October US Pending Home sales joined this morning's "data party" with sales
announced to have grown by 10.4% from September compared to consensus of 2.0%.
As the attached chart shows this still keeps Pending Home Sales at a depressed
level, but at 93.3 (2001 = 100) they are at the upper limit of their post 2007
range (ignoring the artificial spike from the 2009/10 tax credit). The 6 month
ma (red) his at 89.3 and this is probably a fair indicator, showing that the
overall US Housing market continues to bounce along the bottom with no sign of
a deterioration in overall activity. As for October our guess would be that the
cleanup of the "robo-signing" foreclosure process resulted in an increase in
foreclosure sales, for which there is significant latent demand at current
prices.

Meanwhile whatever the cause the recent improvement in housing data has
coincided with an abrupt improvement of the Homebuilding sector. Attached is a
chart of the S15HOME index which is now challenging dual resistance at its
recent high and the falling 200 day ma. If this can be overcome a move back up
to the 240-280 range that contained this index in the first half of the year
would seem to be the least that could be expected over the short to medium term
term, and would seem to be justified by recent data. -
pendinghomesalesoct11.gif - s15homenov302011.gif

The Chicago PMI report became the second positive surprise of this busy
data-week with the headline index coming in at 62.6, well above consensus
estimates of 58.5. The underlying sub-index data is even more positive. Prices
Paid (not shown) fell to 60.2 from 66.6 which represents a benign drag on the
overall index. The key New Order index (red) rose to 70.2, its highest reading
since March 2011. Production (blue) rose to 67.3, the best reading since April.
Inventory growth (olive) slowed to 53.6 indicating a moderate rebuild while
Employment was the only disappointment, falling to 56.9 from 62.3 but still
comfortably positive. Tomorrow's national ISM report is of course a far more
important piece of data but this should not take anything away from a very
encouraging Chicago PMI report. - chicagopminov11.gif

With the first Friday of the month falling on the 2nd, this week will see an
unusual concentration of US Employment, retail sales, car sales, Chicago PMI
and ISM data released over three sessions. Should all the stars align it could
therefore mark a turning point in the appreciation of the state of the US
economy.

Certainly things have started well with a very robust ADP Payroll report. This
estimated Private Sector Job gains to be 206K in November, the strongest
reading since December 2010. This was well above consensus estimates of 130K
and last month's data was also notched 20K higher to 130K. As the attached
chart shows, this takes the rolling 12 month ma up to 155K, its highest level
since August 2006 and also equivalent to the level reached in August 2004. Of
course ADP remains far junior to the BLS Non-Farm Payroll report (although it
is far from clear that either one is less inaccurate). This is currently
estimated to come out at the 125K level for overall payroll and 146K for
Private Sector Payroll. Initial Claims data will come out on Thursday but the
Thanksgiving holiday will make this report much less useful than in a normal
week. - adpnov11.gif

We had highlighted a surge in LIBOR rates yesterday and have been following the
3 month Euro/USD swap rate for several weeks. Both had indicated a growing
shortage of USD funding for money market operations and this clearly caught the
attention of central banks with this morning seeing the announcement that the
FRB together with the ECB, BOJ, BOE and SNB would reduce the overnight swap
rate for USD funding down from 100 bp to 50 bp.

As can be seen the response of the money markets has been swift. The 3 month
Euro/USD swap had reached over 160 bp prior to the announcement but is now back
to 138 bp. This is still an extremely extended reading, but the change of
direction is important and we would expect to see further improvement. Since
LIBOR is fixed at approximately 6.40 am EST the official rate has not had a
chance to respond to this easing (red line on chart) and 3 month LIBOR rose by
0.2 bp to 52.9 bp this morning. However, the Euro$ Futures market opened at
8.30 am and this shows that the implied yield of 3 month LIBOR for March 2012
has fallen sharply from 76 to 62 bp.

The effect of this morning's move is to buy some additional time for the
Eurozone to craft a workable solution and also should take some pressure off
the beleaguered US financial sector. With this move coming at the end of the
tax-selling window, we could see some powerful short term gains for some of the
more beaten up individual names. Of greater importance is the fact that the
removal of the (remote) risk of a US funding crisis should allow us to pay
attention to what is going to be a very interesting set of US data released
over the next 3 sessions. - D-EUBSC_Index.gif - marchlibor.gif

The People's Bank of China (PBOC) surprised capital markets this morning
by announcing a 0.5% drop in the reserve requirement for major banks by 50
bp down to 21%. This marks the first reduction in this key policy tool
since 2008 and even if the direct effect of this morning's move is small,
the change in direction by the PBOC is very telling. We do not doubt that
the conventional commentary will see this move as a positive event, and we
expect to see a deluge of relieved analysts and investors congratulating
the PBOC on steering the Chinese economy towards a soft landing. Unfortunately,
rather like El Dorado and Atlantis, soft landings are far easier to describe
and set out to seek than to discover.

The question that observers should be asking is what has occurred to convince
the PBOC to change a path that it has followed so determinedly since January
2010, raising reserves in 12 discrete steps from 15.50 to 21%, and then leaving
them at this record level from June until today. Although official Chinese data
still points to a robust economy, there have recently been a growing number
of anecdotal reports that suggest that a severe contraction of the local
housing market is underway (we have attached one which was published last night
by Bloomberg). It would appear that the PBOC has trodden the familiar path of
allowing very loose monetary policy to remain in place for long enough to spark
an investment boom in real estate, which drew in vast amounts of speculative
capital. Much tighter monetary conditions combined with a massive acceleration
in the production of housing has effectively killed this boom in many parts
of the country and it would appear that signs of distress are clear enough
to finally get the PBOC's attention.

In our experience the initial move from tight to looser monetary policy is
always greeted enthusiastically by the market but the damage that is
required to force a central bank to change its policy stance generally turns
out to be hard to cure by gently loosening monetary policy. Over a period of
months economic news deteriorates as the central bank starts to move more
aggressively to a looser stance. This process is typically very damaging for
the asset markets that had been tied closely to the prior boom, which typically
experience large cumulative losses over a period of months, interspersed by
powerful relief rallies (which are often sparked by central bank easing). In
China's case this would involve significant portions of the emerging market
equity, fixed income markets and the commodity complex, in addition to their
own domestic housing market.

