In a somewhat surprising comment late this afternoon Narayana Kochelakota, the
new President of the Minneapolis FRB, suggested that the FRB may need to raise
the FDTR by over 50 bp later this year. This is the most aggressive statement
we have seen from a voting regional president since Thomas Hoenig was rotated
out at the end of December (Hoenig repeatedly called for a 100 bp rise in the
FDTR last year) and represents a fracturing of the cozy consensus that
characterized FRB comments in recent weeks.

To place his comments in perspective, the current Eurodollar curve anticipates
90 day LIBOR at around 60bp in December 2011. A hike of 75bp in the FDTR would
put LIBOR somewhere close to 1.00% (see red arrow). This in itself would hardly
be a significant event but interest rate cycles have a habit of gathering force
once they are underway. Given the rock hard belief that the FRB is on
perma-hold and the rigid reliance on this assumption in many of the carry
trades that are so popular at the current time even a moderate acceleration of
FRB rate hiking beyond expectation could prove troublesome to the fixed income
marketplace.

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

Kocherlakota Says Fed Rate May Need to Rise This Year, CNBC Says
2011-03-31 19:58:04.606 GMT


By Jeran Wittenstein
March 31 (Bloomberg) -- Narayana Kocherlakota, the
president of the Federal Reserve Bank of Minneapolis, said the
federal funds rate may need to rise 75 basis points by late
2011, CNBC reported, citing the Wall Street Journal.


For Related News and Information:
Top Stories:{TOP<GO>}

To contact the editor responsible for this story:
Jeran Wittenstein at +1-415-617-7203 or
[email protected]

- eurocurvemarch31st2011.gif

The Chicago PMI report traditionally kick-starts the new monthly data cycle and
March's report represents another strong piece of data that suggests that
activity within the industrial sector continues to expand rapidly.

The overall index (black) fell back slightly to 70.6 (71.2 in February) but
this still represents an extremely high reading and beat consensus estimates of
69.9. Unsurprisingly this strength is shown throughout the sub-indexes. New
Orders (red) remained very high at 74.5 (75.9 in Feb), Production (blue)
dropped to 74.2 from a very extended 78.2 while New Order Backlog (separate
chart) soared to 69.6, the highest reading since 1974.

This may prove to be significant, since it suggests that Production may be
capacity constrained at current employment levels. This is further supported by
another very strong reading in the employment index (pink) which at 65.6 is at
its highest level since 1983. Clearly we would wait until tomorrows national
ISM report before making any meaningful conclusions but this data supports our
view that it is time to ditch the term "recovery" in favor of "expansion". -
chicagopmimar11.gif - chicagobacklog.gif

Monetary cycles rarely have contemporaneous effects across a national
economy and this is one of the reasons why they tend to be underestimated
by "real time" analysis. A good example of this phenomenon can be seen at
present in Australia where the commodity driven portion of the economy
remains white hot and retail sales continue to hit record levels (this news
dominates today's headlines) but other sectors are starting to show distinct
signs of strain.

Nowhere is this more obvious than in the domestic construction industry where
activity has collapsed in recent months. Attached is a chart of Australia
Building Approvals which fell back over 7% last month to a 2 year low of
12,011. We always take single data points with a pinch of salt but it should be
noted that the 12 month ma (red) has started to turn lower and the current
decline very much fits the pattern of cyclical "boom and bust" that has
been present within this industry for several decades. Looking at this
chart we are reminded that US home building activity peaked roughly 24
months before the scale of problems within the US economy became obvious
to most observers. Australia may not face the same scale of issues but the
sharp decline in construction data is probably a sign that a more
problematic period awaits for the overall economy. - M-AUBATOTL_Index.gif -

This week's claims data continues the run of releases below 400K with
initial claims estimated at 388K a little higher than consensus estimates
of 388K. Last week's data was also revised higher to 394K from the
original reading of 382K but this does little to change the clear trend of
improving data from this metric. After today's release the 4 week ma of
claims has fallen to 385.3K and we would still expect to see it move lower
in the weeks ahead. Attention now turns to tomorrow's non-farm payroll
data. Readers should note that since we will be travelling tomorrow our
comment on this and the monthly ISM report will not be published until late
morning. - D-INJCJC4_Index.gif -

Emerging Borrowers Raising $195 Billion in Busiest Start (1)

Those pondering the solidity of emerging market currencies in the face of weak
equity markets this quarter need look no further than the attached article
which outlines the massive flow into emerging market credit that has occurred
at the start of the quarter. With inflationary pressure growing and local
monetary policy tightening rapidly this strikes us as a much better time to be
an issuer of debt (particularly for corporate issuers) than a purchaser of
expensive low yielding bonds, but there is no sign that investors' appetite is
diminishing, in fact the opposite is the case.

 

This morning's ADP Payroll report was in line with expectations (208K) at 201K.
February's data was revised slightly lower to 208K from 217K but these are
essentially rounding errors in what is only a guesstimate of actual national
private sector employment changes.

As the attached chart shows this month's data has taken the 6 month ma up to
174.3K, the highest reading since June 2006 at the peak of the last cycle, and
indentinal to the level reached in May 2004 just prior to the decision of the
FRB to start raising interest rates from their "emergency level" of 1.00%.
Regardless of the specific number released in Friday's Non Farm Payroll report
(an upside surprise is overdue but in no way certain) it seems clear that
employment growth is starting to become a meaningful force in sustaining the
current US economic expansion. - adpmarch2011.gif

It has been a long time since we have seen as positive an article about US
commercial real estate, which as recently as 18 months ago was still sidely
anticipated to be the "next shoe to drop". Although the national picture
remains patchy, certain key markets have moved beyond mere stabilization into a
more positive frame of mind. The Manhattan office (described accurately in this
article) and multi-family rental markets (which we are familiar with as a
Landlord) are perhaps the best examples of the steady process in which the
relationship between Landlord and Tenant has become notably more even-handed in
recent months. With job creation increasingly a factor in the US economic
expansion we would expect to see this regional trend expand into most markets
where over-supply is not an issue over the course of the next few quarters.

