The recent run of disappointing US macro data (See Friday's comment on the
Citigroup Surprise Index) continued this morning with May's Chicago PMI report.
This showed a sharp drop to 56.6 from April's reading of 67.6 and was below
consensus estimates of 62.0.

Although at -11.00 the size of decline for a single month is unusually large
(it is the largest drawdown since October 2008) and the third largest since
1990 the level of the index in May is not abnormal for an expanding economy. In
fact if anything this month's data may indicate a "normalizing" of the current
manufacturing cycle following the collapse of activity in 2008 and tardiness in
rebuilding inventories through 2009 and 2010. It should also be borne in mind
that ex-construction most US industrial activity is now close to the prior peak
levels recorded in the last cycle, making rapid acceleration (as opposed to
steady growth) a little harder to achieve.

In terms of the data itself the drop in the overall index to 56.6 is very
reminiscent of the decline in May 2005 (the so-called "soft patch" in the
middle of the prior cycle). New Orders (red) fell to 53.5 (they hit 55.8 in May
2005), which indicates moderately expanding order books. Production (blue) held
up slightly better at 56 (55.6 in May 2005). Interestingly Inventory rebuild
remained quite strong at 61.6 as did Employment at 60.8. This tallies with our
observation that inventory/sales ratios remain very low, requiring many months
of sustained productive gains in order to bring them back to a more typical
level. Neverthless should tomorrow's ISM data contain similar data we would
expect to see more negativity built into the consensus view of the current US
economic cycle. - chicagopmimay2011.gif

The unwillingness of IPO markets to absorb a packed issue calendar is often a
sign of an important top being put into place. The indigestion being shown in
India should come as little surprise given the recent performance of its equity
market.

Interestingly the market for corporate debt remains extremely robust, with May
seeing $1.2 bln net inflows, almost entirely compensating for the -$1.5bln of
outflows from the equity market, and we would expect a number of corporations
to seek to use debt instruments as an alternative source of capital.

Turkey's trade balance for April came in slightly better than expected at
-$9.1 bln compared to expectations of -$9.8 bln leading to a sharp 2%
rally in the local XU100 index. Nevertheless this is still the 2nd largest
monthly deficit on record and, given the volatility of this data, is not
meaningfully better than March's shocking -$9.8 bln deficit. The pace of
deterioration is shown by the 12 month ma, which fell to a new record low of
-$7.26 bln, copared to -$4.16 in April 2010. Today's data confirms that Turkey
is reliant on massive inflows of capital in order to finance its trade
position, and that should these not continue to be provided the Turkish Lira
will be highly likely to weaken in the months ahead. - D-TUTBEX_Index.gif -

As we mentioned earlier today, the US is currently undergoing something of
a "data shock", which is the term we use to describe a period in which
macroeconomic data falls below consensus for a period of weeks. This
should not be confused with actual economic activity, since in any one
economic cycle there can be a large number of separate data cycles (we
wrote about this at some length during last summer's difficulties) that come
and go over a period of months. We attempt to track these cycles by using the
Citigroup Economic Surprise Index (CESIUSD index) which compares economic data
over a 90 day period to prior expectations.

As can be seen on the attached chart, the CESIUSD has collapsed from an
all time high of 97.5 recorded on March 4th to a current reading of
-57.20. In fact the current reading is very close to that seen at the
August 2010 low (-64.30) which was recorded on the eve of Chairman
Bernanke's Jackson Hole speech that foresaw the introduction of QE2. This
does not mean that data itself is as bad as it was last summer, merely
that it has underperformed expectations to a similar degree. Expectations
themselves have been considerably increased over the last 9 months as a
modest but sustained recovery has been largely baked into the current
consensus, as opposed to a widespread belief that a "double dip" was
occurring back in August. This makes recording a "negative surprise"
number considerably easier.

Our sense is that this process has gone on long enough to promote a wave
of revision amongst economists and strategists, with GDP estimates and SPX
index year end targets likely to be trimmed appreciably. None of this will
change the course of the current expansion, which to our eyes has enough
internal momentum (at least in the domestically focussed economy) to cause
data to recover and extend to new peaks of activity later in 2011. In
terms of timing we would follow the 10 week ma (red) which has the
advantage of smoothing the data over a reasonable time period. This is
still just in positive territory although it will start to enter negative
territory with strong momentum as older strong readings fall out of its
calculation. It may take another 4-6 weeks for this average to form this
data cycle's low, leaving market sentiment quite vulnerable in the
meantime. - W-CESIUSD_Index.gif -

The NAR US Pending Home Sales index showed a steep decline in activity in
April falling to 81.9 from 92.6 in March. Although this is a large
shortfall this data has been extremely volatile in recent years and is
quite capable of bouncing back in the next month's report. The 6 month ma
remained virtually unchanged at 89.8, which is roughly in line with
existing home sales that are tracking a pace of activity seen in the late
1990's. We continue to expect slow progress in the recovery of existing
home sales, but accept that the progress may be quite jerky from month to
month.

