barriers to an effective exit policy should
economic growth one day require one.


(See attached file: D-ILM3NAVG_Index.gif)
(See attached file: 70558795.pdf) - D-ILM3NAVG_Index.gif - 70558795.pdf

We note that today's upcoming FOMC statement has been the subject of a
large body of commentary regarding the potential re-introduction of
Quantitative (or more accurately "Credit") Easing with many calling for the
replacement of MBS securities that are re-funded following re-financing to
a further massive ballooning of the FRB balance sheet.
.
Setting aside our misgivings that the US economy is in need of any further
monetary stimulation there really does need to be a better appreciation of
the realistic policy pathways open to the FRB. In this regard it should be
remembered that the 2008 "CE" policy was designed to deal with a radically
different set of problems to those facing the FRB today. Back in 2008 all
credit markets were frozen, yields of even treasuries spiked higher while
credit spreads reached remarkable levels. The effective shut-down of the
commercial paper market was particularly troublesome as was the fact that
spreads for agency MBS made home loans uneconomic.
.
Facing these problems the FRB devised a set of emergency policy tools that
sought to intervene in gridlocked markets. We (unlike most commentators)
recognized the importance of this move and argued that a gridlocked credit
market could be fixed via the application of overwhelming capital flows.
This of course occurred and did re-stimulate global economic activity.
Later in this process we tracked the transition from multiple emergency
measures that were no longer required (Commercial Paper and Foreign Central
Banks being two good examples) towards the "permanent" duality of large
Treasury and Agency MBS holdings (see attached chart).
.
Today credit markets are fully repaired and are arguably TOO popular. Short
term treasury yields are at record levels as are Agency MBS spreads and
nominal yields. Investment grade spreads are extremely tight and issuance
is off the charts. Commercial Paper remains subdued in terms of issuance
but this is largely a reflection of much lower inventories rather than
absurd pricing. Even new CMBS securities are being issued at reasonable
spreads to (ultra-low) treasury yields. As such it is not clear that a
renewal of CE would be workable let alone welcome. Even the simplest policy
of purchasing treasury securities would have no effect other than to force
excess reserves even higher than the $1.1 Trln that they already represent.
There is quite enough fire-power present on commercial bank balance sheets
to expand their lending should they wish to do so.
.
This is not to say that the FRB is powerless. There is actually good reason
to believe that a reasonably robust US recovery continues to unfold, it
just does not do so according to the unreasonably demanding schedule of
most economic and political commentators. But turning back the policy clock
to the dark days of 2008 strikes us as wholly unwarranted at the current
time, even though we can understand the political pressure for the FRB to
be seen to be "doing something".

(See attached file: W-FARBCRED_Index.gif) - W-FARBCRED_Index.gif

June's Census Bureau data for Wholesale Inventory and Sales continued the
pattern of weak data from this particular body. Inventories were almost
unchanged, rising 0.11% from May while Sales dropped by 0.71% to $347.4
bln. This data actually suggests that Sales ended Q2 2010 at a lower level
than at the end Q1 2010 which clashes entirely with the message coming out of Q2
earnings from public corporations and to our eyes highlights the
unreliability of this data when used over the short to medium term. The
majority of the fall in sales was from in July came a sharp -5.5% drop in
gasoline sales (which is odd given the relative stability of gas prices)
Rather than a change in the trend of activity we strongly suspect that this
(and much other) data overstated activity in Q1 and subsequently corrected
this in Q2. The fact that this data will now feed into a lower GDP report
for Q2 2010 may be a problem for the econometricians model building but is
entirely irrelevant for actual economic activity.
.
What is more clear from the current data is the fact that US wholesalers
are still running extremely tight inventories, with the Inventory/Sales
ratio staying near its all time low at the current time. Although there has
only been limited evidence of supply bottlenecks thus far there is no
guarantee that this will remain the case. Moreover, the fact that GDP has
stopped benefiting from the end of the inventory drawdown is not the same as
suggesting that the inventory cycle has run its course following a rebuild.
We note that a large number of commentators have made this error. We are
not particularly interested in whether inventories contributed or took away
from the revised Q2 GDP report. We are far more interested in whether
depleted inventories represent a potential positive factor going forwards
that is largely unreflected in discussions of future activity even if it
may still be several months before this becomes relevant.