A casual glance at March's Conference Board Consumer Confidence Index will show
that confidence fell back fairly sharply from last month's level of 72.4
(revised up from 70.4) down to 63.4. This was slightly lower than consensus
estimates of 65, but is in line with our own belief that overall consumer
confidence metrics tend to match very closely with changers in investor
sentiment over the short term. As can be seen on the attached chart, even
following this drawdown the overall index still shows very considerable
improvement over recent months and remains comfortably within a longer term
uptrend.

Looking at the various sub-indexes there is further encouragement to be drawn.
One notable change is the level of the "Present Situation" index (blue line on
chart). This had remained stubbornly rooted to its 2008/9 lows until January of
this year but has now started to improve fairly rapidly. March's reading 36.90
this index is at its highest level since November 2008. Of course "economic
reality" in March 2011 is far stronger than that dismal period, but the very
fact that the consumer's polls are starting to finally admit that the "present
situation" is improving strikes us as an important shift in the cycle.

We also note that the "Intend to Buy Automobile" index remained at an unusually
high level in March (see attached) although it did pull back from February's
suspiciously high reading. Despite some of the headlines claiming that "high
oil prices" are dampening consumers' mood this sub index would suggest that
little direct effect can be seen in actual consumer intentions at the current
time. - consumerconfauto.gif - consumerconfmar11.gif

We commented last week on the collapse in BRL denominated debt issuance since
the introduction of new taxes in late 2010. This of course had the effect of
shifting funding into the international market, a point apparently not lost on
Brazil's regulators. As can be seen in the attached story a new tax of 6% on
international bonds and loans of up to 360 days was introduced this morning.

As we have argued before the logic of MPMP is to continuously introduce new
measures until they take effect. This game of "cat and mouse" between central
banks and speculative capital is increasingly unlikely to have a happy ending
for either party.

Despite a number of rate increases and other monetary measures there is no
sign that Brazil's rapid private sector credit growth is slowing down.
February's data showed very robust credit growth across the Brazilian
private sector with a particularly strong reading for housing loans. These
grew by 2.73% in February and are growing by approximately 50% per annum.
Brazilian mortgage rates are typically much higher than western
counterparts which paradoxically makes them much less sensitive to changes
in the SELIC base rate. We would therefore not be surprised to see
specific MPMP measures directed at housing credit (restrictions on Loan to
Value ratios being the most obvious possibility) being introduced in the
coming weeks. At 19.26% general personal sector credit may be growing
slower than housing credit, but it would still seem to be growing at a
level well beyond the central bank's comfort zone. Again there have been
rumors that some sort of "terms controls" may be introduced for credit
issued for the purchase of consumer goods (most likely for automobiles and
large ticket appliances) may be on the agenda later in 2011.

As can be seen by the introduction of a new tax for foreign corporate debt
issuance (see next e-mail) Brazilian monetary policy is becoming
increasingly complex and interventionist, very much in line with our
thinking several months ago. - M-BZLNPERS_Index.gif - M-BZLNHOUS_Index.gif -

Yet another EM monetary surprise was delivered by the Bank of Israel this
morning which elected to raise the Base rate by 50 bp to 300bp, a move
only anticipated by 1 of 21 economists posting consensus estimates to
Bloomberg. This marks the second 50 bp increase in the base rate since the turn
of the year and represents an end to the gradualist policy of normalizing
interest rates that has been championed by the BOI's Chairman Stanley
Fisher.

It is notable that the decision to maintain low rates in 2010 was very much
predicated on the BOI's belief that the US was at risk of suffering a
double dip. With this fear now seen to be misplaced the BOI is now chasing
its own overheated domestic economy which includes a housing market that
is somewhat out of control and very strong investor flows into local
fixed income and currency markets. We have followed the BOI's introduction of a
number of macro-prudential measures which have attempted to soften demand
in some of the more obviously problematic asset markets (we have likened
the BOI's activities to the old "whack a mole" arcade game, a copy of
which is attached) but today's increase in the pace of rate hikes suggests
that a certain impatience is setting in with the stubbornness of
investment activity in the face of these restrictions.

Despite Israel's small size, Stanley Fisher is one of the most influential of
global central bankers at the current time (he was Ben Bernanke's doctoral
supervisor) and has been much lauded for his handling of monetary policy in
recent years. We therefore wonder whether this new tougher line by the BOI
represents the leading edge of a hardening of global monetary policy.
Certainly for most emerging markets this is long overdue. In Israel's
case it should be noted that even after today's announcement the Israel
Base rate is lower than for any period prior to the 2008/9 collapse in
activity. The scope for further tightening should not be underestimated,
and with it the risk of a marketplace mishap. - D-ISBRANN_Index.gif - whack a
mole.pdf

Following poor New Home sales and consensus Existing Home sales data for
February, at least a modicum of encouragement can be found in the Pending
Home Sales report, which generally anticipates sales data by 2 months. The
headline seasonally adjusted index rose 2.10% to 90.8, keeping the data
above the 12 month ma at 88.6. Although this represents a decline of 8.19%
from last February it should be recalled that pending sales for that
period were being artificially elevated by the expiring tax credit
program. February's data is therefore in line with a stable but sluggish
housing market which is pretty much where we would expect the Existing
Home market to be for much of 2011. The Non-Seasonally adjusted data
supports this view and shows an increase in activity typical with the
waning of the winter months. Certainly nothing in this data supports the
view that February's collapse in New Home sales to a record low or the
downward fluctuation in some of the national house price indexes be taken
as a sign of a new leg down for the housing market. This is helpful even
if the data stops short of suggesting that any meaningful improvement in
activity is occurring at the current time. - M-USPHTOTL_Index.gif -
M-USPHNSA_Index.gif -

As most readers will be aware, we view consumer confidence as a contrary
indicator that functions as an ex-post commentary on investment return.
Consequently the most dangerous times to invest in a local market is typically
at the end of an extended series of elevated readings, but prior to a sharp
fall in confidence (since this typically occurs after a correction has begun in
earnest). Brazil appears to be a good example of this, with consumer confidence
remaining above 120 since July of 2010 but showing a distinct deterioration
since peaking last November at the time the local IBOV index recorded its post
crisis high. This morning's data for February for instance took the index down
to 120.1, its lowest reading since June 2010 but still a very strong reading.