We would also accept that today's report will add further encouragement to
those looking for evidence of a US slowdown and it does appear that we
have entered something of a negative "data-shock" in recent weeks (we will
discuss the overall data picture in a separate note), which means that weak
economic reports may start to have a greater emotional impact on the
market than upside surprises. - D-USPHTOTL_Index.gif -

We have highlighted emerging market high yield credit as being one of the most
over-populated areas in global capital markets. We were therefore interested to
finally see some evidence of indigestion in this marketplace, with Brazil's OGX
forced to raise its yield by 100 bp to 8.5% in order to place $2.56 bln of
bonds.

A sensible column that correctly places the odds of a US recession close to
zero. What the article does not say (reasonably enough since its author was
focussing on the US) was that in a number of emerging markets the yield curve
has either inverted or is close to doing so. For instance India's swaps
currently have a higher yield for 1 year (8.20%) than 5 years (8.16%) and
although the 3m rate remains at 7.80% it is only a matter of time before it
inverts.

One of the more reliable signs that an economy is overheating is a sudden
deterioration in the trade balance. We have discussed the example of
Turkey on several occasions but this morning's report on April Trade from
Hong Kong also caught our eye. This showed a monthly trade balance of -$42.437
Bln HKD (approximately $5.44 Bln), the second widest deficit on record. Even
though this data was distorted by a reduction in exports to Japan
following the tsunami, the attached chart shows a sustained deterioration
in Hong Kong's trade postilion over the last 18 months, and the training
12 month ma set a new record low of 27.95 Bln HKD in April. The problem
for Hong Kong's monetary authorities is that their USD peg means that they
are forced to follow the FRB's largesse with regards to convenetional monetary
policy, while the close ties to the far larger Chinese economy further
complicates matters. We would therefore expect to see further implementation of
MPMP restrictions (particularly with regard to housing credit and capital
inflows) on the HK banking system, since to an extent these overcome the
limitations of conventional interest policy under a currency peg. -
D-HKETBOT_Index.gif -

The weekly Initial Jobless Claims report remained elevated at 424K this
week, somewhat above consensus estimates of 404K and last week's reading
of 414K (revised up from 409K). This keeps in place the 5 week run of
surprisingly poor data from this metric, causing the 4 week ma of claims
to rise to 438.5K from a level below 400K in mid-April (see attached
chart). The source of this deterioration is something of a mystery, at
least within the private sector. All anecdotal evidence points to an
increase in hiring in multiple industries and coincident metrics such as
credit card delinquency and apartment rental occupancy rates all
corroborate a steady improvement in employment has occurred. It is possible
that the public sector has increased the pace of lay-offs as budgetary
pressures mount, but it should also be realized that we are dealing with an
ESTIMATE of claims based on a survey of offices and not an actual MEASUREMENT.
We would therefore hesitate to assume that anything meaningful has changed
within US employment over the course of the last 6 weeks.

What this string of poor reading does do, however, is put pressure on an
economic consensus that was already fraying at the edges. We have
suggested for some weeks that Wall Street economic projections were likely
to be trimmed and this process can be expected to pick up momentum. In
terms of market action it will help maintain the strong performance of US
treasuries and the weak performance of industrial commodities, the
material and energy sectors. The fact that today's GDP report also came in
light of expectations will only magnify this effect, even though it refers
to a period which has already been shown by corporate earnings to have
been an excellent time to be operating a business within the US economy.
We remind readers that as a general rule of thumb this sort of "big
picture" data is of extremely limited use to understanding what is
actually occurring in real time and we would not pay too much attention to
either the data or the numerous commentaries that will be issued over the
course of today. - D-INJCJC4_Index.gif -

Since silver's sudden reversal from its April peak we have been internally
tracking the course of the metal and comparing this with the collapse of the
metal in 1980 and also that of the Nasdaq Composite index back in 2000 (we
rebased the latter by a factor of 0.01 which allows us to use the same scale).
We would stress that this is a relatively unscientific comparison, and that
markets can often follow a similar path to prior events for a while before
diverging markedly. Having said this the comparison certainly bears close
scrutiny almost one month into the process.

Of the two charts Silver in 1980 is probably the better guide, since it
involves the same metal albeit in a very different marketplace (nothing close
to an ETF existed 31 years ago). The creation of the Nasdaq's peak was a much
wider social phenomenon and involved hundreds of billions of dollars being
channeled into a quite subset of US economic activity (real estate for instance
went unloved for most of the 1990's). On the other hand the creation of a major
historic top and its subsequent collapse seems to often unfold in a similar
manner.

