The Chicago PMI index for April showed a modest deceleration from March, coming
in slightly below consensus at 67.6, but still at a level consistent with
robust growth in the industrial sector. New Orders (red) fell from 74.5 to 66.3
and Production (blue) from 74.2 to 70. Neither of these are levels to cause us
any concern at this point in the cycle. Meanwhile Inventory (olive) rebuild
dropped back to a near-neutral 53 (down from 60.5) while Employment (pink)
stayed near its cycle peak at 63.7 (65.6). We would therefore categorize this
as a solid report but note that consensus has started to look for extremely
strong data as a matter of course. - chicagopmiapr11.gif

Turkey released another poor set of trade data this morning with its
monthly trade balance plunging to a new all time low of -$9811 Bln in
March. Although export data was strong at $11.8 bln (up 19.65% YoY) these
were dwarfed by imports of $21.6 bln (up 44.1% YoY). This month's data
takes the training 12 month ma of the trade balance to -$6970 per month,
or $83.6 Bln over the course of the year (approximately 11.3% of 2010 GDP).

As we commented yesterday the actions of the central bank scarcely seem
sufficient in the face of this sort of data. Although the initial reaction of
the market was to push the Turkish Lira (TRY) higher, on the basis of further
interest rate hikes, this seems a gross simplification of the risks facing this
economy at the current time. Turkey combines reckless economic policy with
growing political uncertainty. Although capital flows are capable of ignoring
this reality for a number of months (and in fact have already done so) the
growing likelihood is that this long boom will end in a period of considerable
duress for the local economy and hose who have invested wholeheartedly
within it. - D-TUTBEX_Index.gif -

Banking scandals are one of the signs that monetary pressures are building in
an economy since a tightening of conditions often brings malpractice to the
surface. In Brazil's case, there have now been two significant examples in the
last 6 months. This is not quite enough to represent a trend but it is another
sign that the quality of the current cycle is starting to deteriorate along
with its velocity.

One of the most persistent worries for the domestic US economy has been
that of a "double dip" for the housing market. In recent months these have
been fueled by a drift lower in home price indexes (Case Shiller being the
most widely quoted) and some very mediocre New Home data. On the other
hand overall activity in home sales (which we would argue is the key
metric to follow) has remained quite stable in recent months, once one
adjusts for the over stimulation and collapse of demand caused by the
2009/10 tax credit program. March's pending home sales data continued this
trend rising by 5.4% to 94.1 on a seasonally adjusted basis. This was
substantially better than the consensus estimate of 1.5% although we would
caution that this is a very volatile data set and February's data was
revised lower by 1.4%. Even so this data suggests that overall home sales
continues to recover and that the important spring selling season is off
to a strong start with the non-seasonally adjusted data showing March
sales as being the strongest since 2007. Thus far there is no suggestion
that New Home sales have started to participate in this improvement, but
even if the trend of rising sales is confined to the existing home market
it will still provide the vital service of absorbing the overhang of
foreclosed inventory in the months ahead. - D-USPHTOTL_Index.gif -

As we have outlined on a number of occasions, Turkey's economy appears to be on
the verge of dangerously overheating and two pieces of data struck as
confirming our concerns. Turkey's central bank raised its CPI forecast for 2011
to 6.9% from its prior level of 5.9%. Although this was a significant
surprise (the official target is 5.5%) there was no indication given that the
central bank expected to increase the pace of monetary tightening, at least
through the use of conventional interest rate policy. As with other central
banks, MPMP (which in Turkey's case seems to be centered around reserve
requirements) seems to be the policy tool of choice.

A more tangential sign of inflationary pressures (but no less accurate) is
given in the accompanying news story which describes the plan to build a new
canal from the Black Sea to the sea of Marmara. These seas are of course
already linked by the straight of Bosporus, which while crowded, scarcely needs
to be replaced. This sort of maniacal hubris is typical of the ends of long
periods of expansion and is typically manifested in the private sector by the
construction of exceptionally tall buildings. Whether or not this project is
ever started or completed is probably besides the point. The very fact that it
is being considered and placed at the heart of the incumbent Prime Minister's
election plans is an accurate guide to the state of thinking at the current
time.