As can be seen the final surge higher in confidence started in February 2010
and was in direct response to the strong gains recorded in the local equity
market after the January 2010 mini-correction. Since briefly breaching 70,000
in April 2010 the IBOV has had a very hard time making further progress, but
cannot be said to have broken down either.

With the local central bank one of the most enthusiastic proponents of
"macro-prudential" monetary policy (MPMP) this stand off has taken place
against a steady wave of tightening measures that have kept interest rates
fairly low but intervened quite radically on the functioning of funding markets
(we noted the complete collapse of local BRL bond issuance on Friday). With
more measures likely to be introduced (we would be particularly sensitive to
those directed towards consumer and mortgage credit growth) our concern would
be that the local equity market (especially the financial and consumer sectors)
may be somewhat more vulnerable than most suppose. - brazilconsumerconf.gif

Given the remarkable popularity of VIX related future, options and ETFs it is
hardly surprising that the CBOE has elected to introduce futures on the "Gold
VIX". Should these prove to be popular no doubt futures and ETFs will follow.
However, this should not disguise the facts that:

1. VIX related products have proved to be spectacularly bad investments (on the
long side) for the majority of the time they have been in operation. In fact it
is ironic that the Gold Vix futures should be launched at the end of the week
in which the VIX index itself has just suffered the largest ever 7 day drop on
a percentage basis (according to Bloomberg News).

2. The idea of using the "Gold Vix" as a hedge for one's exposure to gold is a
very strange idea given the fact that gold itself was somehow meant to be a
"hedge" (variously quoted as being a hedge against inflation, deflation, global
turmoil and not making money elsewhere) in the first place. Should one own "too
much" gold one could simply either sell some or perhaps buy some puts (we note
that over 114K put contracts traded on the GLD ETF today demonstrating the
abundant liquidity available).

Nevertheless the fetish of volatility has become firmly ingrained in today's
post-crisis environment, with an ever expanding list of asset classes receiving
their own "VIX" type indexes (for instance JP Morgan introduced a new 3 month
implied volatility index for global currencies this week). Our view remains
that implied volatility is simply another source of information regarding the
pricing of risk by the marketplace. It is not and never should be considered an
"asset class" in its own right and the proliferation of tradable products is
one of the great fallacies of the current time.

An interesting story that gives some insight into the effects of one of the
more interventionist MPMP actions. Brazil starting aggressively addressing
inflows into Real denominated debt during the 4th quarter of 2010 and issuance
has abruptly shifted to non-BRL denominated debt. Of course this is not quite
the same as halting credit growth itself (and adds the specter of greater FX
exposure for issuing corporations), but it does fit our general thesis that
monetary policy is having a much more restrictive effect than a simple
monitoring of interest rates would suggest.

One of the first detailed articles we have seen outlining the compression of
operating margins within India's banking system. Our expectation is that it
will prove to be very difficult to pass on higher loan rates to borrowers
without compressing credit demand and/or raising delinquency levels.
Delinquency is likely to be of increasing importance at this point in the
economic cycle since this typically starts to become an issue at around the
time the yield curve inverts.

An interesting chart of the day that highlights the disconnect between foreign
investor flows into Turkish bonds and equities. This anomaly can be seen across
the EM spectrum at the current time and is a good reminder that flows can
remain disconnected from fundamental drivers for a significant period of time.
Perhaps the greatest surprise thus far in 2011 is that fairly sharp losses in
EM equity markets that were very much driven by domestic EM concerns have not
spilled over into weakness in fixed income and currency markets and there has
been no "bond rout" in Turkey or any other emerging market in recent weeks,
despite the use of that term in the headline.

This does not reduce the potential for something ugly to occur at a later point
of this cycle, but with quarter end approaching and allocations once more
likely to favor emerging market fixed income, it may take another set of
monetary tightening and perhaps some hard evidence of deteriorating economic
activity to set this train in motion.

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

Turkey Bond Rout to Worsen as Foreigners Exit: Chart of the Day
2011-03-23 22:00:30.0 GMT


By Michael Patterson
March 24 (Bloomberg) -- The biggest tumble in Turkish bonds
since October 2009 will deepen, sending yields to 10-month
highs, as tighter monetary policy spurs foreign investors to cut
holdings from record levels, according to Societe Generale SA.
The CHART OF THE DAY shows overseas investments in Turkish
debt reached an all-time high of $37.9 billion on March 11, the
last day data from the central bank were available. Money
managers bought bonds even as they reduced stock investments to
$55 billion from a peak of $74 billion in November.
“There’s a disconnect because the correction has occurred
on the equity side but not in bonds,” Benoit Anne, the head of
global emerging-market strategy at SocGen in London, said in a
phone interview yesterday. “We’re probably going to see a
reduction of exposure to the bonds. It’s been a very slow
response by long-term investors.”
Turkish bonds sank yesterday, driving yields on the
benchmark index up 31 basis points, after the central bank
increased lenders’ reserve requirements by more than investors
had anticipated. Yields will rise at least another 50 basis
points, or 0.5 percentage point, as overseas investors sell
holdings, according to Anne.
Yields on the RBS Istanbul Benchmark Bond Index have
climbed 200 basis points from a record low on Jan. 5 amid
concern that accelerating inflation will force the central bank
to lift interest rates. Turkey’s ISE National 100 Index of
shares has slid 11 percent from its all-time high on Nov. 9.
Central bank Governor Durmus Yilmaz cut benchmark borrowing
costs in December and January in an effort to narrow the
current-account deficit and weaken the lira. Yilmaz has relied
on higher bank reserve requirements to cool the economy and slow
credit growth even as he predicts inflation will accelerate from
a four-decade low in February.