Whether this spills over to the Chinese banking system is open to question, but
housing market collapses are not normally good news for local lenders. The
decision of S&P last night to upgrade certain senior Chinese banks while
downgrading their Western counterparts looks to be one of the stranger
decisions made by an industry whose reputation already lies in tatters.

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

Shanghaied Home Buyers Take to Street as Cuts Shatter Dreams
2011-11-29 16:01:00.0 GMT


By Bloomberg News
Nov. 30 (Bloomberg) -- Danny Deng and his bride-to-be
dreamed of their lives together as they walked through the
showroom for a Shanghai housing project almost three months ago.
Pooling his own and his parents’ savings, a loan from his boss
and a 1.1 million yuan ($172,000) mortgage, he bought an
apartment and secured his fiancee’s hand.
On Nov. 19, Deng faced off a ring of security guards three
rows deep wearing camouflage and carrying shields as he joined
more than 100 homeowners rallying in front of the development’s
sales office. His transformation from newlywed to street
protester came after China Vanke Co. slashed prices for future
buyers at the Qinglinjing complex, erasing about 20 percent of
the value of his three-bedroom unit overnight.
“If I’d paid for it all myself, the price cut wouldn’t
bother me as much, but there’s a lifetime of my parent’s blood
and sweat in it,” said Deng, a 30-year-old electrical systems
salesman. “Developers’ profits are outrageous. The price they
set when the housing market kept going up was far more than the
real value.”
Deng’s anger underscores the dilemma facing China’s
government as it tries to cool the property market. If policies
such as increased down payment requirements don’t go far enough,
it risks a housing bubble; if it pushes too hard, it may provoke
the ire of a new generation of middle class “fang nu,” or
housing slaves, in a reference to the lifetime’s work needed to
pay off debts.

Homebuyers Stung

Demanding Vanke, China’s largest publicly traded property
developer by market value, compensate them or cancel their
contracts, Deng and his fellow picketers on that rainy day are
among homebuyers stung as prices reverse. Urban residential
values have risen 155 percent nationwide since reforms 13 years
ago created a private residential market in the communist nation.
Prices in Shanghai almost quadrupled over the past decade.
In October, hundreds of homeowners demonstrated outside the
offices of China Overseas Property Group Co. over cuts at
another project in Shanghai, according to the Chinese-language
New Century Weekly. There have also been Chinese newspaper
reports of similar protests in Beijing and the industrial city
of Shenzhen near Hong Kong.
“This is certainly sending a very alarming signal,” said
Cheng Li, a senior fellow at the Brookings Institution in
Washington. “If property prices really go down, there will be a
serious political crisis led by the middle class.”

Customer Anxiety

China Vanke, in an e-mailed response to questions, said
that while it understood customers’ anxiety, prices were set by
supply and demand.
“In a market correction, it’s hard to avoid that both
sides, developers and homebuyers, will be affected,” the
company said.
Residential property prices fell from the previous month in
33 cities of the 70 measured in October, the worst performance
this year, after the government imposed restrictions on
mortgages and loans to developers.
Analysts at Credit Suisse Group AG say prices may fall 10
percent this year and another 10 percent in 2012. Huang Yiping,
a Hong Kong-based economist at Barclays Plc, said the drop would
be between 10 to 30 percent in the next 12 months.
In an indication of how seriously the government is taking
the matter, a Nov. 21 commentary by the official Xinhua News
Agency said that such protests are “a social phenomenon that
cannot be ignored,” before adding that their appeals aren’t
supported by law.

Middle Class Power

China’s emerging middle class represents a potent new force
that may number as much as 243 million, said Li of the Brookings
Institution. On a growing number of issues from housing to the
environment they are voicing their opposition online and on the
streets.
Another Xinhua article argued that some price declines
could be beneficial, enabling more people to afford a home.
Also at stake is the pace of economic expansion in one of
the world’s few growth engines. Property directly accounts for
12 percent of China’s gross domestic product even before taking
into account building materials, furnishings and appliances,
according to a July report by the International Monetary Fund.
A drop in real estate prices could undermine the value of
the collateral for about 40 percent of the loans issued by
China’s biggest banks, the IMF said after a November survey of
the lenders.

Price Move ‘Danger’

Falling land values may also impact local governments which
depend on them for one-third of their revenue, said Wang Yi, a
Beijing-based real estate analyst at Goldman Sachs Group Inc.
“The government thinks they have everything under control
and can set the bottom,” said Du Jinsong, head of property
research for Credit Suisse. “The danger is they may do more
than enough, and it may be too late to stop a bigger fall.”
Questions over China’s housing policy are “overshadowing”
China’s economic outlook, the Paris-based Organization for
Economic Cooperation and Development said Nov. 28. A day earlier,
Xinhua reported Chinese Vice Premier Li Keqiang as saying the
government should continue tightening after some observers,
including scholars at Renmin University of China in Beijing,
suggested the government would start lifting restrictions next
year.
Residential property-related companies are already
suffering on the stock market. China Vanke, based in Shenzhen,
is down 25 percent this year in Shanghai trading, while Soufun
Holdings Ltd., owner of China’s biggest real-estate website, has
dropped 36 percent.
For Deng, the pain is more than financial. Tears swell in
his eyes as he recounts the moment his father handed him access
to his life savings of 360,000 yuan to help make the down
payment.

Gnawing the Elderly

The gift made Deng consider himself a member of the “ken
lao” generation, meaning to gnaw on the elderly.
“I was depressed, uncertain, touched and a bit ashamed,”
he said, asking not to be identified by his full Chinese name
because of the personal nature of his story. “I had been proud
and didn’t think it was their business. But when the moment
really came, I knew it was impossible to manage only by
myself.”
Deng had moved to Shanghai three years earlier from a small
city in the north to be closer to a girl he met in college. When
talk turned to marriage, his girlfriend insisted they buy an
apartment first, he said.
“At my age, I should get married and I should have my own
home whether or not I can afford it so that I can be the same as
my classmates,” Deng said.