It is a sign of quite how frothy Brazil's loan market has become that a 1%
increase in overall loans outstanding in March has been greeted as something of
a success for the central bank's implementation of MPMP. In fact looking at the
data in detail, it can be seen that industrial credit is starting to grow
quite slowly (up 0.28% in March and 1.58% YTD) while consumer and housing
credit continue to explode higher with the latter up 3.00% in March
alone. This suggests that consumer activity continues to rely
increasingly on credit growth, which is very much contrary to the wishes of
the central bank and explains their decision a couple of weeks ago to
introduce an additional 3% tax on consumer loans.

We would of course grant that housing credit remains quite small in
absolute terms and at 8.6% of total credit outstanding hardly poses a
significant threat to the financial system, but the strength of the local
housing market is still now much more reliant on mortgage credit than it
has been at any point in modern history, and this is a change that few
investors are sensitive to. Meanwhile there is increasing evidence that
the delinquency cycle for existing personal loans may be turning. The
March data showed total delinquency (accounts 15 to 90 days late) for
personal loans rising to 6.5% from 5.9%. We would not call this rate
alarming but it does represent a significant change in trend from the
extremely low delinquency levels seen in 2010 and it does suggest that
either underwriting standards may have slipped appreciably in recent
months or that monetary tightening may be having an effect on marginal
borrowers (not that these are mutually exclusive). - D-BZLNTOT_Index.gif -
D-BRCDDESH_Index.gif -

We have been following Israel's monetary cycle closely in recent weeks since we
see this country as offering significant insight into policies likely to be
followed by other emerging markets. As we had anticipated the BoI has radically
tightened credit terms for variable rate mortgages. With interest rates at
historic lows, these had come to dominate mortgage applications with roughly 85%
of mortgages being variable over the last 12 months (note that by comparison
variable rate mortgages peaked in the US at 36.6% of loans in March 2005).
Tellingly the release included the statement that:

"The Bank of Israel notes that many financial crises that have occurred in
other countries began with housing credit granted under terms that did not
reflect the risks developing in the sector, and that were inappropriate in
light of the rapid rise in housing prices. The new directive is intended to
prevent developments of this type, for the interest of the public and the whole
financial system."

Following the implementation of this directive on May 5th, only one third of a
mortgage may be subject to variable rates. This very much fits the template of
MPMP being both intrusive into capital flows and arbitrary in its formulation.
Its main effect will be to increase the cost of credit to home-purchasers and
the complexity of loans being utilized. By itself it is unlikely to cause a
correction in the housing market, but our sense is that the acceleration in
supply of new units may already be close to doing so. It remains to be seen
whether further MPMP addressing foreign flows into domestic fixed income will
be implemented in the coming weeks, but our assumption is that this will prove
to be the case.

The April meeting of the Bank of Israel continued to demonstrate a marked shift
in monetary policy away from simple interest rate management and towards macro
prudential measures (although it is interesting to note that unlike the
majority of emerging market central banks, the attached statement avoids the
use of the term "prudential"). Although the local economy is showing clear
signs of overheating, the strong performance of the Israeli Shekel and low US
and European rates has deterred the BoI from raising interest rates further.
However, as the statement makes clear new MPMP restrictions can be expected in
the near future:

"The Bank of Israel will continue to monitor developments in Israel's economy
and the global economy and in the financial markets. The Bank will use the
instruments available to it to achieve its objectives of price stability, the
encouragement of employment and growth, and support for the stability of the
financial system, including keeping a close watch on developments in the assets
market, and especially in the housing market."

The Philly Fed April survey came in at 18.50 in April, well below both
consensus estimates of 36.9 and March's stunning reading of 43.4. Nevertheless
18.50 is still a strong reading and given that this is a diffusion index with
significant month to month volatility we would assume that perhaps March's
strength was an overstatement that led to an exaggerated fall-back in April,
but that the robust trend manufacturing expansion remains intact.