For Related News and Information:
Charts homepage: GRAPH <Go>
For emerging-market stocks news: TNI EM STK <GO>
Developing economy market moves: EMMV <GO>
Emerging-market economic statistics STAT4 <GO>
World equity index rankings: WEIS <GO>

--Editors: Stephen Kirkland, Gavin Serkin
- codmar242011.gif

Further confirmation of the improvement in US employment was delivered by
this week's Initial Claims data. Claims were estimated at 383K, in line
with consensus estimates (385K) and last week's data (revised slightly
higher to 387K). This allowed the 4 week ma (attached) to edge lower to
385K, the lowest level since July 2008 which represents an improvement of
approximately 35K a week since the end of 2010. It would seem likely that
this pace of improvement can be sustained through the next quarter, which
would bring the 4 week average of claims down to the psychologically
important 350K level around the end of Q2 2011. - D-INJCJC4_Index.gif -

This morning's meeting of the Turkish central bank contained a surprise,
since although the benchmark policy rate was kept on hold as expected at
6.25%, a new round of MPMP was enacted. Specifically the Reserve
Requirement for local banks was increased for demand deposits by 3 bp and
1 month deposits 5bp (both to 15bp) while requirements for 1-3 month
deposits were increased to 13bp. This sort of tinkering is typical of the
messy and arbitrary nature of MPMP and its illusion that central banks can
introduce policies tailor made to the specific requirements of particular
cycles. The main takeaway from today's action is that Turkey's monetary
policy mix is only going to get more complicated from this point onwards.

The other central assumption should be that credit growth is now being
directly targeted by the central bank. The experience of other countries
has been that it has taken several months and several hikes to reserves to
have any appreciable effect of credit growth (which in Turkey is currently
a frothy 34% YoY) and this will probably prove to be the case in Turkey as
well. We would expect to see a somewhat quicker response by the short term
interest rate markets (as we have seen in both India and China) and this
implies a growing pressure on the profitability of the banking and retail
sectors going forwards. This is unlikely to be good news for the local
equity market which has had a poor start to 2011 but recovered a portion
of its losses in recent weeks. Following this morning's announcement the
XU100 index fell back from important resistance at 65,000K and now looks
likely to test short term support at 62,500. - D-XU100_Index.gif -

Although a number of the public homebuilders have suggested that a modest
improvement in market conditions has taken place in recent weeks, the
official Census Bureau data for New Homes was the weakest on record for
February. Annualized seasonal adjusted sales were reported at 250K units,
well below consensus estimates of 290K and January's 301K sales (revised up
significantly from the original report of 284K). Non-Seasonally adjusted single
month sales were reported as 19K, the lowest total on record, with a mere 1,000
units being sold in the entire North East region. Total inventory was unchanged
at 186K, close to the record low of 181K recorded in 1967.

Even though we suspect that the official data somewhat overstates the
weakness in the New Home market we would certainly accept that there is no
evidence of a meaningful recovery taking place at the current time. The
degree of dislocation between New Home purchases and every other facet of
consumer behavior remains one of the greatest anomalies of the current
cycle. Although we remain very surprised at the length of time this has
remained in place we continue to believe that its aftermath will see a
surprisingly swift surge in activity that will lead to extremely tight
inventories in a number of geographic regions. - D-NHSLNFS.gif -
D-HSMNTOT_Index.gif -

India's Interbank Rate market continues to suggest that monetary conditions are
tightening appreciably. Attached is a chart that shows the Overnight, 14 Day, 1
Month and 3 Month rates together with the generic 10 year bond yield.

Although the initial surge in the cost of borrowing was really limited to the
longer dated 3 month series, the recent moves have been concentrated on 1 month
rates (which have increased by over 150 bp in March) and the 14 Day series. The
latter increased by a highly unusual 111 bp last night, which is the largest
single day move since August 2007. This indicates that there is an ongoing
deterioration in funding conditions and that there is currently a lack of
liquidity available for even short term borrowings at rates anywhere close to
the current RBI REPO rate of 6.75%.

Another traditional warning that monetary policy has become restrictive is an
inversion of the yield curve. As can be seen all Offered rates, with the
exception of the overnight rate, are now considerably higher than the 10 year
bond yield (light blue). Although it can take several months for such an
inversion to be reflected in actual economic activity, liquid financial markets
tend to be much more sensitive to monetary conditions and we note that India's
equity market has been one of the worst performing global markets since the
start of 2011. - indiainterbankmar222011.gif

February's Existing Home Sales data came in light of expectations at
4.88mm (5.13mm consensus), but this shortfall still leaves the data in line
with our assumption that the existing home market is operating at a
tolerably active pace. This month's report takes the 6 month ma for Single
Family home sales up to 4.22mm, which is roughly the level seen at the
start of 1998. This is far from the boom conditions of 2001 - 2006 but it
is also over double the pace of the nadir reached in 1982 (unlike the New
Home market which is well under this level). It also seems to be a pace
which is sufficient to slowly absorb the large overhang of inventory which
remained virtually unchanged at 2.97mm Single Family homes in February.
Condo inventory, which tends to be much more seasonal and to trough in
January, increased to 518K homes in February. This is the lowest February
report since 2006 and 9.3% below the level one year ago. The condo market
seems to be attracting considerably more distressed investors than the
single family home market which is starting to have a meaningful impact on
the still sizable inventory present in the marketplace. - D-EHSLSL_Index.gif -
M-ECSLHAFS_Index.gif -

We note a surprisingly weak set of Export data for Taiwan's February
activity was released last night. Total exports fell back to $28,872 mln
USD which represents annual growth of only 5.33%, the weakest level since
the 2009 recovery picked up its head of steam, Perhaps most interesting is
the source of weakness. Taiwan's exports to China and Hong Kong fell very
sharply in February and only grew at an annual pace of 2.7%. In contrast
US exports continue to grow rapidly at 16.91%, even though they still lag
exports to China and Hong Kong in terms of size by $871 mln.

Trade data is notoriously volatile and we would not make any conclusions from a
single set of data but we are intrigued by any evidence that supports our
thesis that the US is returning to its traditional position at the fulcrum of
global growth, while China's significant monetary tightening may be
finally affecting industrial activity to a degree unappreciated by most
observers. Today's data hints that this may be the case but in itself in not
conclusive. - M-TWEOTTL_Index.gif - D-TWEOUS_Index.gif -

With hall the excitement over Japan and Libya it has been easy to miss 3
significant separate monetary tightenings by important emerging market
central banks this week. The RBI was first to move, hiking the REPO
cut-off yield to 6.75% in a widely expected move. As we have explained
before, the RBI has lost control over short term rates in recent months
with both the 3 month overnight borrow rate and (related) 3 month deposit
rate moving significantly higher than the RBI's target. As of last night
both were over 10%, indicating that monetary policy in India is having a
marked effect on local liquidity.