Interestingly both charts suggest that silver would find its intial support
around $35 (as did occur) and then manage to progress to a little over $40
sometime in the near future (it is certainly possible that month end inflows
will establish this level early next week). In the case of Silver in 1980 a
fairly rapid decline then ensued that took the metal down to $20 three months
later. The Nadsdaq's decline was much more protracted with the index being at
the equivalent of $30 six months later, although it then experienced a very
rapid decline to $25 over the next couple of months. - silvernasdaq.gif -
silver20111980.gif

Turkey's Central bank met today and elected to keep the local 1 week REPO
rate at 6.25%. This itself was unsurprising since the bank had previously
indicated its intention to use "macro-prudential" measures to slow down
credit creation. However, while most had expected to see another hike in
bank's reserve requirements to 17% no such hike was announced today.
Turkey's central bank therefore continues to err on the side of
recklessness on the face of an economy that is clearly overheating. We
cannot help but wonder whether the bank's recalcitrance is being
encouraged by the upcoming election in June that the incumbent
administration seems determined to win at all costs. The clear danger is
that financial markets lose patience with this process and that foreign
capital in particular starts to fear inflationary pressures eroding real
returns. We would therefore keep a very close watch on the Turkish Lira
(TRY) which after a strong rally in April (helped by massive foreign
inflows into the local bond market) has slipped rapidly from 1.50 to 1.60.
The March high was 1.62 and a breach of this level would suggest that a a
sizeable move is underway. - D-XU100_Index.gif -

Attached is a link to today's Bloomberg TV Interview with Michael Shaoul

http://www.bloomberg.com/video/70103440/

The monthly New Home sales report for April came out somewhat stronger
than expected, rising to 323K compared to a consensus expectation of 300K
and March sales which were revised up a notch to 301K. Although we are happy
to finally see an upside surprise this still a very weak report in historical
terms and one which keeps the US New Home market "on the outside looking
in" at the rest of the US economy, which can either be said to be in
recovery or expansion mode.

We would not call this spring season an entire "bust" but we clearly
have yet to see the sort of acceleration in activity that we hoped for.
Nevertheless we remain resistant to the idea that the New Housing market
is permanently impaired, and continue expect an eventual resolution to be
marked by a strong acceleration in activity, or at least as strong as
paltry inventory levels will allow. In this regard it is worth noting that
the total national inventory of new homes has fallen to a record low of
175K. At existing pace of activity this represents 6.5 months of sales,
just above the 6.3 month average over the 43 years of this data. Clearly
any pickup in meaningful sales will lead to a dramatic decline in this
metric, and there is a reasonable chance that the record low of 3.5 months
(set in September 1998) will be challenged at some point in the future. -
D-NHSLTOT_Index.gif - D-NHSLNFS_Index.gif -

An interesting article that highlights the need for India's capital market to
remain "open for business" simply to keep funding existing obligations. The
rash of zero coupon convertibles issued is somewhat reminiscent of the late
stages of the US technology cycle when similar instruments became one of the
most popular sources of financing for 2nd and 3rd tier issuers. Our view is
that funding conditions for emerging market corporate debt is much more likely
to deteriorate than improve from this point on, which would create something of
a credit crunch in this marketplace.

The bank of Israel chose to raise its Base Rate to 3.25% from 3.00% this
morning (consensus was spit evenly between a 25 bp rise and no action) which
means that local rates have now increased by 1.25% since the start of the year.
As the attached release makes clear the BoI is concerned that local CPI is
approaching the top end of its stated target and that the local housing market
requires restraint. In addition to the news on interest rates comments from the
Finance Minister this morning made it clear the legislative action (in the form
of taxation) is being considered to "halt the price dynamics" present housing
market. Our belief remains that these steps will eventually prove to be all too
succesful.

Historically there has been no better indicator of a top in an emerging market
cycle than the large global banks rushing to participate fully in the
opportunities. The opposite is true at the bottom when many foreign ventures
either shutter their doors or sell to locals at a deep discount to original
expectations.

The attached story would seem to be typcial of a "late cycle" entry and it is
notable that one of the "benefits" to gaining a local bank license is that it
will enable the issuance of "bridge financing" for acquisitions.

South Korea Will Tighten Curbs on Currency Derivatives

We note Korea's decision to tighten curbs on currency derivatives which have
apparently ballooned once more following the "KiKo" debacle of 2008. For those
who have forgotten, KiKos were structured notes that gained from the Korean
Won's appreciation against the USD (Brazil experienced a similar rash of
products that were known as "TARNs") but performed horribly during the
post-Lehman collapse of the KRW.

This time around speculation apparently is centered around exporters wishing to
"hedge" their future USD receipts, and has reached a level sufficient to cause
the local authorities to bring in curbs as described in this article. This is
very much in line with the current fad for "macro-prudential" monetary policy
that has been sweeping across the emerging market complex in recent months.