In terms of the sub-indexes New Orders (red) fell back sharply to 18.80 (from
40.30) but remain strongly positive. Shipments (not shown) remained high at
29.10 (34.90) as did Prices Paid at 57.10 (63.80). The weakest data was
generated by Inventories (blue) which fell back to a neutral 1.70 (12), while
Employment (green) came in at 12.30 (18.20) suggesting that manufacturing
employers continue to add positions. - phillyfedapr11.gif

In line with consensus estimates Turkey's central bank left its benchmark
interest rate on hold. Attached is a copy of the release that accompanied the
decision which outlines the same MPMP logic that was used last night in Brazil.
In Turkey's case the evidence of overheating is much more significant, with
both inflation and the balance of payments signaling that the multi-year boom
is starting to exact a toll of economic stability. Nevertheless, while foreign
investment flows remain powerful and the currency strong, the central bank is
clearly inclined to use non-interest rate measures to dampen credit growth.

The Central Bank of Brazil announced a 25bp increase in the SELIC target
rate to 12.00% last night, somewhat smaller than the 50 bp increase that
most had expected. However, this should not be seen as a sign that the
Bank intends to tread softly in the months ahead. The accompanying
statement made clear that a number of future increases should be expected
and that these would continue to be supplemented by a variety of
macro-prudential measures. Indeed, as we have argued before, the use of a
MPMP framework suggests that rather less emphasis should be paid to the
overall level of interest rates since this is a far less accurate gauge of
monetary conditions in the key portions of a booming economy, but this
point seems lost on most observers. Under MPMP one of the problems the
central bank faces is that it is much harder to determine the stance of
the bank, and the efficacy of its policies than under a simple interest
rate regime, risking a loss of credibility during a vital stage of the
business cycle. Our belief remains that this technocratic experiment will
end badly, perhaps with the worst of all worlds, accelerating consumer
prices coming at the same time as an unwind in local asset markets. -
M-BZSTSETA_Index.gif -

April's NAHB Homebuilder survey shows no meaningful change in the sentiment of
this industry. The overall index ticked down to 16 from 17 and this was
primarily caused by a drop in the Future Sales index to 23 from 26. On the plus
side the Traffic sub-index ticked higher to 13, the best reading since June
2010, but still well below the sort of reading that would indicate a meaningful
spike in activity. The NAHB reading suggests that new home starts and sales
will remain very weak when they are released later this month, pushing back any
overall recovery of the industry later into 2011. As we have noted before, this
does not preclude some modest improvement being reported this quarter by the
small public homebuilders. The fact that the NAHB index is a poll of a large
number of builders (350 in this month's poll) skews its results to the
sentiment of small private builders which will lag any recovery by the much
more liquid and stable public builders. - nahbapri11.gif

Today's news that S&P has downgraded the outlook on the long-term rating
of the U.S. sovereign to negative from stable will no doubt generate many
headlines and op-eds, even though the rating agencies themselves lost
their position of authority in the early stages of this cycle. In terms of
today's announcement (see attached for full press release) we would view
it as a milestone of sorts but neither particularly surprising or
important, although we could not help chuckle at the irony of the S&P Primary
Credit analyst going by the name of "Swann". Our own definition of AAA credit
has always been a credit so clean that you don't need to argue about it, and
under this practical guideline the US lost its rating sometime towards the end
of 2008. This of course does not suggest that a probability of default or
restructuring is anything other than extremely remote, simply that it is no
longer impossible to consider occuring at some point in the future.

As many observers expected, China moved to raise reserve requirements for large
banks to 20.5% (effective April 21st) on Sunday. In making this move the PBOC
indicated that there is no "absolute limit" to the setting of reserve
requirements and more intriguingly that this move is part of a transition of
monetary policy from "moderately loose to prudent". Those who followed our work
two years ago will recall that "moderately loose" was the term used to describe
the ballooning of M2 to a growth rate of 29.70% in the summer of 2009, a move
that ignited the housing boom that the PBOC is still trying to quietly deflate.
One could therefore infer that "prudent" represents a similar understatement of
intent in the tightening direction. Our view remains that the steady ratcheting
of reserves and other MPMP are likely to prove effective at dampening activity,
but that this is likely to be achieved at the cost of stability in local asset
markets. This weekend's move while expected only serves to bring this
turbulence another step closer. - chinareserveapr11.gif