Raise a Child

Deng saw an ad on Soufun.com for pre-sales of a project
called Qinglinjing, meaning “Clear Forest Path,” that was
being constructed near a soon-to-be built subway station next to
the future home of the Shanghai Disney Resort. Deng and his
girlfriend visited a showroom to walk the wooden floors of the
replica 96-square-meter (1,033-square-foot) apartment, planning
how they would fill its two bedrooms, living room and study.
“We loved it,” Deng said. “It suits us for the next
three to five years because we plan to raise a child soon.”
The snag was its 1.7 million yuan price tag. Chinese policy
requires a minimum 30 percent deposit. Deng had saved 70,000 --
not enough. That’s when he called his parents, then borrowed
another 50,000 yuan from his boss, and secured a loan of 1.1
million yuan paying as much as 7.8 percent interest from
Agricultural Bank of China, he said.
On Sept. 28, Deng and his girlfriend signed a contract with
the developer, happy after winning discounts including 40,000
yuan off for being a member for the Soufun.com website and a
20,000 yuan markdown by collecting 20 stamps on a red “home-
passport” issued by Vanke. The end price: 1.58 million, or
about 13 times Deng’s annual wage.
The next month, they got married. Paying the mortgage will
take up 40 percent of the new couple’s combined salary.

Housing Boom

The new norm for Deng’s generation stems from housing
reforms begun in 1998, when then Premier Zhu Rongji privatized
state-owned housing provided at low rents to urbanites,
transferring home ownership from the government to the families
occupying the dwellings. The housing market has boomed ever
since, with a brief reversal in 2008 overcome by government
stimulus.
Some 290 million city dwellers own their own homes,
according to consultants Gavekal Dragonomics in Beijing.
China’s official home-ownership rate of 87.8 percent, which
excludes migrant workers, exceeds the U.S. level of 66.3 percent
in the first quarter of 2011, according to U.S. census data.

Rising Household Debt

While the property privatization has helped fuel one of the
fastest episodes of wealth creation in world history, new buyers
like Deng must mortgage their futures to afford a home in
China’s swelling cities. The home-buying boom has contributed to
a doubling of household debt in China since 2008, though the
amount is still far below U.S. levels, according to Dragonomics.
Concerned a bubble was forming, the government this year
stepped up measures to curb the market, including limiting home
purchases in some cities, raising down payments and warning
banks and other lenders to cut back loans to builders. That’s
left some developers facing a liquidity crunch, necessitating
price cuts to ensure enough sales are made to pay off upcoming
debts and payrolls.
“It’s a game between developers and the state,” said Li
Yun, an engineer who borrowed 280,000 yuan from his friends and
relatives to buy an apartment at the Qinglinjing complex and who
joined the protest. “Now that they cut prices so much it pushed
homeowners to the frontline.”

Sales Agents Clapped

Zuo Hongxia, mother of a 15-month old baby, said she
became a home owner after losing patience waiting for years for
prices to come down. She recalled the frenzied scene when she
picked her apartment in the same development as agents crowded
around urging her to buy and then clapped and congratulated when
she nodded agreement.
Just weeks after Deng had signed his purchase contract, he
found out about the price cut when he saw a leaflet advertizing
apartments in the same development with a discount of 4,000 yuan
per sqm. The previous asking price was about 17,000 yuan to
18,000 yuan per sqm, according to Soufun’s website.
Acknowledging he’s unlikely to get the difference refunded,
Deng said he’s now pushing for a waiver to management fees or a
free parking lot. With talk some people have been detained by
police after protesting, he’s also taking precautions, standing
on the sidelines with a cap pulled low and bandana masking his
face at a separate rally on Nov. 23.
“I didn’t have a choice,” he said of the decision to buy.
“I don’t want to be too different. Otherwise, maybe for a long
time, I would be alone.”

For Related News and Information:
Stories on China’s real estate market: TNI CHINA REL <GO>
Most-read China economy stories: TNI CHECO MOSTREAD BN <GO>
Top China news: TOP CHINA <GO>
Top real estate stories: TOPR <GO>

--Fan Wenxin and Shai Oster, with assistance by Bonnie Cao in
Shanghai. Editors: Malcolm Scott, Neil Western.

To contact the reporters on this story:
Fan Wenxin in Shanghai at +86-21-6104-3045 or
[email protected]
Shai Oster in Hong Kong at +852-2977-4615 or
[email protected]

To contact the editor responsible for this story:
Melissa Pozsgay at +33-1-5365-5056 or
[email protected]
- W-CHRRDEP_Index.gif

The Conference Board Consumer Confidence Index surged back up to 56 in
November, well above consensus estimates of 44 and last month's reading of 40.9
(revised up from 39.8). At 15.10, this is the largest increase in nominal terms
since April 2003's 19.60 increase (from 61.40 to 81) although the April 2009
13.9 surge from 26.90 to 40.80 was greater in percentage terms (51.67% vs
36.92%).

To our eyes, November's report is simply a rebound from an unrealistically
negative October print. At 56, the index (red line on chart) remains at a
historically low level (and somewhat lower than the University of Michigan
poll) and is in the middle of its post-Lehman range (the 36 month ma is 51.91).
Since we never thought that a collapse in confidence would affect spending
habits, we doubt that a rebound will cause an acceleration (although one may
still occur coincidentally). What it may indicate is that the US equity market
has made its low for 2011 since major lows in the equity market do often
coincide with lows in consumer confidence.

Of much more interest is that the headline print was the improvement in the "Jobs
Hard to Get" sub index. This fell to 42.10, the lowest reading since January
2009 (the "Jobs Plentiful" index rose to its highest reading since January
2009). This is interesting because the overall headline confidence reading is
well below that of early 2011 (it hit 72 in February), suggesting that a slight
shift in employment confidence is taking place. As the attached chart shows,
there is a good long term correlation between this index and the weekly Initial
Claims report. A fall below 40 in the coming months would indicate that the
Conference Board report is picking up a meaningful change in the perception of
employment opportunities (note this would probably LAG an ACTUAL improvement in
these opportunities), and is therefore something to look for in the coming
months. - confboardconfnov11.gif - confidencejobs.gif

The ECB's efforts to sterilize their bond purchases are becoming increasingly
ineffectual. For instance this morning's attempt to drain E203.5 bln from the
system only generated 194.2 bln of bids and in any case banks maintain the
right to obtain loans from the ECB against securities considered to be good
collateral (a very generous interpretation in many cases). As a result, the
ECB's balance sheet (ex gold) grew by another E26.2 bln (1.33%) taking the 52 
week RoC up to 26.44% and the 13 week RoC up to a much higher 17.05% (over
85% annualized). This underlines a point we made yesterday. The market remains
transfixed by a vary narrow range of yields for instruments that have become
politically toxic to hold for most private sector institutions leading to
massive selling pressure (we note that MF Global's Trustee has now announced
that it has sold virtually all positions, something we suspected was behind the
initial dislocation in Italian yields a month ago) and a great reluctance to
participate in auctions of new bonds.