 

US Existing Home sales were virtually unchanged in April at 5.05mm sales
compared to 5.09mm in March. Although this was slightly less than
consensus estimates of 5.20mm this shortfall is well within the error
tolerance of this statistic. Single Family sales were also virtually
unchanged at 4.42mm (4.44mm in March), which coincides exactly with the 6
month ma. Therefore after a decade of fairly violent change, it would
appear that the US Existing Home market has finally found a stable run rate for
the current portion of this economic cycle. This level of activity is similar
to that seen at the end of the 1990s prior to the great boom that
started in 2002. Although we would hope to see some further improvement we
doubt whether this will extend activity much above 4.75 - 5.00 mm homes,
and the latter may prove to be a stretch. However, this is far from
unhealthy and would represent a much more balanced and sustainable role
for the housing market in terms of overall economic activity. It should
also be sufficient to clear up the overhang of foreclosure inventory over
time. One sour note in April's data was a large jump (11.1%) in inventory
to 3.32mm Single Homes and 550K condos (1.85%). We suspect that this surge
is seasonal in data and represents the voluntary listing of homes at the
start of the spring selling season. The evidence of the last 24 months is
that current activity is sufficient to slowly chip away at the official
and "shadow" inventory of homes, although it will take several more
quarters to bring national inventory back to more normal levels. -
D-EHSLSL_Index.gif -

The ZEW German Investor Confidence Index reported a surge in the "Current
Situation" index to an all time high of 91.5 in May (index data goes back to
1992). Although on the surface this may seem to be both good news and justified
by corporate earnings it does bring up the question as to whether the German
marketplace is now being driven by overconfident investors. Certainly over the
last 20 years peaks in the ZEW have been closely matched by peaks in the local
DAX index (see attached chart) and we wonder whether the enthusiasm for
Germany's export driven economy will start to be tempered by some concerns at
future growth within the emerging market complex. We also note that the DAX
index suffered a very sharp reverse between late February (7412) and mid March
(6483) and that although these losses were recouped and the index went on to
record a new recovery high in May (7600.41) the speed of the earlier drop
suggests that an element of overcrowding is present in this marketplace. All in
all the time to take profits and redeploy capital elsewhere has probably been
reached. - daxzewmay2011.gif

The New Home market remains very much the "sector the recovery forgot" and
about the only good thing that can be said about the US Housing
Construction industry is that it has been so poor for so long that its
weakness is now baked into to every forecast. April's data showed no sign
of recovery (hardly surprising given that sales would presumably lead any
uptick in activity). Total starts were reported at 523K with single
family starts at 394K and multi-family starts 129K. The more reliable
permit data showed single family permits at 385K, still well below the
plunging 36 month ma (red) at 455K. However, despite the fact that this data
falls short of consensus estimates we would not conclude that the industry has
actualy deteriorated, it simply has not started to recover in the aftermath of
its historic excess earlier this century. - D-NHSPSTOT_Index.gif -
D-NHSPA1_Index.gif -

State Bank of India Falls After Profit Unexpectedly Plunges (2)

This is exactly the sort of problem that we have been anticipating within the
emerging market banking sector in recent weeks, with India remaining the locus
of our concerns. It would appear that the majority of this quarter's write-offs
actually occurred some time ago but are only being recognized at the current
time. This blow from earnings comes one day after news leaked that a planned
rights offering for the company would be deferred due to a shortage of
government cash (the bank is 59% state owned), further complicating the process
of raising new capital for the bank.

 

The NAHB Sentiment Index continues to indicate no recovery in the moribund US
new home market. The overall index was unchanged at 16, in line with 6 month ma
(see attached). Present sales ticked up to 16 (from 15) but Future Sales were
downgraded to 20 (from 22). A small uptick in Foot Traffic to 14 was reported,
which while the best reading since May 2010 is still indicative of a very quiet
marketplace. The New Home market therefore remains a notable outlier in what
has otherwise proved to be a decent recovery in overall consumer activity. -
nahbmay2011.gif

Since we try not to bring the obvious to our clients' attention we have
refrained from commenting on silver's rapid decline. However, it is worth
noting the similarities of silver's path to $50 with both its terminal move in
1980 and that of the Nasdaq index in 2000. Attached is a chart of silver and
the Nasdaq with the latter rebased by 0.01 (thus allowing the same scale to be
used). As can be seen, a broadly similar path was followed to these two
market's peaks and the initial stage of the declines also bears comparison.
This does not guarantee that the two moves will continue to converge, but if
they were to do so, silver would find support somewhere between $30 - $34 and
mount a recovery that took it back to the low $40's before a long, grinding
decline took it down well below $20 later this year.