(See attached file: D-MWINTOT_Index.gif)
(See attached file: D-MTISAPPA_Index.gif) - D-MWINTOT_Index.gif -
D-MTISAPPA_Index.gif

July's China trade data continued the run of statistical releases that both
indicate a deceleration of the domestically focussed portion of the Chinese
economy but also an acceleration of global trade activity. Chinese imports
shrank by $580 mln (-0.5%) in July which is unusual for what is typically
the strongest month in the year for imports. This takes the 12 month RoC
down to 23%, which although still punchy is far lower than recent months.
As ever we would hesitate to make too much of a single month's data, but at
the very least Chinese import growth has decelerated markedly. No such
restraint is visible in export data which forced its way up to a new record
high of $145.52 bln in July. Although partly aided by seasonal factors,
this still represents a very healthy advance on the pre-crisis peak of
$136.68 recorded in July 2008 suggesting that gloabl demand for Chinese
products has now fully recovered from the post-Lehman collapse.
Interestingly this is even true of exports to the US (see attached) which
marked a new record high of $27.35 Bln in July. This data is in marked
contrast to other metrics of US demand which have been hinting at a
slowdown in inventory rebuild and consumer activity.



(See attached file: D-CNFREXP$_Index.gif)
(See attached file: M-CHEXUS_Index.gif) - D-CNFREXP$_Index.gif -
M-CHEXUS_Index.gif

For all the angst being directed at the US economy it still strikes us that
the greatest dangers lie in those economies which dodged the worst of the
2008 collapse and have started to significantly tighten monetary
conditions. Australia is a prime example of this combination and so we
continue to track the rapid slowdown of its local real estate market with
interest. June's lending data was released last night and showed that the
number of housing loan approvals fell to 46,420, the lowest reading since
February 2001 and a 28.6% drop over the last 12 months. The majority of
this collapse is in the refinancing market. Purchase loans have fallen
13.7% over the same period and are at the level seen in mid-2005 and so the
data does not yet reflect a total collapse in housing demand, merely an
abrupt slowdown. Interestingly, the value of total loans has held up rather
better than the actual number of loans (see attached) which is a reflection
both of the fact that the majority of the pain has been felt at the lower
end of the property market, and that underlying house prices have
themselves risen considerably over the last 18 months. It remains to be
seen whether the slowing (or possible halting) of rate increases is enough
to stabilize this market. Historically, real estate markets that suffer
this kid of reverse do not go from being "frothy" to "healthy" and stay at
this level. It is far more normal to see activity fall to a more
problematic level and for a strong lending cycle to claim its cost in
delinquencies and credit write-down.


(See attached file: M-AUHFTOT$_Index.gif)
(See attached file: M-AUHF.gif) - M-AUHFTOT_Index.gif - M-AUHF.gif

July's Non-Farm Payroll report is chaotic even by this data-series erratic
standards but the data it contains is broadly negative with the headline
category missing estimates by -66K (-131K vs. consensus -65K) and Private
Sector Payrolls missing their own estimate by 19K (71K vs. 90K). To make
matters worse June's reading was revised sharply downwards to -221K from
the original reading of -125K. The only positive data concerned
Manufacturing employment which rose 36K, the 7th consecutive positive
report.
.
Today's data therefore continues the trend of disparate public and private
sector employment data. Although there is little doubt which of these will
grasp the public's attention this in no way determines which will be a
better guide of trend. Indeed even after this month's poor report the 6
month ma of Private Sector payroll growth remains at 95.5K. This compares
with similar readings seen in February 2004, November 1992 and April 1983,
in other words this portion of the official data is recovering within the
bounds of acceptable norms for this stage of recovery. To the extent that
private sector payroll growth correlates with corporate activity the
message from even the official employment data is that corporate activity
continues to grow at a historically normal pace, even though this recovery is
coming of a historically ABNORMAL base. In the meantime today's report will
keep negative pressure on both consumer and investor sentiment and keep the
investment flow spigot wide open for the bond market. We note that both the
2 year note yield and 30-10 year spread have registered new records in the
aftermath of today's report.