Chile was the next central bank to move, with a surprise 50 bp rate hike
to 4.00% announced last night (only 3 of 22 economists polled expected a
hike). This surprise move has led to a fairly abrupt change in market
expectations with the 3 month deposit rate moving up to 59bp to 4.64% this
morning and suggesting that more hikes are on the way. Finally China
rounded off the week with yet another increase in Reserve Requirements to
20%. There is some evidence that these are having effect, at least at the
level of the cost of capital within the Chinese banking system. Last night
saw a record rate of 6.23% paid at the regular auction for 6 month
deposits of government cash, while 3 month SHIBOR remains elevated at
4.25%, albeit somewhat lower than the 5.75% seen just prior to the Chinese
NEw Year holiday.

Each of these markets shows a clear trend of deteriorating financial
conditions (but not yet actual economic conditions). Our concern therfore
remains that the profitability of a number of Emerging Market commercial
banks will prove to be the first portion of the emerging market complex to
feel the strain of monetary tightening. - W-CHRRDEP_Index.gif -
W-INRPYLD_Index.gif - W-CHOVCHOV_Index.gif -

It has been one of the more chaotic weeks in recent memory as global asset
markets have struggled to digest the news overload emanating from Japan
and the Middle East. It is simply too early to take a viewpoint regarding
the true long term significance of any of these events but this has not
stopped large sums of capital being shunted abruptly across markets in
response to headlines. Attached are two charts that demonstrate this, both
use a 30 minute candle chart over a one week period that shows the speed
of reversal.

The first chart shows the JPY/AUD cross rate. This has long been one of
the favored "carry" trades, not only amongst professional investors but
also Japanese retail savers who have poured funds into savings products
that deliver yields many multiples of those available in domestic markets.
As news of the severity of the earthquake hit, speculation grew about the
need to Japanese investors to repatriate capital, leading to pressure in a
number of known popular destinations for Japanese investors. Tellingly
these were all liquid markets. The Brazilian corporate debt market, which
was the most popular single destination in 2010 for Japanese retail flows
according to most accounts, never showed any pressure from liquidation
while much more liquid currency markets such as the AUD, NZD and ZAR all
saw sizeable, rapid liquidation. This suggests that the price swing was
caused by traders betting on a future repatriation of funds rather than
any meaningful action by Japanese investors. As the attached chart shows,
the JPY/AUD moved from approximately 1.20 on March 11th to as high as 1.34
on March 16th before pulling back to 1.29. News that the G7 had intervened
to sell JPY against foreign currencies then saw the cross take a large
step backwards, falling from 1.29 to 1.24 over a one hour period, since
which time it has drift up to 1.246. We doubt that this marketplace will
settle down any time soon and even though the JPY may drift lower against
the USD and EUR its progress against the most popular "carry" currencies
should still be monitored.

Crude oil has had a similarly frantic few days, although here the catalyst
has been the continued turmoil in the Middle East. After peaking at over $106
last week crude fell back to as low as $96.22 on March 15th, before an
escalation of violence in Libya once more sent traders to their buy buttons. By
last night crude had reached $103.66 and looked to be capable of recording a
new 2011 high until news arrived of a UN resolution empowering military
intervention. The subsequent cease fire announced by the Qadaffi administration
sent crude immediately lower to the $100.50 level over a matter of minutes. We
remain unconvinced of the arguments that crude is inevitably moving higher, or
of the economic significance even if this were to occur. - 30-JPYAUD_Curncy.gif
- 30-CL1_Comdty.gif -

We refrained from commenting on this morning's Industrial Production data which
showed a -0.1% drop in Production for February and a drop in Capacity
Utilization (one of the FRB's favorite metrics) to 76.3% since this struck as
an utterly unreliable report (which unfortunately may not stop the FRB relying
on it).

Certainly the March Philly Fed report which was released 45 minutes later
contrasts markedly with this data. The overall index reached 43.40 which the
strongest reading seen in over 25 years. The New Order index (red) reached
40.30, the strongest reading since 1983. Inventory rebuild (blue) would seem to
have begun in earnest with the index reaching 12 and Employment (green) stayed
strongly positive at 18.20. Regular readers will know that we always prefer
fairly simply survey type data such as PMI reports to the much more (honestly
but inaccurately) concocted reports that supposedly measure country wide levels
of activity. In recent months these have suggested the US economy is starting
to transition from a "recovery" into a straightforward "expansion", and perhaps
it is time that we started to employ this term in its stead. -
phillyfedmar11.gif

One of our contentions in recent months has been that consumer sentiment
surveys have become much more indicative of investor sentiment than their
name or methodology would suggest. Thus it came as little surprise to see
a simultaneous breakout by the University of Michigan, Conference Board
and Bloomberg Comfort (formerly ABC) surveys in February coincide with
strongly bullish AAII poll readings, which followed the SPX doubling its
March 2009 low over 23 months. It is equally unsurprising to see the
simultaneous collapse of both the AAII poll and Bloomberg Comfort Index
(which is also published weekly on Thursday mornings) following the sharp
pullback in the US and global equity markets in recent sessions.