We have seen a number of commentaries admit that although clear signs of
speculative excess were present in silver's rapid ascent, gold's recent advance
is far more reasonable. We would caution that although it is true that gold's
rise has been much less parabolic than silver, after a 12 year, 6 fold advance
it can hardly be considered to be without speculative qualities. Indeed a
comparison of Gold today to the SPX in 2000 shows a fair degree of similarity.
As most readers will recall, although the SPX's advance was far gentler than
the Nasdaq this did not stop the index from falling almost exactly 50% by
October 2002, and 11 years later the index remains 13% below its 2000 high. The
key level to watch for gold remains its 150 day ma (currently $1405) which has
represented trend support since early 2009. A breach of this level would
suggest that a significantly more difficult period lies ahead. - goldvsspx.gif
- silver2011vsnasdaq2000.gif

Chile's central bank elected to rase its target rate by 50 bp to 5.00%
last night surprising most observers who had anticipated a 25 bp hike.
This means that Chilean funding costs have risen tenfold in less than 12
months, and although this is a reflection of the fact that they started at
a mere 50 bp, the nominal increase of 450bp is also the largest on record
since late 1998 when rates briefly soared to 14.00% during the LTCM
crisis. Given last night's move, and the fact that the target rate is
still 300 bp below the peak reached in 2008, it seems likely that further
hikes will be enacted in the months ahead and Cile is the clear global
leader in terms of raising interest rates during this tightening cycle.

This may prove to be problematic for the local equity market (IPSA Index)
which was one of the best performing emerging markets following the 2008
collapse, rising from a low of 2017 in October 2008 to a peak of 5048 in
January 2011. Recent performance has been much less impressive, with a
drop of 16% being suffered before a powerful recovery in March and April
took the IPSA back over 4800 but the index now faces strong resistance
around its recent all time high. - D-CHOVCHOV_Index.gif -

There are growing signs that liquidity levels in China have started to be
affected by the aggressive implementation of MPMP. As we noted earlier this
week, China's M2 shrank in April by the most since 2001 and this morning came
the news that China's latest debt sale of 1 year government securities was
significantly under-subscribed (11.71 bln CNY out of 20 Bln offered were sold).
On the other hand New Bank Loans for April continued to track the robust pace
seen before the start of Reserve Requirement hiking last November.

It would therefore appear that faced with a shrinking pool of capital, banks are
keeping their liquidity for higher margin lending activities and cutting back
on less lucrative destinations for capital such as government securities (this
is particularly true when MPMP is utilized since the interest rate on
government securities lags that seen in a traditional interest rate cycle).
Again this points to the difficulty of regulating even a semi-liberated
financial system such as China via monetary policy. Our assumption is that
further efforts will be made to restrict lending in "undesirable" portions of
the economy and that reserves will continue to be raised.

The drumbeat of MPMP continues to quicken in emerging markets with news
this morning that China has raised its reserve requirement yet again by 50bp to
21%. The increase in reserve requirements is starting to resemble a metronomic
trend, much as the FDTR took on between 2004 and 2006. This sort of steady
increase lulls observers into the belief that nothing tangible is happening in
reaction to the tightening of conditions, only for the inevitable effects to
kick in after a time lag of several months. We are only likely to understand
the "tipping point" for the Chinese banking system in retrospect, and in fact
it may already have been passed (note that M2 actually shrank in April). The
important notion to grasp is that monetary authorities are likely to continue
to tighten policy until clear signs of distress are seen in one or more
portions of the economy and/or asset markets.

Meanwhile the Bank of Israel continues to struggle to control the rush
into mortgage lending by the local banking sector and news came today of
the issuance of an order to local banks to immediately increase their bad
debt provisions (see link).

http://www.globes.co.il/serveen/globes/docview.asp?did=1000644408&fid=1725

The BoI seems unlikely to rest until it has succeeded in moderating credit
issuance and this in turn is likely to cause a substantial downturn in the
local housing market. Our advice continues to be to move capital away from
those portions of the emerging market spectrum that are in the direct
firing line of monetary policy, which in Israel's case would include real
estate, the equity of local banks and both the equity and debt of
construction companies. - W-CHRRDEP_Index.gif -

Uruguay becomes the latest emerging market to embrace MPMP.

Even by recent standards Turkey's trade data for March was shockingly
poor, with the monthly deficit hitting a new record of -$9.8 bln, well
below the already aggressive consensus of -$8.2 bln. This takes the
trailing 12 month ma down to $-6.970 Bln ($-83.6 bln for the entire 12
month period). In the face of such poor current account data the
resilience of the Turkish Lira (TRY) takes some explaining. In part this
is due to its measurement against a weak USD. Against the EUR (see
attached) the TRY is already pushing up against the top of its 10 year
range (meaning the Lira is getting weaker). However, this is not the whole
story. Turkey has been at the heart of the massive flows of funds into
emerging market fixed income securities (possibly the least commented on
excess commitment of capital at the current time) and the end of Q1 2011
saw a massive surge of new allocations. As can be seen on the attached
chart, total Foreign Investment in Turkish debt securities reached $4.89
bln in March, the second highest flows on record. The 12 month ma of flows
are $1.915 bln, which is approximately 27% of the entire current account
deficit over this period. Together this paints a picture of significant
vulnerability, with any slowdown in investor flows requiring a rapid
improvement in the current account or a sizeable adjustment in the local
currency. Should the latter path be taken this would prove to be quite
problematic for those crowding into fixed income positions, since the drop
in the TRY has the potential to overwhelm the additional yield being
generated by Turkish debt when compared to more prosaic developed
sovereign or corporate credit. - D-TUCADS_Index.gif - D-TUTBEX_Index.gif -
W-TRY_Curncy.gif -