(See attached file: D-NFP_T_Index.gif)



(See attached file: D-NFP_PCH_Index.gif) - D-NFP_T_Index.gif -
D-NFP_PCH_Index.gif

Bloomberg story based on yesterday's comment on 30/10 year spread. Copy of
chart is attached for non-bloomberg users.

+------------------------------------------------------------------------------+

‘Too Much Excitement’ in 10- to 30-Year Yield Gap: Chart of Day
2010-08-05 14:57:18.388 GMT


By Liz Capo McCormick and Daniel Kruger
Aug. 5 (Bloomberg) -- The difference in yields between 10-
and 30-year U.S. Treasuries is the widest in at least three
decades as concern rises that the risk of deflation will
increase as the economic recovery shows signs of faltering.
The CHART OF THE DAY shows the gap reached 1.14 percentage
points on Aug. 3, the widest level since the Treasury began
regularly scheduled sales of 30-year bonds in 1977. That
surpassed the prior high touched in March 2009 when the Federal
Reserve began buying U.S. government securities to help lower
long-term rates and support the housing market.
“These remain extraordinary times in the U.S. Treasury
market,” wrote Michael Shaoul, chief executive officer of New
York-based Oscar Gruss & Son Inc., in a note to clients
yesterday. “Not just given the paltry yields on offer, but also
when considering the relationship of one yield to another, such
as the 10- to 30-year spread. All in all, it is fair to say that
the Treasury market seems to be enjoying rather too much
excitement than is healthy at the current time.”
Mohamed A. El-Erian, chief executive officer at Pacific
Investment Management Co., which runs the world’s biggest bond
fund, gives a 25 percent chance of deflation and a double-dip
recession, yet still expects the U.S. unemployment will probably
stay unusually high, he told reporters today in Tokyo. Holdings
of U.S. government-related debt in the firm’s $239 billion Pimco
Total Return Fund were raised in June to the highest level in
eight months, according to the company’s website.
The U.S. inflation rate is at the lowest in four decades as
the pace of economic growth has been slow even as Fed Chairman
Ben S. Bernanke and his colleagues have kept the benchmark
interest rate near zero since December 2008 and purchased more
than $1.7 trillion worth of mortgage and government debt to keep
borrowing costs low.
The U.S. two-year note yield touched a record low of 0.51
percent on Aug. 3. The 30-year bond yield was 4.049 percent
today while the 10-year note yield was 2.92 percent.


(To save a copy of the chart, click here.)


For Related News and Information:
Bond yield forecasts: BYFC <GO>
Top bond market news: TOP BON <GO>
World bond markets: WB <GO>
Active Treasuries traded: BBT <GO>
Generic government bond rates: GGR <GO>
Sovereign debt ratings: CSDR <GO>
For U.S. economy stories: TNI US ECO <GO>
For U.S. budget news: NSE US BUD <GO>
For Treasury news: NI TRE BN <GO>
Credit crisis news: EXTRA <GO>
Top financial industry news: FTOP <GO>

--With assistance from Yusuke Miyazawa in Tokyo. Editors: Paul
Cox, Greg Storey

To contact the reporter on this story:
Liz Capo McCormick in New York at +1-212-617-7416 or
[email protected];
Daniel Kruger in New York at +1-212-617-2986 or
[email protected]

To contact the editor responsible for this story:
David Liedtka at +1-212-617-8988 or [email protected]
- 30-10yearspread.gif

The strong recovery in German manufacturing activity continued in June with
Bundesbank German Manufacturing Orders Index increasing by a larger than
expected 3.4% to reach 108.9 (2005 = 100). This is the best reading since
August 2008 meaning that the entire post-Lehman collapse in production has
now been repaired. The index is still approximately 12% below the peak
November 2007 reading of 126.1 but at the current torrid pace this could be
overcome by the end of 2010 and the short term 3 month RoC gives no hint of
deceleration at the current time.
.
Unsurprisingly the local DAX index has historically had a strong
relationship with German Manufacturing activity (see attached). In fact
with the exception of the late 1990's when German equity values ran well
ahead of production (in line with the exuberance seen in most developed
markets) the long term charts are barely distinguishable. This suggests
that the DAX has a very good chance of following Manufacturing Production
higher over the next few months.