Both indexes recorded their lowest readings since the end of August this
week with AAII Bulls minus Bears falling to -11.63 and the Bloomberg
Comfort index to -48.5. We would not draw any conclusions from this
utterly predictable drop other than it confirms our suspicion regarding
what is driving Consumer Sentiment at the current time. With regards to the
AAII poll, which draws off to small a sample set to be relied upon by itself,
we doubt that a reading of -11.6 is quite low enough to signal an end of this
corrective phase. Nevertheless this is a sizeable shift in opinion that
suggests that the modest over excitement present in the market a month ago has
already been largely corrected. - D-COMFCOMF_Index.gif -

The weekly Initial Jobless Claims data continues to suggest a rapid
improvement in employment levels has taken hold in the US economy. This
weeks report saw claims fall to 385K from last week's elevated 401K report
(revised 4K higher). This sort of fluctuation is quite typical of this
data but a casual glance at attached chart of the 4 week moving average
demonstrates the powerful downward trend in Claims that has been
established in recent months. It is still true at at 386K the 4 week
moving average is still somewhat higher than the 350K level (green band on
chart) that typically demarcates a strong employment environment but
historical precedence suggests that we will have reached this level
sometime around the middle of the 3rd quarter, well ahead of consensus
expectations.

On a separate note it is also worth using this chart to remind oneself of
the transient nature of sudden shocks to a large diversified economy.
There are two such episodes shown on this chart, the 9/11 attacks and
Hurricane Katrina (September 2005). Both led to a substantial spike in
Claims that was short lived. In the case of 9/11 Claims remained elevated
due to the fact that the US was already in the midst of a recession but
following Katrina, claims were to fall back to a new cycle low of 286K by
early February 2006. This should be bourne in mind when estimating the
longer term economic significance of the unfolding events in Japan. -
D-INJCJC4_Index.gif -

One of the most significant after-effects of the financial crisis has been a
growing fascination amongst investors with volatility. When we first started
writing regularly about the VXO index (still our prefered metric) 7 years ago
this was very much a backwater of the marketplace whereas today the VIX has its
own radio slot on Bloomberg's morning show and has become one of the most
widely traded option classes and spawned one of the most popular ETFs (VXX).

This may seem to be a natural outcome, but as we have commented on several
occasions it is based on a misconception that volatility is a useful tool to
trade rather than simply observe. In fact the VXX ETF has been one of the
poorest performing products in living memory (even after adjusting for the
trend downwards in volatility) due to the steep contango in place in the VIX
curve (which itself is a reflection of participants constant bias in favor of a
future spike in volatility).

None of this has dampened the popularity of the products and the CBOE has not
been slow to realize this. As the attached release shows a substantial roll out
of Volatility products is being undertaken under the premise that anything that
has substantial trading volume is a natural candidate for a volatility index.
This strikes us as fairly ludicrous but the CBOE is a for profit enterprise
that is perfectly within its right to follow this path. Quite why participants
should wish to employ them within their portfolios is far more puzzling, but
the need to always "hedge" exposure is also just one of the many "false
lessons" learned from the events of recent years.

The strong US economic recovery continued to take a bypass around the New
Home construction industry in February, with both Housing Start and Permit
data slipping back towards the low end of their 30 month "dead zone". Total
starts were estimated as 479K, well below both consensus (566K) and
January's level of activity (revised up to 618K from 596K). Although the
percentage shortfall is large it is within the bounds of the normal
volatility of this data set, and simply confirms that no recovery of
activity has yet taken place across the industry. We also note that the
Multi-Family data, dropped very sharply from 193K to 104K. Again this
tends to be very volatile data and we would simply average across these
months and note that no material change has taken place.

Our favored metric is the Single Family Permit report, since this tends to
be a little more reliable as an indicator of trend. This also fell back to
382K, which pulled the 6 month ma of Permits down to a new all time low of
464K, which is a less than 29% of its peak reading in May 2006. As poor as
this data is it does not change anything. The economic recovery that is
underway has overcome the headwind of stagnant home construction and will
continue to do so. We have also always expected a recovery in home sales
to lead a recovery in construction (although we did not expect either
metric to remain as depressed as the are for as long as they have). The
current housing market strikes us as highly anomalous given the level of
activity in the existing home market, the housing rental market and
general consumer activity. We understand the forces that brought this
situation about, but note that most of these have dissipated with the
glaring exception of the fact that consumers simply appear to be
psychologically averse to purchasing new homes at the present time.

Although some argue that this aversion will remain in place for many
quarters we note that the same could have been said about investing in US
equity mutual funds three or four months ago, but is certainly no longer
the case today. The New Home Market still strikes us as one of the
likeliest sources of upside surprise for 2011, if only because both
activity and expectations are so remarkably low. - D-NHSPA1_Index.gif -
D-NHSPSTOT_Index.gif -

Reading the FOMC statement over the years one becomes used to the distorted,
time lagged view of the US and global economy that they typically provide.
Today's release of the March policy statement (attached) is typical in this
regard, since although it represents a fairly sizeable shift from the language
used 3 or 4 months ago, it still falls far short of showing any appreciation of
the fact that the last 2 months (the FOMC did not meet in February) have seen
some of the strongest economic data seen in decades. Admittedly this strength
has not been shown across the board, but most of the strong data is of the
"leading" variety and the only truly weak portion of the economy is the New
Home market. For instance, the committee described the labor market to be
"improving gradually" while Initial Claims (which typically lead Non Farm
Payrolls) have fallen as fast over the last few months as any time they have
since the early 1980's.

In any case the message from the FOMC is clear. QE2 will be completed (this has
always been our assumption) and the FDTR is to be kept on hold for an "extended
period". The bond market right now is in no mood to argue with the FRB, but the
longer the FRB keeps rates inappropriately loose, the greater the eventual
adjustment will be. Meanwhile a completed QE2 should see Commercial Bank Excess
Reserves up somewhere close to the $1.5 - 1.6 Trln range (compared to total
assets of $9.11 Trln and total Credit of $6.7 Trln). Perhaps the most
interesting aspect of QE2 is how little of the money "created" has seeped
directly into the wider economy, with the vast majority still sitting idly as
cash held by the Federal Reserve. A year ago the FRB was struggling to convince
sceptical onlookers that it could manage an "exit policy" that would control
Reserves close to the $1 Trln level. This task has only got harder in recent
weeks.