China's mass release of economic statistics for April continues to paint a
picture of a country facing considerable inflationary pressures (CPI
moderated to 5.3% from 5.4%) but there are some tentative signs that
monetary conditions are finally starting to tighten, at least at the level
of aggregate monetary statistics. M2 for instance actually SHRANK in April
by -82.98 bln CNY, the first drop since October 2004 and the largest
nominal drop since May 2001. This is largely obscured for those following the
headline YoY% change for M2, which only shows a moderate drop to 15.3% (from
16.6%). One month does not make a trend, but this is the first clear sign that
multiple MPMP tightening steps are having some effect and this data now needs
to be watched very carefully going forwards.

Interestingly this is less obvious in the actual loan data, with New Yuan
Loans remaining buoyant at 739.6 bln (above consensus of 700 bln) and so
it may be that loan demand is now being met at the expense of overall
liquidity in the rest of the economy. The demand for credit is certainly
still in place, as can be seen from the activity data for Industrial,
Retail and Fixed Assets. All remain strong although there is some
suggestion in the data that Industrial Production may be moderating
(April's data fell to 13.4% from 14.6% YoY) while Fixed Asset Investment
continues to outpace all other activities, rising to 25.4% from 25%. This
of course is precisely the opposite of what monetary authorities want to
see, which once more underlines the difficulty of tailoring monetary
policy to an entire complex economy. Our conclusion remains that further
tightening measures are likely and that in the end considerable duress
will be suffered. - D-CNMSM2_Index.gif - D-CNCPIYOY.gif - D-CNRSACMY_Index.gif
-

The US Census Bureau estimation of US Wholesale Inventory and Sales for
March 2011 showed inventories to be growing slightly faster than expected
(1.1% versus 1% consensus) but the really interesting data was to be found
in the Wholesale Sales series which is ignored by most headline writers.
This showed sales to have grown by 2.93% in March, taking them to within 1%
of their all time high recorded in June 2008. As the attached chart shows,
US Wholesale Sales have now risen by over 31% over the last 24 months (a record
pace by some margin), which helps explain the ferocious rebound in US
Industrial earnings over this period.

The acceleration of sales also means that US Wholesale Inventory levels remain
extremely tight when compared to sales. The Wholesale Inventory Sales ratio
(MTIS index on Bloomberg) actually recorded a new all time low in March 2011,
meaning that even after the 15% rebuild of Inventories that has taken place
since September 2009, supply lines remain as stretched compared to sales as
they were at the depth of the drawdown. This suggests that manufacturing
production can continue to expand for a considerable period without creating a
problematic rebuild of inventories, and in fact will need to do so even if
sales grow at a more tranquil pace going forwards. - M-MWSLTOT_Index.gif -

An interesting story from China that suggests that lending standards are
finally being meaningfully tightened at least in some of the hotter regional
markets.

China's April Trade data suggests that there has been no appreciable
change in China's Industrial economy in recent months. In terms of overall
activity both exports and imports continue to grow by well over 20% per
annum (29.83% for exports, 22% for imports), which is in line with the
growth rates seen for most of the last decade. Although the surplus of
$11.42 bln was somewhat greater than consensus estimates of $3.20 bln it
should be understood that this is a very volatile number and April is
typically in the middle of the springtime surge in the seasonally of the
surplus. As can be seen on the attached chart, the 12 month ma of the
surplus (red line lower chart) is virtually unchanged in recent months and
reached 14.92 bln in April, which is significantly less than the peak of
$26.3 bln recorded in 2009. We expect this number to drift lower during
2012 (in part due to the sizeable deficits already reported during the
winter months) but not dramatically so. - D-CNFREXP$_Index.gif -

The US economic data-cycle has continued its down-draft data with recent
reports falling below buoyant consensus. Even after Friday's strong
Non-Farm Payroll report the Citigroup Economic Surprise Index fell back to
-32.10, marking the worst reading since early September 2010. Of course
data itself is much better than it was 8 months ago, but the bar of
consensus expectations has been raised considerably, and can no longer
absorb a typical negative fluctuation in economic readings. As would be
expected Wall Street's ever twitchy economists have already started to
trim estimates of US GDP, and given that this downdraft probably still has
some time to roll we could see a fairly sizeable downward revision to
consensus estimates by the time it is completed. As the attached chart
shows other "data cycles" have seen the daily index (currently -32) fall
to the -60 to -80 range and the 10 week indicator (currently +24) fall to
-30 to - 50.