It is therefore ironic that under the guise of monetary soundness the ECB is
forbidden from purchasing these securities at issuance (perhaps the only
intervention that would have a chance of controlling these yields) but is as a
result of this inaction, it has been forced to expand its balance sheet at a
pace somewhat greater than the FRB's implementation of QE2. We continue to see
this expansion of liquidity as a helpful tonic for non-sovereign and
non-financial credit markets, but it is a hell of a way to run a continent. -
W-.ECB-GOLD_Index.gif -

Although in general, evidence of US financial stress has been quite muted in
recent weeks (the BFCIUS index remains at an acceptable -1.442 this morning,
well above a -2 "crisis" reading) one market that is showing increasing
strains is the Interbank Borrow rate, or LIBOR. As can be seen on the attached
chart, the 3 month LIBOR rate has risen steadily in recent weeks and is now at
0.527% while the 6 and 12 month rates (not shown) have reached 0.746 and
1.067% respectively. Most readers will recall that three years ago the daily
LIBOR fixing became a news worthy event. One breakfast show reserved a special
slot for it during their daily schedule, causing some confusion on the Monday
morning of the week in which the UK pushed back its clocks one week earlier
than the US, since LIBOR is fixed in London.

Back then, 3 month LIBOR reached 4.75% even as the FDTR was cut to 1.5% in 
early October 2008 and did not truly normalize until the end of the summer of 2009.
The current situation is far milder with LIBOR some 27bp above the FDTR of 25bp
and 44bp above the Fed Funds rate of 0.08 bp. The latter indicates that
aggregate liquidity in the US economy remains excessive (again a deliberate
policy of the FRB) but the rise higher in LIBOR shows that some tightness is
present in the Interbank market, which suggests that large banks are a little
less willing to trust each other than they were 6 months ago.

The other important distinction between 2008 and 2011 is the sheer size of the
market. Interbank loans held by US Commercial Banks at the time Lehman failed
were $485 bln and have fallen to $118 bln today (green line, lower chart). This
suggests that LIBOR is a far less useful indication of the cost of accessing
short term funding than it was pre-crisis (again an outcome of the FRB's
massive injection of liquidity into the financial system) and that to an extent,
the use of the Interbank market may have become somewhat stigmatized. On the
other hand LIBOR is still the benchmark that most variable rate loans are set
off, and so any increase in the LIBOR rate translates into higher borrowing
costs in the US economy. At present we do not consider the situation to be
alarming, more an anomaly that bears watching, although hopefully not deserving
a slot on the daily news this time around. - D-US0003M_Index.gif -

October New Home Sales were estimated to be 307K, just below consensus of 315K,
while September Sales were revised lower from 313K to 303K. Given the inherent
volatility of this data we would describe this as an "in line" report and it
shows the New Home market continued to bounce along the bottom for another
month. We would look for a move above the declining 36 month ma (currently
337K) to signal a potential change in trend. Non-Seasonally Adjusted sales came
in at 25K, a little higher than their level of 23K in October 2010. Total
inventory stayed unchanged at 162K, an all time low.

In summary, this report is the least encouraging of the housing data inputs that
we have been given in October, since it lacks the clear signs of improvement
seen elsewhere. On the other hand the data is no worse than recent readings and
we are now in the quietest seasonal period of the year making the overall
impact much less important than the upcoming spring and early summer seasons. -
D-HSMNTOT_Index.gif - D-NHSLTOT_Index.gif -

After the doom and gloom of Thanksgiving week markets have rebounded strongly
this morning. Just as we were not overly troubled by last week's decline we are
not very impressed by today's "over-reaction to the over-reaction", although
for a number of emerging and European markets the rally came just as key
support levels were under threat.

Meanwhile the attached story is an important reminder of where we find
ourselves. Investors across the globe have become obsessed with a the yields of
Euro-sovereign paper without understanding the depth of the market. As we have
argued several times, the trouble with the current ECB stance is that in times
like these secondary markets take their cue from primary bond auctions. The
lack of ECB participation in auctions leaves a vacuum that private sector
corporations and foreign central banks are unwilling to fill. The lack of
normal liquidity in the secondary market then exacerbates the initial
dislocation of price in the poorly attended auction. Gaps in the auction
calendar then see a brief period of improvement in the secondary market (see
attached chart for today's levels) before the cycle repeats itself once again.

As troubling as it is to watch, this is more about a failure of market structure
and intervention policy than it is about the straightforward credit-worthiness
of European nations (although fears of the latter clearly have been a cause of
the former). As we argued on Friday, it would now seem that Germany is
determined to force any solution to match its own blueprint (what we termed the
Prussiafication of the ECB), with fiscal rectitude becoming enforceable by
sanction (the details of how this would work are still far from clear). This
marks a change in our interpretation. Previously we had believed that a
dislocation between French and German bond prices would encourage these
countries to collaborate on a bail-out (this has been the pattern since the
Treaty of Rome was signed in 1957). It now appears that the Germans are willing
to take a much more forceful stance that brings their traditional post-war role
as the enabler of French leadership into question.

Some readers interpreted this as a negative change in our outlook regarding US
markets. It does not. We still believe that Germany will allow a rescue to take
place once it has clearly got its way over the future path of the Euro-zone. In
the meantime Europe will remain the primary catalyst over short term gyrations
across asset classes, taking attention away from an increasingly robust US
economy and a worsening of conditions within the majority of emerging markets.
We continue to believe that these two issues will prove to be far more
important for the majority of portfolios over the medium to longer term.

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

Price Swings Accelerate as Bond Trading Dwindles: Euro Credit
2011-11-28 13:25:06.651 GMT


(For more on the euro crisis, click on EXT4 <GO>.)