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

Brd of Governors: Press Release FOMC statement
2011-03-15 18:14:09.114 GMT

http://www.federalreserve.gov/newsevents/press/monetary/20110315a.htm

PageExcerpt:
Release Date: March 15, 2011 For immediate release Information received since
the Federal Open Market Committee met in January suggests that the economic
recovery is on a firmer footing, and overall conditions in the labor market
appear to be ... - frbbalancesheetmar11.gif

Up until the last 48 hours it has been an open question as to whether to
treat the global equity markets as being in a consolidation or corrective
phase. Events in Japan have obviously answered the question and even
though we believe their actual significance for the global economy is
being vastly overrated by the reaction of capital markets, we respect that
fact that markets and economic reality can diverge for an extended period
(as we saw last summer in the US).

The early stages of a correction are typically the most informative since
it tends to uncover the relative willingness of holders to hang on to positions
under duress. This is typically the best guide to where leadership will
reside in the next rally phase of the market. It is already fairly clear
that the US equity market holds this position at the current time, with
today's drop of approximately 2% in the SPX index comparing very favorably
to other developed markets. Perhaps most surprisingly the SPX is down
almost half of the losses seen in Germany's DAX index (3.87% at the time
of writing) which arguably had been prior leadership for global markets.
This is already a marked distinction from last spring's sell off. Moreover
within the US equity market several (non commodity related) economically
sensitive groups have performed much better than could have been expected.
This is also true further down the capitalization scale, with the RTY
index still trading above its own key support at 775.

It may therefore be premature to set a downside target for the current
move (assuming that it extends into several more sessions) but this is
never as useful an exercise as most suppose. What is far more interesting
is to discern which markets can be expected to eventually recover and
resume their advances and at the current time it appears that the US has a
greater chance of doing so than the vast majority of global markets. -
D-SPX_Index.gif -

Today's headlines are understandably dominated by Japan's disastrous
earthquake and tsunami. We currently view as far more of a humanitarian tragedy
than a globally significant economic event, but we will watch developments over
the next few days and comment accordingly. In general our view is always to do
as little reflexive trading as possible in the aftermath of a natural disaster
(we remember the gasoline debacle that took place following Katrina, when
futures spiked from $1.90 to $2.92 in a matter of days only to fall back to
$1.50 by mid November) but wait until less patient trading flows create
mismatches between opportunity and price.

What may go unnoticed is some interesting data out of China which suggests
that the series of monetary restrictions introduced in recent months may
finally be having some effect. This follows last week's trade data which
shows China moving into a trade deficit for the first time since 2008
(something we had predicted would occur a month ago), although the
lagging 12 month ma is still strongly positive at $13.5 bln (see chart).
China's monetary data shows M2 growth slowing quite rapidly to 15.74%, the
lowest level since November 2008. Narrower definitions of money show an
even sharper slowdown, with M1 growing 14.50% (down from 39% in January
2010) and M0 only growing 10.3% over the last year. This compares to an
increase in Fixed Asset investment of 24.9% over the last year, Industrial
Production of 15.8% and Retail Sales of 14.9% (data was released last week). We
would therefore seem to have reached the crossover point at which the growth of
money within the Chinese Economy is at or lower than the increase in economic
activity, which is perhaps the best definition of a tight monetary policy. Of
course it can take several months for this to have a tangible effect on actual
economic activity, particularly in the slow moving world of real estate
development which has been the target of many of the new policies, but
this does not alter the fact that something material has changed within
the Chinese economy over the last 6 months, namely a rapid transition from
loose to tight monetary policy. - D-CNMSM2_Index.gif - D-CNRSACMY_Index.gif -
D-CNFRBAL_Index.gif -

Strong payroll data and better than expected Factory Orders (up 3.1% in
January on a Month over Month basis and over 9% YoY) have finished off one
of the strongest week's for US economic data in recent years. The effect can
be seen in the attached chart of the Citigroup Economic Surprise Index
(CESIUSD) which has pushed out of its historic range to reach an all time high
of 97.50 this morning, well above prior data-cycle peaks that have been
recorded over the last 8 years. This suggests that the last 90 days have seen
the largest upside surprises over the course of the last two cycles and we
suspect that this would be true of the 1992-3 recovery period as well if the
index went back that far in time. There are several implications to take from
this.

Firstly the US economy is much stronger than people expected 3 to 6 months
ago. In fact we we would argue that last August's low point (which
coincided exactly with Chairman Bernanke's Jackson Hole speech) represents one
of the greatest miscalculations of underlying economic strength in the modern
history of macro-economics and central banking. Secondly market expectations,
which tend to get recalibrated much more quickly, have moved well ahead of
official consensus (note the sell off in the face of strong data both on
Tuesday and this morning). This does not mean that the full extent of the US
economic cycle has been priced into this market, but simply that this
current stage is finally appreciated to be an abrupt acceleration in
activity of the type last seen in the early 1980's. The third implication
is that official consensus is about to be changed quite radically with
much more punchy estimations of growth, corporate earnings and employment
being built into official models. At some point this will even be true of
the Federal Reserve but the "aha moment" for this slow-moving body
probably still lies several weeks in the distance. Finally (and less
positively) this is probably about as good as it gets for this particular
phase of the cycle. Going forwards data will have a harder time beating
consensus (although in absolute terms it should still on average be very
strong) and the growing risk of a change in monetary stance will
increasingly prey on the nerves of the market. This is in line with our
belief that we have entered a more volatile phase for the equity and
treasury markets but that over the medium to longer term the former should
advance on to higher levels while the latter (together with high quality
fixed income) will provide mediocre absolute and relative returns. -
D-CESIUSD_Index.gif - W-CESIUSD_Index.gif -

February's US Non-Farm Payroll data came out in-line with expectations at
192K, with Private Sector Payrolls growing at a a strong 222K and the
Manufacturing sector adding 33K. If there was any disappointment in the
data it was that January's shockingly low print was only revised higher to
63K (from 36K). Nevertheless while some may have hoped for a true "blow-out"
report given the much better than expected series of Initial Claims report,
most observers will take the view that this is a robust set of data that
suggests a marked improvement in US employment is underway.

Our preferred way of looking at the data is restricting it to the Private
Sector report and then using a fairly long moving average (12 months) to
discern the direction and speed of trend. 3 months ago we created the
attached chart and placed two trend lines on it, one (red) which
represented the "Jobless Recovery" and the other (blue) a much more rapid
improvement in Employment. As can be seen, even with January's weak print
in the data the 12 month ma looks to be far closer to the more optimistic
scenario and this would suggest that we should start to see +300K prints
or higher sometime in the next 90 days or so.