None of this would change the facts on the ground (and we should state
clearly that we believe the US expansion is still on track), but a
deterioration of official data is likely to have a dampening effect on
market sentiment and capital allocation for a period of time. This is
particularly important for industrial commodities and their related
equities, which are under duress following last week's plunge. The big
winner could be expected to be the long end of the yield curve, which has
already been showing surprising resilience in recent weeks.
W-CESIUSD_Index.gif

Link to Bloomberg News Interview with Michael Shaoul on commodities

http://www.bloomberg.com/video/69484624/

It is typical of the erratic official employment data that in a month that
Initial Claims have suggested worsening employment trends the senior Non
Farm Payroll report has comfortably beaten consensus. Non Farm Payroll was
estimated to have risen by 244K overall (185K consensus) and both February's
and March's reports were revised significantly higher. Private sector
payrolls were estimated to have risen by 268K (200K consensus) which is
the strongest report since February 2006.

As encouraging as this month's data is, our argument has always been that
longer time periods must be used to smooth out the volatility of single
reports. The attached chart uses a 6 month ma, which shows an average gain
of 191.5K private sector jobs over this period. This is is line with gains
recorded in Q2 2004 and the summer of 1993, but still lies short of the
sort of "blow out" gains that would be required to really put pressure on
the FOMC to reconsider its monetary policy. Perhaps for US asset markets
this is the best possible scenario. Payroll gains of 200K or more are
sufficient to further improve aggregate demand in the US economy and
indicate that corporations are back in expansion mode and today's data
should put a lid on some of the concerns that the US economy was starting
to decelerate. Later on this cycle (possibly by mid summer) we should see
data that really signals a shift higher for interest rates but this
month's report is unlikely to cause any meaningful change in rhetoric
coming from the majority of FOMC members. - M-NFP_PCH_Index.gif -

The Bank of Japan (BOJ) continued to pursue an accelerated growth of money
in April, causing the Monetary Base to grow by 8.12%,for a gain of over 20%
since the earthquake and tsunami hit in March. From our perspective surges in
monetary base always make it that much easier for local liquid assets to
appreciate in value, and this is particularly true when they are fairly
depressed to begin with.

In Japan's case the local equity market comes to mind, particularly since all
the pre-quake data pointed to a steady recovery in industrial activity and
valuations are reasonable. As the attached chart shows the size of Japan's
monetary base compared to the value of the NKY index (strictly speaking we
should be using market cap not the price) is approaching a record high. and the
last two times this level was reached (April 2003 and February 2009) both
marked the start of a multi-month rally in equity values. This itself does
not guarantee the same thing happens third time around, but we would say
that if the BOJ continues to accelerate the growth of the monetary base
the odds will be in favor of the Japanese equity market making upside
progress. - M-JNMBMOB_Index.gif -

Today is turning into one of the uglier sessions for those who have chased
recent trends in commodity and currency markets and it therefore makes sense to
look at our favorite proxy for gauging the overall stress levels, the EUR/JPY
cross rate (clearly those markets at the center of the storm such as silver are
subject to much higher levels of liquidation).

Today's decline at the current time is 2.3% on the day which puts this in the
top 10 "stress days" since the start of the recovery rally in 2009. It is
interesting to note the relatively moderate decline in the US equity market in
response to this event, which really suggests that it is the crowded flows
within the commodity and currency markets that are being disrupted at the
current time. Here losses are likely to be magnified appreciably by the
leverage that has been employed. One note of caution would be issued if the
cross was to fall significantly later on this session since this would imply
that continued liquidation of positions across a range of asset markets is
taking place. We have never forgotten that the Flash Crash of May 2010 was
immediately preceded by a 5% spike down in the EUR/JPY cross and while we would
not expect a direct repeat of this particular episode, the odds of something
disorderly occurring would be magnified considerably by a further collapse
in the EUR/JPY cross. - D-EURJPY_Index.gif -

We have been tracking the excess enthusiasm in the EM corporate bond space for
a number of weeks but even so we were surprised to see unrated perpetual
Chinese bonds snapped up by investors (see attached article). This area of
capital markets strikes us as significantly overvalued with both currency and
credit risk being under-priced in the current environment.

Initial Jobless Claims surged by 43K to 474K last week, their highest
level since last August. However, this alarming statistic appears to be a
result of a number of unusual seasonal factors and adjustments that should
have little lasting effect on the data (these included an "unexpected"
spring break in New York, a new benefits package in Oregon and some
automobile layoffs caused by shortages of Japanese components) . Since
this time of year typically sees employment growth the seasonal adjustment
process magnified the boost in "actual estimated" claims in the headline
data.