By Paul Dobson
Nov. 28 (Bloomberg) -- Bond traders were left scrambling
for prices in the aftermath of a Spanish debt sale on Nov. 17.
Ten-year borrowing costs at the offering had surged to almost 7
percent, up from 5.43 percent the previous month, and the amount
sold fell short of the maximum volume available.
“Immediately after the auction, screens went blank,” said
Padhraic Garvey, head of developed-market debt strategy at ING
Groep NV in Amsterdam, referring to trading platforms where
dealers post bids and offers for government bonds. “The
liquidity situation is very bad. What we can’t afford now is a
shock on the primary market.”
Bond-market trading conditions in the euro area are
deteriorating as the region’s sovereign debt crisis deepens,
inflating transaction costs and boosting price swings that are
eroding investor and dealer appetite for the securities. The
difference in yield between the best bid to buy French two-year
notes and the best offer to sell them widened to 14 basis points,
or 0.14 percentage point, at the end of last week, from 6 basis
points a month ago. For two-year Italian debt, the spread
reached as much as 40 basis points.
“Investors are frightened by the volatility,” Maria
Cannata, the Italian Treasury’s director of public debt, said at
a conference in Milan on Nov. 16.

Trading Ranges

The turmoil that elevated bond yields and caused trading to
seize up for Greek and Portuguese securities showed signs of
infecting even AAA rated German bunds last week, with an
undersubscribed auction triggering higher borrowing costs. The
rate on 30-year German debt in the so-called secondary, or
traded, market rose 21 basis points last week to 2.83 percent,
the sharpest increase since Sept. 3, 2010, amid speculation
Asian investors were reducing their holdings of the securities.
The yield rose eight basis points to 2.90 percent at 1:16 p.m.
London time today.
Two-year Italian notes traded with yields in a range of 82
basis points, between 2.27 percent and 3.09 percent, in the
first six months of this year. They reached a high of 8.12
percent today, having surged 508 basis points from July 1,
including an increase of about 300 basis points in November
alone. Italy is Europe’s biggest sovereign debt market.
“At the moment, it’s very hard to trade anything because
liquidity in the market is very difficult,” said Ruediger Kerth,
a fixed-income manager at Frankfurt-based Union Investment GmbH,
which oversees 171 billion euros ($228 billion) of assets. “The
illiquidity makes it even more unattractive to take a position.
There’s really no reason to be heavily involved.”

Bailing Out

With politicians still debating potential fixes to the debt
crisis, international investors are reducing holdings of euro-
area bonds at the same time that banks curb their ownership of
the debt. Kokusai Asset Management Co.’s Global Sovereign Open,
Japan’s biggest mutual fund, sold all of its Italian government
bonds by Nov. 10, a report from the fund showed. German lender
Commerzbank AG said in an earnings report this month it is
unloading sovereign bonds at a loss.
The slump in bond prices is being magnified by banks
scaling back their market-making, where they post bid-offer
prices without knowing whether they will be obliged to buy or
sell, creating a “vicious cycle,” according to Patrick Jacq, a
senior fixed-income strategist at BNP Paribas SA in Paris.
“When you see these kinds of movements of price, yield, or
spread, it’s clearly highlighting the lack of liquidity,” he
said. “If you are a market maker and you see movements on price
or yield of 25 basis points intraday then you are very cautious,
and bid-offer spreads are widening.”

Auction Reluctance

Haggling between banks and policy makers over a potential
50 percent writedown for Greek government bonds on a voluntary
basis that may avoid triggering default-swap insurance also has
sapped trading appetite.
“Banks don’t want to hold government debt if they have to
take writedowns on supposedly risk-free assets,” said Soeren
Moerch, head of government-bond trading at Danske Bank A/S in
Copenhagen. “Primary dealers may pull out and won’t overbid at
auctions because they can’t get rid of the bonds.”
Nomura Holdings Inc., Japan’s largest brokerage, said today
it reduced assets linked to Italy by 83 percent since the end of
September by lowering holdings in southern Europe.
Bigger price swings make holding bonds more costly by
boosting measures for risk. LCH Clearnet Ltd. raised margin, or
deposit, charges on Italian-bond trading on Nov. 9 “because
we’re seeing more volatility and less liquidity,” said John
Burke, the firm’s head of fixed income in London, in an
interview that day. “Liquidity is the key issue,” he said.

‘Massively Illiquid’

While electronic trading of Greek government bonds slumped
to 1 million euros across all maturities in September, volume on
Italian futures contracts totaled as much as 2.86 billion euros
on Nov. 10 and daily German futures trading exceeded 100 billion
euros as recently as Nov. 23.
Volumes typically deteriorate toward the end of the year,
with December showing the lowest trading of bond futures
contracts in each year since 2005.
Markets are already “massively illiquid and seem to be
getting worse day by day,” said Jamie Searle, a fixed-income
strategist at Citigroup Inc. in London. “Any flow that does
come along is going to potentially have a quite large market
impact. Everyone is very reluctant to keep risk on the table.
The year-end has come early.”

For Related News and Information:
Top fixed-income stories: TOP BON <GO>
World bond spreads: WBX <GO>
Debt movers: WBMV <GO>
EU credit stories: NI EUCREDIT <GO>
Debt crisis monitor: CRIS <GO>

--With assistance from Takahiko Hyuga in Tokyo. Editors: Mark
Gilbert, Tim Quinson

To contact the reporter on this story:
Paul Dobson in London at +44-20-7673-2041 or
[email protected]

To contact the editor responsible for this story:
Mark Gilbert at +44-20-7073-3051 or
[email protected]
- eurostressnov282011.gif

The last week has seen a substantial worsening of the Euro-zone crisis and as
the attached chart shows, sovereign markets look set to close the week in
Europe in their worst state since the start of this sorry saga. As can be seen
all Euro-Sovereign yields have risen over the last sessions, with Germany
(green) losing some of its safe-haven status following a poorly received debt
auction. This point should not be overly belabored though since German yields
remains approximately 75bp below their level at the start of the crisis, while
those of Italy and Spain are threatening the horizon of our chart.

What appears to be happening is a wholesale exit of non-Eurozone investors from
this area, and we base this claim on the blow-out 154bp Euro/USD swap spread
(grey line). This accounts for the recent weakness in German sovereign credit.
Thus although the France/German spread has improved to -144bp, this cannot be
said to represent an improvement in the situation.