March's Industrial Production and Capacity Utilization report was stronger than
anticipated and also contained positive revisions to the surprisingly weak
February data (justifying the market's non-response a month ago). This month's
data took Capacity Utilization up to 77.4% (in line with consensus), which
places the index at the level reached in June 2004 at the time the 2004/7
monetary tightening cycle kicked into motion. Although it could be argued that
Capacity Utilization is still a little below its long run average (30 year ma
is 79.16) given the rapid pace of repair this level seems likely to be reached
by the early summer. Thus another of the FRB's favorite macro-statistics is
starting to call for a rather more robust stance than a perma-hold of a 25bp
Fed Funds rate. - capacityutilizationmar11.gif

Our point about investor flows and risk (see earlier mail) has been
painfully demonstrated by Peru's IGBVL index which has declined by 17.1%
over the last 5 sessions in response to fears that the populist leader
Ollanta Humala will win control in the upcoming run off vote. As the
attached chart shows, Peru's strong equity gains in 2009 & 2010 attracted
powerful investor flows (we are using shares outstanding in the EPU ETF as
a proxy), with these flows peaking approximately 4 weeks after the index
made its all time high on February 11th, just a whisker above its prior
2008 peak. Since this time losses have been extremely rapid, exhibiting a
degree of panic amongst local and foreign investors. We have no sense as
to the end of this story at present, other than to note that the next
obvious support comes in around the 15,500 to 16,000 range where a series
of peaks were made in 2009 and 2010. More important is to consider the
short warning that was given to a decline of this magnitude, which
indicates the level of crowding that was present at the time the market
reached its peak. Although Peru may have been at the extreme end of allocations
relative to market size we suspect it is not alone amongst emerging markets in
being vulnerable to a reversal of investor flows. - D-IGBVL_Index.gif -

We returned from our client road show this morning to see the release of
China's monthly monetary data. This confirms the recent trend of slower
monetary growth, but at 16.63%, or close to twice the pace of GDP, M2 can
hardly be said to be said to be restrictive at the level of the overall economy.

Total new loans came in at 679.4 bln CNY, which is virtually identical to
the trailing 6 months figure of 648.29 bln CNY. Our assumption would
therefore be that further tightening measures lie ahead for the Chinese
monetary system, which is pretty much in line with current expectations of
yet another increase in bank reserves either tomorrow or next Friday.

However, we would hesitate from concluding that the slowdown in M2 growth
has had no effect, since for the hotter portions of the Chinese economy,
particularly its real estate market, current monetary growth may already feel
restrictive. Regional growth rates that include a combination of the number of
homes being constructed or sold and price appreciation now comfortably exceed
monetary growth and this is before taking into account the fact that additional
MPMP measures have been introduced to restrict lending to second homes in
hotter markets.

The history of monetary tightening cycles is that authorities grow frustrated
with the slow reaction of the lending and investment cycle they wish to
curb and therefore continue to tighten well past the point that a
restrictive policy has been enacted. In fact there have been some recent
local news stories that suggest that Beijing prices and activity for March
have fallen very sharply, while second tier markets continue to boom (this
sort of geographical dispersion is quite typical, with the original
leaders of a cycle typically the first to give way). Our sense is that this
familiar story will play out in China and other emerging markets over the
course of the next few months and view that activity reports for key sectors
and tracking monetary policy changes are a far more accurate gauge of the
state of the cycle than local asset prices, which merely reflect the
continued robust flows into this area of global markets. - D-CNMSM2_Index.gif -

Notwithstanding the very robust performance of the entire emerging market
complex around the end of the quarter, our belief continues to be that local
economies are on the point of being impacted by the monetary tightening that
has taken place in recent months. Asset prices are a reflection of capital
flows, which historically have been remarkably poor at seeing around the corner
of cyclical turns. We therefore believe that readers' attention should be drawn
towards economic and corporate data within the key sectors of individual
countries (note these vary considerably across the complex), some of which are
showing distinct signs of moderating.