We would therefore expect to see a marked improvement in Claims data
over the next couple of weeks but until this takes place today's data will
form additional basis for the belief that the US economy started to slow
in Q1 2011. As we have remarked before there is absolutely no evidence of
this in either corporate earnings or management guidance, but this does
not mean that slowdown fear cannot dominate investor flows over the short
to medium term, particularly given the sharp losses being seen in the
commodity market. - D-INJCJC4_Index.gif -

The ISM Non-Manufacturing Index has nothing like the pedigree or utility
of the Manufacturing survey, but of course this does not stop people
watching it closely in these macro-dominated times. April's report was
disappointing both at the overall and sub index level. The headline index
came in at 52.8, well below consensus estimates of 57.5 and March's reading
of 57.3. This deceleration was shown in Business Activity, which fell to
53.7 (59.7), Back Orders 55 (56) and Employment 51.9 (53.7). Perhaps most
alarmingly, New Orders fell to 52.7 from 64.1 and no doubt this will
encourage many commentators to conclude that the service economy
decelerated meaningfully in April. We would be quite resistant in making
such an assumption. Quite simply, the ISM Non-Manufacturing survey is far
too volatile to take any single month's reading as an accurate reflection
of growth trends.

The New Order index is particularly volatile (see attached chart) and
during the post 2009 expansion, has already signalled 3 separate
decelerations in New Orders, of which the first 2 have been proved to be
false signals. Whether this is a methodological flaw of the index or a
reflection of Service industries not following the type of regular order
cycles seen in Manufacturing, is open to question, but the only sensible
conclusion is to use a reasonable moving average to smooth out these
changes. Certainly there has been no hint in corporate guidance for US
service corporations that any meaningful change took place in April and we
would be inclined to assume that no meaningful change in activity has in
fact taken place absent any other confirmation and we would expect the 6 month
ma of this metric to remain somewhere between 55 and 60 for the next few
quarters. - D-NAPMNNO_Index.gif -

The April ADP payroll report came in at 179K versus consensus estimates of
198K. Almost a third of this shortfall was made up for by a revision of
March's number up to 207K (from 201K) and this report should be
interpreted as being in line with both expectations and the recent pace
of private sector employment growth. At 191K the 6 month ma of ADP Payroll
gains is close to the pace of gains recorded in June 2004 at the time that the
FOMC elected to raise rates from the 1% level.

As ever, we would caution that April's Non-Farm Payroll report could still
differ meaningfully from this data since separate methodologies are used to
construct these two estimates. Current consensus estimates call for a 185K gain
in Non-Farm Payrolls, which would maintain the steady growth in employment
without signalling the sort of acceleration that we would hope to see as the
economy gathers pace. - D-ADP_CHNG_Index.gif -

US New Car Sales once more beat expectations in April, coming in at
13.14mm units versus consensus estimates of 13mm. Domestic produced
vehicles did somewhat better, coming in at 10.20mm versus 9.90 consensus
estimates. This report keeps the annual growth rate at over 16%, with the
3 month ma closer to 20%. This would imply sales for April 2012 running
somewhere between 15.25 and 15.75mm units, which would be somewhat above
the 20 year average of 15.07mm units. M-SAARTOTL_Index.gif -

Any lingering doubt about the strength of the US Manufacturing recovery
should have been dispelled by this morning's Census Bureau estimation of
New Orders. This showed growth of 3.00% in March, well above consensus
estimates of 2.0%, while the surprising drop of 0.1% for February was
revised up to +0.7%. Together these changes took the index up to a new
recovery high and this measure of activity is now only 4.7% below its
prior peak. As the RoC lines show, at the current rate of expansion
Manufacturing Orders will mark a new all time high sometime between Q2 and
Q3. There is also a distinct sense of acceleration, with the current 3
month RoC reaching 7.15% (its best level since the boom in orders at the
height of the 2000 tech bubble), an annual growth rate at over 30%. Even
though we would expect this pace to moderate (and perhaps for this
volatile number to disappoint in the next month or two) it is clear that
the US Manufacturing sector is revelling in the current combination of lax
monetary conditions, weak local currency and recovering consumer and
corporate demand. - M-TMNOTOT_Index.gif -

It has been our view since the middle of Q4 that India faces a period of
monetary tightenings that is highly likely to disrupt local asset markets
and activity in those sectors most reliant upon credit. This viewpoint
received further validation last night when the RBI chose to raise the
local REPO Cutoff Yield by 50 bp to 7.25% (most observers had expected
a 25bp increase). In addition to the decision to raise rates the RBI
implemented a significant piece of MPMP last night, forcing local banks to
divest holding of mutual funds (see attached story).

As would be expected, this combination was not received well by the local
market. The SENSEX index fell 2.44% to 18534, breaking important support
at the 19,000 level. The index would now seem likely to retest a strong
band of support that exists between 17500 and 18000 and we still believe
that this move could extend lower to 16,000 later in 2011. As may be
expected the poor performance of the Indian market in recent months has
had a marked effect upon foreign capital inflows (see chart). Through
April 29th these totaled $916 mln, well below the $6.2 bln that had been
invested by this time last year, and under half of the average investment
made between January and April for the last 6 years. On the other hand there
has been no divestment of the roughly $19bln that poured into the marketplace
between August and December 2010, much of which at prices well above current
levels. - W-FIINYTDN_Index.gif - D-SENSEX_Index.gif -

| |