(See attached file: M-GRIORTOT_Index.gif)

(See attached file: D-GRIORTOT_Index.gif) - M-GRIORTOT_Index.gif -
D-GRIORTOT_Index.gif

These remain extraordinary times in the US treasury market, not just in
terms of the paltry yields on offer, but also when considering the
relationship of one yield to another. One such relationship is the 30 to 10
year bond spread which today broke out to a new all time high of 114.97,
before pulling back to its current level of 111.91. Although this level is
only marginally higher than that seen in 1992 it should be considered that
back then the 30 year and 10 year yields were approximately 8% and 7%
respectively making a 110 bp differential far easier to maintain. As with
our comment made yesterday regarding 2 year swaps, we would see this
breakout as technical rather than fundamental and, as such, additional
evidence of duress amongst Treasury investors. We commented 2 weeks ago that
the surge of refinancing was likely to cause some forced purchasing of the
10 year note by MBS holders and it would seem that this additional buying
has been sufficient to break the prior relationship between these two
instruments. This is of course bad news for any traders who had been
playing the "flattening" trade, which had become increasingly popular in
recent weeks. All in all it is fair to say that the Treasury market seems
to be enjoying rather too much excitement than is healthy at the current
time.

(See attached file: W-.30-10SP_Index.gif) - W-.30-10SP_Index.gif

China Said to Tell Banks to Stress Test for 60% Home-Price Drop

The possible deterioration of China's property market continues to rumble on in
the background and a story such as this will hardly calm sentiment. Perhaps the
most interesting thing to note is that the prior stress test which supposedly
assumed a 30% drop in national prices only saw estimated non-performing real
estate loans rise by 2.2%. We would find this very hard to believe as a
realistic scenario if prices were to drop that far and therefore we would have
doubts at the value of this exercise. We also find the idea of a national price
drop of 60% hard to credit even if China is in the midst of a true bubble. This
degree of drop can occur within the hottest local markets (Miami condominiums
being a good example in the current cycle) but not on a national basis.
.
On the other hand this story, if true, is a good indication that China's
monetary and regulatory authorities are increasingly concerned about the state
of their residential market. We would expect to see increased lending curbs and
greater a wave of recapitalization of large banks via the local equity market,
with clear negative implications for local Chinese asset prices.

 

While the key government employment statics in recent weeks have suggested
that employment trends stagnated during the 2nd quarter a number of private
sector measures of employment have continued to improve in recent weeks. We
noted earlier this week that the ISM Manufacturing Employment index has
been at a historically high level for several months and this morning's
release of Challenger Job Cut and ADP Payroll data both suggest that July
saw a steady improvement in private sector employment.
.
The Challenger Job cut data has been at a level that is typically
associated with robust employment growth for several months and July's
reading of 41,676 takes the 6 month ma (red) down to 44,645, the lowest
reading since October 2000. Back then the 4 week ma of Initial claims were
approximately 300K, compared to the current level of approximately 450K and
although we would not expect an exact match of these two data series (small
firms for instance would not typically issue an announcement when cutting
jobs) the current differential strikes us as something of an anomaly that
will not remain in place for too much longer. Clearly we would hope to see
it resolved by lower Initial Claims rather than higher Challenger Job Cuts.
.
The ADP Payroll data also suggests that the steady improvement in
employment has continued in recent months. We would never use this data to
directly compare to the official Non-farm Payroll report (the sample size
and methodology are too diverse to marry the data) but we would use the ADP
data for trend confirmation. Looking at the 6 month ma we can see that this
is now comfortably positive at 41K, a level which compares to Q3 1993,
another period in which a broad economic recovery took place against a
backdrop of angst.
.
None of this guarantees that this Friday's Non-Farm payroll data will
exceed or even meet expectations, single month releases being simply too
random to be predictable and the mood of the market will still be set by
the "senior" official employment data going forwards. Nevertheless, private
sector data should not be ignored, and so long as its trend of improvement
remains in place there is reason to believe that the public data will
follow suit later this cycle.