This morning for instance, saw another poor set of data from Indian
manufacturing. Although this economy is widely believed to be one of the
power-houses of global growth, official data shows that the annual rate of
growth has slipped sharply in recent months. February's data showed YoY growth
of a mere 3.6%, well below consensus estimates of 5.1%. Using a more reliable 6
month ma (red line on chart) we see growth falling to 5.1%, down from 15.7% in
May 2010. It should be noted that this growth rate is well below the funding
cost of the average Indian industrial borrower (3 month Libor is just under
9%), which is an indication of monetary tightness within this key portion of
the Indian economy. - indianindustrialproductionfeb11.gif

The FOMC minutes for March 2011 (see link below)

http://www.federalreserve.gov/monetarypolicy/fomcminutes20110315.htm

China Raises Interest Rates to Counter Inflation Pressure (1)

This morning's announcement that the PBOC has moved to raise its base rate by
25bp to 6.31% effective tomorrow is in line with our belief that we are in the
middle of a considerable tightening cycle with the emerging market complex.
Although much of the tightening has come in the form of alternative "MPMP"
directives this does not mean that the traditional tool of interest rates is
being ignored. It is not clear that this particular announcement will prove to
be meaningful in the course of the investment cycle but the decision to raise
rates by an influential central bank will not be ignored by this most herd-like
of professions.

 

The devastating earthquake and tsunami in Japan appear to have achieved
something the financial trauma of 2008 could not, namely to cause a shift in
the rigid policy at the BOJ against quantative easing. As we commented on a
number of occasions in 2008 and 2009, the BOJ was alone amongst major central
banks in keeping the size of its monetary base near constant. This was in part
a legacy of the memories of hyper inflation that followed Japan's debt
monetization in WWII and its aftermath, but also the disappointment with the
effects of the prior experiment with quantative easing that was followed
between 2001 and 2003. One clear reason for the failure of the latter
experiment was the speed with which it was withdrawn in 2004 and 2005, despite
a lack of any inflationary pressure within the Japanese economy at that time,
while the adverse conditions present in WWII clearly went well beyond monetary
exuberance.

March's monetary data suggests that a fairly powerful initial response by the
BOJ has taen place. The monetary base grew by over 11% or 1173 Bln JPY
(approximately $140 bln), which represents about 25% of the size of the entire
QE2 program over a 3 week period of time. Of course creating money and having
it circulate in the wider economy are two quite separate processes, but the
early signs in Japan are that perhaps a key turning point in monetary policy
has been reached. We will be following this quite closely in the weeks ahead. -
japanmonetarybasemar11.gif

March's ISM report was in line with expectations of a strong report and
supports our view that the US has entered a period of industrial expansion that
may remain in place for a considerable period.

The overall index was 61.2, almost identical to February's 61.4 and was
supported by strong readings in all sub-indexes with the exception of
Inventories. Most importantly the New Order index (red) remained very strong at
63.3 which Production moved up to a new cycle high of 69 (blue). The employment
index (pink) at 63 once more suggests that the increase in production is
leading to re-hiring but not yet to a rebuild in inventories, since that index
(green) remained in marginal negative territory at 47.4. - ismmarch11.gif

It is always a relief when the monthly Non-Farm Payroll report passes without
too much of a surprise, particularly when expectations had been for a positive
report. March total payroll gains were estimated at 216K with Private Sector
payrolls growing by 230K. This takes the trailing 12 month ma up to 138K which
is a very normal level for this point in an employment cycle. In fact it is
almost identical to the level reached when the FRB raised the FDTR in June 2004
(134K) although a little less than the 230K in January 1994 which preceded the
surprise hike in rates by the Greenspan FRB a few weeks later.

Perhaps all that is missing this cycle is a single "upside shock" report of
275K or more. For instance things were never the same for the US yield curve
after the March 2004 300K report, which finally exposed the wooly thinking
behind the much used "jobless recovery" metaphor. On the other hand we are
starting from a base of only 25 bp this time around and, as we commented last
night, we may start to see a much more fractious debate over monetary policy
played out by FRB governors and regional presidents over the coming weeks. -
privatenonfarmmarch2011.gif