Today's report is not of that ground-breaking variety and has been greeted
with a yawn by the Treasury and equity markets. Given yesterday's sharp
reaction to Claims data this is reasonable, but the fact that February's
Non-Farm Payroll report was in line with consensus does not mean that
consensus represents an accurate prediction of the the future trend of
employment this cycle. We still would expect a far more rapid improvement than
is currently priced into today's marketplace. - M-NFP_PCH_Index.gif -

We try not to get too excited about single economic reports and so we will
restrict ourselves to noting that this week's Initial Jobless Claim report
is the sort of upside surprise that we had been hoping to see at this
point in the cycle.

Total Claims were reported at 368K with NSA claims a little lower at 351.1K,
while last week's strong report was improved by another 3K. This was
significantly lower that consensus estimates of 395K and is the lowest level of
claims reported since May 30th 2008. The more reliable 4 week ma collapsed to
388.5K, the lowest reading since July 11th 2008.

As can be seen on the chart since breaking down through support at 450K (the
multi-week stasis at this level we suspect was in part caused by a
ill-conceived statistical adjustment within the BLS) the 4 week ma has moved
forcibly downwards in a similar fashion to the earlier 1983 recovery (see
shaded ovals on chart). What we have not seen is this rapid improvement in
Claims resulting in a surge in the Non Farm Payroll report, but frankly with
virtually all other data series pointing to a rapid improvement in employment
metrics it is only a matter of time before we start to see the Non Farm data
step up to levels that far exceed the expectations of most observers including
the Federal Reserve. - D-INJCJC4_Index.gif -

Bloomberg Chart of the Day based on our observation regarding the surge in
short interest in EEM ETF (although Jimmy Rogers supplies the quote). As we
wrote a couple of days ago short sellers would probably do better to
concentrate on specific sectors (financial and consumer discretionary) rather
than the simple overall asset class.

Both of this morning's "minor" payroll studies suggest that February saw
an uptick in hiring. The monthly ADP estimation of payroll change came in
at 217K, slightly above consensus and this data continues to reflect
payroll gains in line with those experienced in Q1 2004. It should be noted
that consensus estimates for Friday's Non-Farm Payroll report are
currently at 190K, which is essentially equal to this data, but we would
caution that anything is possible following the very strange print of 36K
that was reported in a heavily weather adjusted January data.

The Challenger Job report at first glance looks to be alarming with Job Cuts
rising 20% on a YoY basis, but on closer inspection is a more positive piece of
data. Total job cuts rose to 50,702 which is the highest reading since March
2010 but is still a very moderate level for this data series. The 6 month ma
remains unusually low at 40,800, which is lower than its level at the height of
the 2000 tech boom. Moreover the little watched "New Hire Announcement" sub
index came in at a very high 72,581, taking its 6 month ma up to 64,400. This
would appear to be the largest positive spread between the 6 month ma's of the
"Job Cut" and "Job Hire" indexes since the latter was created in 2004, which is
supportive of our belief that the employment picture is improving somewhat
faster than the official data has recognized. - D-ADP_CHNG_Index.gif -
D-CHALTOTL_Index.gif -

It is ironic that on a day in which the market was busy extrapolating the crude
oil price higher and judging this to be a significant problem for consumer
demand, further confirmation of the turnaround in US new car sales was
delivered by February's data.

Total sales were reported at 13.38mm, well above expectations of 12.60mm and
the strongest sales (ex-cash for clunkers) since June 2008. As the attached
chart shows, this suggests that sales are following the "fast track" back to
pre-crisis levels that we suggested would occur back in September and we still
think it reasonable to look for sales well above 15mm by the end of 2011 even
if crude oil were to remain close to $100 per barrel.

We were not surprised to see this strong data largely ignored by the market
today, since we had already seen buoyant ISM data dismissed in the morning
session. However, the pace of car sales recovery has a host of positive
implications for industrial activity and employment over the coming months,
even if they are unlikely to be considered significant by the equity market in
the immediate term.

We also wonder what implication surging car sales have for the new home market,
the one large ticket item that has so far seen absolutely no sign of a pick up
in demand. Clearly these two markets have diverged now for several months and
there are not the same issues with replacement needs that we highlighted for
cars several months ago. Nevertheless, it is a remarkable anomaly that New Home
sales can remain at 50 year lows when homes are extremely affordable (the cost
of owning in many markets is now less than the cost of renting an equivalent
home) and consumers are increasingly willing to purchase other large ticket
goods. While we have no certainty as to when this will change we have much more
confidence in saying that whenever consumers start exhibiting a willingness to
purchase homes we will see the same sort of "V" shaped recovery in activity
that has tracked through other consumer metrics since they bottomed 2 years
ago. - newcarsalesfeb11.gif

The February ISM Manufacturing index proved to be as strong as we had expected
with the overall index reaching 61.4, slightly ahead of consensus estimates of
61.0. This is the strongest reading since May 2004's identical reading (which
marked the peak for this data last cycle) and is the second strongest reading
since 1983, which should give a sense as to the unusually rapid pace of
industrial recovery.

Encouragingly strength was recorded across the board with New Orders (red)
reaching a new cycle high of 68 while Production (blue) rose to 66.3. We were
surprised to see Inventories (olive) slip back into negative territory at 48.8
since this clashes with some other inventory metrics. The most positive data
came in the form of the Employment index (pink) which reached 64.5, the second
highest reading on record, only bettered by the January 1973 reading of 67.8.

We would note that the equity market's intial response to this data has been to
trade lower, which indicates that participants have adjusted their expectations
considerably over the last 60 days. Official consensus estimates have probably
started to lag the opinion expressed by investment activity, but as we enter
the last month of the quarter we would expect to see some fairly hefty
revisions to Wall Street's economic models in the near term future. All of this
tally's with our belief that we have entered a more difficult phase for the US
equity market, but not necessarily a straightforward corrective phase. -
ismfeb2011.gif