(See attached file: D-CHALTOTL_Index.gif)
(See attached file: D-ADP_CHNG_Index.gif) - D-CHALTOTL_Index.gif -
D-ADP_CHNG_Index.gif

An excellent example of "data volatility" (see our recent Speculator Extra
"Stats Don't Kill Markets") was provided by the June Factory Order report.
According to the Census Bureau, Factory Orders fell by -1.2% in June
(consensus was or a drop of -0.5%) while May's activity was revised sharply
lower to -1.8% from -1.4%. This takes the 3 month change in Factory Orders
(see attached chart) to -2.07% which in the surface is an alarming change
in the rate of activity. Fortunately we have other more timely (and we
believe accurate) sources of data concerning Factory Orders. Firstly the
ISM New Order Index (which is published a whole month ahead of the Census
Bureau data) for June remained as high as 58.5 and average 62.9 for the
same 3 months. This is quite simply irreconcilable with the Census Bureau
data and if we have the choice of a simple sample set like the ISM data
series or a data series that is the product of an army of public sector
econometricians it is fairly clear which one we would prefer. Even though
the July New Order subsequently index fell to 53.5 this is still
expansionary and clashes with today's data.
.
Another useful cross check comes from US corporate earnings. If one simply
looks at the Capital Goods GICS sector (see attached screen shot) we can
see that 164 out of 401 US companies have already reported earnings for Q2
2010. These show total sales growth of 3.87% with 122 positive surprises
and 41 negative surprises. Again this is very hard to marry with the Census
Bureau data which, if correct, should have led to a measurable shortfall in
public company sales last quarter. As we have written before, understanding
the source, historical accuracy and volatility of data is crucial if useful
macro conclusions are to be made. The Census Bureau in general has a track
record of producing data that is erratic from month to month (and even
quarter to quarter) at least when measured against consensus estimates that
require a degree of accuracy that is impossible to produce. Over the longer
term these fluctuations work themselves out and no doubt a portion of the
Q2 weakness in the Census Bureau data reflects the fact that Q1 orders were
almost certainly overstated, but this is not the same thing as actual
activity accelerating and decelerating which is how this data is
interpreted.



(See attached file: D-TMNOTOT_Index.gif) - D-TMNOTOT_Index.gif -
industrialq2sales.gif

US Pending Home sales were reported to have fallen by -2.6% in June,
compared to a consensus gain of 4.0%. A miss of this size is in itself
unremarkable (the metric is simply too volatile to be estimated accurately)
but the fact that this keeps Pending home sales at a very low level is more
troubling, even if we are still dealing with the hangover from the expired
tax credits. To confuse matters further the drop in Pending sales has not
been matched by a deterioration in existing sales (see attached chart) and
although it is possible that the latter will fall off a cliff when the July
data is released in late August the gap between these 2 measures (which are
both created by the National Association of Realtors) is starting to become
quite puzzling. Actual Existing sales seem to us to be the more important
metric, since even if in theory Pending sales should lead the latter this
is not bourne out by a comparison of the data. Furthermore, the Pending sales
index seems to consistently understate Existing sales by 10-15%. We would
therefore expect to see a drop in July's existing home sale number, but not
by an alarming manner. Later on in 2010 the effect of the tax credit
expiration will greatly diminish while the substantial drop in the cost of
mortgage borrowing should start to re-stimulate sales. Our conclusion
remains that the US existing home market is in the midst of a slow and
steady recovery and not in imminent danger of relapse.