As for a solution, this seems as far away as ever, certainly for those
expecting to see the ECB forced to play the role of a reluctant parent bailing
out a dissolute child's gambling debts. If this could be termed the
Franco/Italian approach it would appear that a rather sterner prussianised role
is envisaged by Chancellor Merkel. Reading between the lines of yesterday's
summit it would appear that the Merkel administration is determined to only
allow a solution to emerge on their own terms, with strict controls over member
countries' fiscal expenditure that could actually be enforced. It is important
to realize that this is perhaps the clearest use of "stand-alone" power by the
German state in Europe since the end of WWII, and therefore, setting aside its
economic implications, a recasting of the distribution of political power in
Europe appears to be the most important outcome of this crisis.

Our suspicion remains that should Germany succeed in forcing its blueprint for
fiscal rectitude over its European partners it would then be much more willing
to allow an "emergency" stabilizing role by the ECB, but this is a dangerous
game to be playing against a backdrop of significant stress building in global
financial markets. - eurostressupdatenov252011.gif

The recent sell-off has been particularly harsh on the Diversified Financial
sector, which in addition to its myriad of fundamental issues has presumably
become the focus of 2011 tax loss selling. A number of individual large
financial corporations have recorded new 2011 lows over the last 48 hours,
although the index itself is still hovering at 210.7, about 5.7% above the 2011
low of 198.18. However, on a relative basis this sector has now recorded a new
all time low against the overall SPX index, surpassing the level reached in
October and also that of March 2009, when the price of the index was a mere
125.35. We would imagine that this has put simply intolerable pressure on the
long term holders of this sector (who have been remarkably stubborn in their
pursuit of "value"), adding to the already considerable selling pressure being
generated by Europe's lurid headlines. - divfinpricechart.gif -
divfinancialsvsspx.gif

As we expected the EM currency complex has now entered its second phase of
liquidation with weakness appearing across geographical zones. In terms of the
cross rates we track, today has seen South Africa's ZAR (olive) move up to a new
2011 high of 8.54 bringing the 2011 loss to 28.8%. India's INR (black) made a
new all time high of 52.73 and has lost 17.1% this year. This morning saw the
easing of non-INR debt issuance restrictions in an attempt to encourage local
issuers to increase USD supply (we very much doubt this measure will work).

Elsewhere cross rates remain below their September peaks but are starting to
rise sharply. Turkey's TRY (purple) has now reached 1.87 and is in danger of
surpassing the all time high of 1.91 recorded in October. Poland's PLN (red)
has started to be pulled into the Euro-quagmire. Perhaps most disappointing for
investors (given the vast investment flows that have poured into the country)
is the performance of Brazil's BRL (light green), which is back up to 1.85
compared to its 2011 peak of 1.95. This takes the 2011 loss up to 11.6%,
enough to wipe out the benefit of high local interest rates for USD investors.
- emfxnov2311.gif

This morning's headlines are understandably dominated by the poor German
auction, the aftermath of which has seen Bund yields rise sharply to 2.13%. Not
surprisingly weaker credits have performed even more poorly with the Spanish 10
year yield reaching a new crisis high of 6.65% and the Italian note 6.96%. Yet
again we see the rule forbidding the ECB to participate in primary auctions has
a direct deleterious effect upon the secondary market that it has spent over
€500 bln trying to bring under control.

We are also finally seeing signs of stress within the industrial investment
grade market. Attached is a chart comparing ENI's 4⅛% September 2019 note to
the Italian 10 year. As can be seen ENI's yield has risen sharply from 3.61% at
the start of November to 4.49% today, taking this instrument below par in the
process. It is therefore fair to say that we are entering a more acute phase of
this crisis in which even "good credits" are starting to be liquidated into a
market with insufficient demand. Whether this is enough to move Europe's
leaders to reconsider their position still remains to be seen. -
eniitalynov2311.gif

Brazil's loan and default data in October suggests that the pace of credit
creation has finally crested but that loan delinquency and default continue to
accelerate. This of course is an unpleasant combination for local lenders who
now risk seeing top-line growth come under pressure while charge-offs
accelerate. At present loan growth remains brisk with overall private sector
credit growing YoY at 17.45%, but this is some distance below the pace of
20.57% seen in July. Total Private Sector Loans increased by 0.96% in October,
the second time in 3 months that loan growth has been below 1.00%. Housing
credit continues to grow at the fastest pace and increased by 2.80% in October,
but this remains the smallest segment of loans in terms of value.

More troubling for lenders is the further spurt higher for loan delinquency.
Although apparently October's data was affected by a bank strike the trend
towards higher delinquency rates has now been established for many months, as
can be seen on the attached charts. Overall Personal Loan default (loans 90+
days late) grew to 7.1% while the September data was revised up from 6.8 to
7.0%. We had argued earlier in the summer that 7.0% represents the boundary for
acceptable defaults and this has now been crossed, although the trailing 6
month ma remains at 6.71%. Loans merely delinquent (30 - 90 days late) grew
sharply to 6.9% from 6.4% (if there is a distortion from the bank strike we
suspect it is in this data). This gives a total of 14% of Brazil Personal loans
due 30+ days, which is the worst reading since October 2009. This metric
crested at 15.76% in march 2009 and 15.89% in May 2002 (the last time Brazil
could be said to be in a domestic recession), but the parabolic increase in the
local loan industry means that the value of loans in BRL that are overdue is
far greater today than in those prior periods. If we simply apply the
percentage to the value of total loans outstanding we get a reading of 85.85
bln BRL which compares to a reading of 63.95 bln BRL in March 2009 (note this
is only an estimation since the actual loans that are overdue could be
concentrated in either higher or lower than average sized loans). It therefore
seems clear that the Brazilian loan system faces a greater test in the months
ahead than it has seen for the last decade, certainly far greater than the
violent but brief stress created by the 2008/9 collapse of global asset
markets. This time around the problem appears to be far more local in nature,
and we expect to see a true credit default cycle play out over the months
ahead. - D-BZLNPTOT_Index.gif - D-BRCDDEFT_Index.gif - D-.BRAZDEF_Index.gif 

The weeks around Thanksgiving are often a quite volatile time for Initial
Claims data, but today's data came in at 393K, just above expectations of
390K while last week's data was nudged higher by another 3K to 391K. Today's
report took the trailing 4 week ma down to 394.3K, the lowest reading since
April 1 2011. Thus far, November's Initial Claims data has been consistent with a
solid gain in the monthly Non-Farm Payroll report (due in 9 days time), which of
course does not guarantee that the BLS's eccentric estimation process will
provide one. Nevertheless we remain confident in our belief that US employment
is improving at a steady but gradual pace. - D-INJCJC4_Index.gif -

The ECB's balance sheet continues to grow much faster than would be
expected given the public announcements of officials. This week's data
shows total assets ex gold rising by €49bln or 2.59% (value of gold
holdings was unchanged). This is even though only approximately €8bln of
securities were bought under its EFSF facility (total holdings rose by
€9.337 to a new record high of €590 bln). What appears to be happening is
a massive usage of the ECB's REPO facilities by Euro area banks, in what
is essentially a vote of no-confidence in each others' safety but also a
reminder of the generosity of the ECB to Euro-zone lenders. Whatever
the cause at €450 bln over approximately 3 months, the expansion of the
balance sheet is now comparable to that seen in late 2008 and there is no
sign that it is about to reverse. Although the ECB can be said to be
losing the battle over sovereign debt pricing, it is perhaps doing rather
better in the overall war over aggregate Euro-zone liquidity. We remain
aghast at much of the ineptitude shown by Europe's leaders in recent weeks,
but we have been equally impressed by the resilience of non-financial
credit markets over this period, and much of this can be ascribed to a
substantial easing in aggregate liquidity. - W-.ECB-GOLD_Index.gif -

As a general rule, US small cap equities have performed somewhat worse than
large cap equities during 2011. The S&P 500 index is down -5.14% YTD
compared to losses of -6.13% in the S&P 600 Small Cap index and -10.43% in
the Russell 200 Index. Interestingly the opposite is true within the
Financial Sector, where the larger more complex franchises have done
substantially worse than their smaller peers in recent months. This
divergence has become much more obvious in recent weeks, especially during
November's abrupt sell off, and this can clearly be seen on the attached
chart which compares the YTD performance of the S&P 600 Small Cap Bank
Index (black) to that of the S&P 500 Bank Index (red) and the S&P 500
Diversified Financial Index (blue).

None of these sectors can be said to have performed well, but there is a
world of difference between being down 12% and 35%. It would appear that
in recent weeks investors have started to hone in on the specific problems
facing large highly regulated financial firms in the currently
inhospitable environment, and to penalize this area accordingly (no doubt
heavy tax loss selling is also a factor in the recent decline). For the
smaller banking franchises the environment can be said to be challenging,
but there is a sense that the worst of the legacy issues from the collapse
of real estate markets are now behind us. In fact, with Commercial and
Industrial lending moving back into expansion and Consumer Credit finally
stable, the opportunity to conservatively grow a revenue base is becoming
apparent, particularly in certain stronger regions of the US. We are not
sure that this yet constitutes enough of a reason to invest in smaller cap
banks (which are still down significantly more than the overall market),
but it does bear watching for signs of strength going forwards. - D-S6BANKX.gif
-

October Existing Home Sales kept the string of decent US housing data going
with total sales of 4.97mm units beating consensus estimates of 4.80mm and
September's reading of 4.90mm units. Total Single Family sales rose to 4.38mm
units from 4.31mm units, which is almost exactly in line with the trailing 6
month ma. This is equivalent to the pace of sales in the middle of 1998
(coincidentally this is also true about the level of the SPX index) and this
pace appears to be sufficient to bring inventory down to more normal levels
over a period of several quarters. Total single family homes for sale are now
2.86mm units, their lowest reading since December 2009.

Condo inventory looks to be somewhat tighter (see separate chart). At 467K
units this is the lowest October reading since 2005 (condo inventory is very
seasonal and so can only be compared to the equivalent month) and is 136K
or 11.55% below the level of one year ago. Condo inventory remains almost
double that seen prior to 2004 but it is starting to drop at the sort of
pace that should create reasonably tight supply in certain regional markets. In
summary this is a solid report that should help allay any residual fears that
US housing faces a double dip. - D-EHSLSL_Index.gif - M-ECSLHAFS_Index.gif -

Although this morning's headlines are dominated by the dual impasse in Europe
and Washington (the latter strikes us as a much better outcome than bilateral
faux-prudence no matter how poorly it is initially received) perhaps the most
interesting moves in markets are taking place in the emerging market complex.

For many investors this remains the most hopeful portion of their portfolio,
based on the bullish secular story that the vast majority of investors and
commentators have bought into. Following October's sharp recovery rally, many
were confident that the summer's decline had represented yet another buying
opportunity but recent days have suggested that instead a classic bear trap had
been laid, with a number of markets moving sharply lower to within striking
distance of their 2011 lows.

This weakness in equities has been matched by a second wave lower for emerging
market currencies. Following widespread intervention, these had stabilized in
mid-September and most had posted good gains in October. The picture today
looks much more fragile and a clear uptrend in spot rates is visible on the
attached chart. In terms of YTD performance, the South African rand (ZAR, olive
line) remains the worst performer, down 25%, but at least this cross rate
remains well below the level reached in 2008. Of much more concern is the
performance of the Turkish lira (TRY, purple line) and Indian rupee (INR, black
line). The former reached a record spot rate of 1.909 on October 4th before
recovering sharply to close the month at 1.744. As of today the spot rate is
back up to 1.844 and rising sharply. The INR has fared even worse and closed at
a new all time closing high cross rate of 52.14, just below the intra-day high
of 52.18 recorded in March 2009 (see separate chart of INR & TRY). Both India
and Turkey have been very popular destinations for equity and fixed income
investors since mid 2009.

In addition to magnifying losses for foreign equity and fixed income investors,
sharp drops in currencies pose a significant risk to actual corporate
profitability. We get the sense that few large EM corporations had taken steps
to protect themselves via hedging and many had in fact issued USD, EUR or JPY
denominated debt this year in order to take advantage of much lower interest
rates. Further weakness in the EM currency complex would therefore pose a
significant risk to the many investors with heavy commitments to this area of
capital markets. - emcurrencies2011.gif - inrtry.gif

Since the Conference Board Leading Indicator Index is little more than an
amalgam of economic monetary data already known at the time of publication, it
should come as little surprise that October was a strong report, with the index
gaining by 0.9% to a new all time high of 117.4. This beat consensus of 0.6%
although this is probably because analysts had not updated expectations after
yesterday's good building permit data (a key component of the LEI index). As
ever we like to take a significantly longer view when analyzing cyclical data
and the attached chart shows the LEI index with a 12 month ma. As can be seen
the 12 month ma is at a healthy 0.5 which puts the current recovery at the
higher end of the range seen in other recoveries since the start of the data in
1981, if one ignores the very high "snapback" readings seen in the "V shaped"
recoveries of 1982/3 and 2009/10.