(See attached file: D-USPHTOTL_Index.gif) - D-USPHTOTL_Index.gif

As many readers will be aware the 2 year Treasury note has recorded a
series of record low yields in recent days and this morning has fallen as
low as 52.2 bp. As if a 2 year note yield at this level were not remarkable
enough in itself, what is perhaps more interesting is that this has occurred
in the aftermath of a 10% bounce in the equity market and a general calming
of US economic fears. Therefore unlike the collapse in yields which took
place at the end of the 2nd quarter, it seems that this time we are dealing with
something other than a rush of additional retail and institutional money
out of equities and into treasuries and instead dealing with much more
technical flows. This sense is confirmed by the highly unusual behavior in the
swaps market (see last week's note) which has seen swap premiums collapse
across the curve. In the case of the 2 year note the 2 year swap yield is now
just under 70 bp, arguably a much more dramatic number than the underlying
treasury yield itself, and some 30 bp lower than the prior record low set
earlier this year.
.
This current move in treasury yields very much has the feel of market
action being taken under duress and we would not be surprised to hear news
of one or more victims in the coming days. Nevertheless we would expect the
damage to be "local" rather than "systemic" and in the meantime the effect
has been to take the funding costs for new borrowers well below where they
were a couple of months ago while stimulating investment returns for fixed
income and therefore drawing additional investment capital into the space.
The result has been a renewed boom in corporate issuance at eye-catching
yields. IBM issued 3 year paper at 1% last night while the far lower
quality EXPE issued $750mm of 10 year paper at just under 6%. In many ways
the current portion of the cycle has become a direct subsidy of corporate
activity by the nation's savers, which is increasingly weighing long term
relative returns in favor of equities rather than credit.

(See attached file: D-USSWAP2_Index.gif) - D-USSWAP2_Index.gif

The Conference Board Help Wanted Index is a relatively new data series
(commenced December 2005) that tracks total Online Help Wanted adverts.
This relative youth and the rapid transition from print based advertising
to online advertising that has taken place over the last 5 years this makes
historical comparisons difficult, but if one merely looks at the last two
years and uses a sensible moving average (6 or 12 months) then this report
offers some useful insight into the changing employment landscape. As can
be seen on the attached chart, the number of Help Wanted adverts has grown
rapidly since last October when only 3279K adverts were recorded. July's
reading was 4293K, an increase of over 30% and the highest reading since
November 2008. This index also suggests that an uptick in hiring took place
in July compared to other months, which contrasts somewhat with the Initial
Claims data and the expectations for July's non-farm payroll data which
will be released this Friday. If this data series had greater historical
pedigree we would be quite excited about this improvement, but as it is we
would merely note the discrepancy from the official data at the current time
and re-visit later this cycle.
.
On a separate note our comment on this morning's ISM data stated that
consensus was 56.2. This was in fact the prior months reading. The correct
consensus number was 54.5 meaning that the report of 55.5 was slightly
better than expected. Nevertheless our analysis of the report remains
unchanged.

(See attached file: M-HWOLTOT_Index.gif) - M-HWOLTOT_Index.gif

July's ISM report came in at 55.50, a reading which if slightly below consensus
expectations of 56.2 still represents a healthy pace of expansion and marks the
12th consecutive positive reading for this key index of US Manufacturing
Activity. The only hint in weakness was in the New Order sub-index (red) which
fell to 53.5, but given the recent strength of readings and the fact that we
are dealing with diffusion indexes (meaning that New Orders continued to
increase) we are not yet concerned by this metric. Production (blue) moderated
to 57 from 61.4, but again this still represents a decent pace of activity for
this point of a recovery. Inventory data (green) remains static at 50.2,
meaning that the long awaited re-build has been put off for yet another month
and this is exacerbated by another weak number in Customer Inventories (not
shown) which remain very negative at 39. Interestingly the Employment number
(pink) improved to a new cycle high at 58.6. This has pulled the 6 month ma of
this sub index to 57.6 (see attached chart) which compares very favorably to
other prior cycles. This clashes with official employment data which still
shows a weak rate of hiring in the Manufacturing sector, other than in
temporary labor. This data-clash should be resolved one way or another later
this year, but we have not given up hope of a substantial wave of industrial
re-hiring in the coming months. - ismjuly2010.gif - ismemployment.gif