The LEI index therefore supports the notion that we are still in the middle of
a period of expansion for the US economy that is likely to take a number of
domestic sectors to peaks of activity that comfortably exceed that seen in the
last cycle. - leileadingindicatoroct11.gif

No sooner had we typed up yesterday's note reminding readers that the FRB
may yet have a role in the Euro-crisis than we noticed James Bullard,
President of the Federal Reserve Bank of St Louis mention this possibility
in an interview on CNBC. This comment garnered far less headlines than his
other musings but, as we have pointed out before, intervention in foreign
sovereign bond markets was part of Ben Bernanke's 2002 codex for fighting
deflation. For a serial interventionist such as Chairman Bernanke the stunning
inability of Europe's leaders to make forward progress must make for
frustrating viewing.

With this in mind we have been keeping a close watch on the weekly publication
of the FRB's balance sheet for any changes to the size of the Central Bank
Liquidity Swaps (FARBCBLS). During the 2008 crisis this reached a high of
almost $600 bln but was fully repaid by early 2010, only to be briefly used
during the early stages of Greece's travails in the spring of 2010 (when the
EUR fell sharply to below $1.19). The facility then lay fallow through the next
few months before rumbling into life in April, in what we assume was an
operation to make sure that lines were working efficiently should the need to
inject large amounts of capital to a foreign central bank become urgent. As can
be seen in early October the total sum extended was a mere $500mm (a rounding
error on the FRB's $2.82 trln balance sheet).

Since this time the facility has become rather more active, rising fairly
rapidly to $2.35 bln and by $404mm over the last week. We believe that this
rise is due to the participation of the FRB in the 3 auctions held to boost USD
liquidity in the Euro-zone, a policy which thus far has failed to keep the
EUR/USD 3 month swap from blowing out to record levels. Clearly the FRB has yet
to commit to a meaningful role in this ongoing crisis, but it can also be said to
have now crossed the line of becoming involved. President Bullard's comment
suggests that the level of involvement is currently a matter of debate within
the FRB, although we think it unlikely that the FRB would seek a large role
unless it was part of an agreed international intervention.

One crucial benefit that the FRB would have over the ECB is an ability to
participate in the primary market. As recent weeks have shown buying large
amounts of bonds in the secondary market does not stabilize bond yields if
relatively small amounts of debt sold at auctions clear at much higher yields.
We still view the participation of the FRB as very much an "outlier event", but
it now makes sense to pay attention both to public comments on this matter as
well as any further changes to the size of the CBLS. - D-FARBCBLS_Index.gif -

We started the year by predicting that India was likely to be one of the
most disappointing markets for investors and events have so far proved us
to be correct with the local equity market leading the overall emerging market
complex lower before stabilizing a few weeks ago. There are now signs that the
predictable recovery rally of the late summer has run its course and a steady
stream of poor economic and corporate news seems to be eroding investor
confidence. The central bank has also sown some confusion with contradictory
policies, an increasingly common theme amongst emerging markets. For instance
although the RBI is still officially in a tightening stance (understandably
given local inflation is still at around 10%) they have been forced to step in
and purchase 100 bln INR ($2 bln) of local bonds in order to inject liquidity
into the local marketplace.

As can be seen on the attached charts the local benchmark SENSEX index has
started to decline quite sharply at this morning's close of 16461.7, which is
approximately 4.5% above the key support level of 15750. The BSE Small Cap index
has already broken down below the equivalent support level, which increases the
odds that the large cap index will follow suit. Meanwhile foreign investors
have been remarkably patient with this performance. Total YTD equity purchases
are still just positive at $571mm and this creates the risk that, should outflows
start to take place there will be insufficient local buying power at current
prices. Of course this year's inflows are only a fraction of the record $29.3 bln
that were seen in 2010, which helps explain why the INR has been so weak in
recent weeks, closing this morning at a new 2011 low of 50.90 and magnifying
losses for foreign investors. - W-BSESMCAP_Index.gif - W-SENSEX_Index.gif -

US Initial Jobless Claims were estimated to be 388K this week, the lowest
reading since April 1, 2011, and very much keeping to our expected pattern
of seasonality. As can be seen on the attached chart the 4 week ma of
claims has now fallen to 396.8K and is below the key 400K level for the
first time in 6 months. We would expect to see this data continue to
improve in the coming weeks partly due to kinder seasonal adjustment but
also since we do believe that there is some improvement visible in the
domestic US economy. The next milestone to watch is the recovery low of 4
week average claims at 386.8K, recorded on March 11, 2011. We would expect
that a move below this number would coincide with some significant upward
revisions to models describing the state of the US economy. -
D-INJCJC4_Index.gif -

There is growing evidence that the US New Housing market may finally be
starting to pick up in activity after almost 4 years of total collapse.
This week's better than expected NAHB survey has been followed by decent
Housing Permit and Start data this morning. Again in historical terms the
level of activity remains pathetic, but we can discern a distinct
improvement of tone that could mark the start of something much more
impressive.

Total starts were reported at 628K, beating consensus of 610K, while last
month's suspiciously strong data was revised down to 630K from 658K.
Building Permit data (which we find to be a little more reliable) came in
at 653K, well above consensus of 603K and last month's data was only
revised 5K lower to 589K. Again the multi-family sector has a much more
clearly defined recovery pattern in place, and is now approximately 45% of
the size of the New Home construction market. No doubt this reflects
strong demand for rental property at the current time, but it will still
feed into overall economic activity.

The key metric we follow is the Single Family Permit data (see separate chart).
This rose to 434K, the best reading since December 2010 (when seasonal
adjustment was at its kindest). This has allowed this metric to finally
cross its 36 month ma for the first time since March 2006, again lending
some credence to the notion that the New Home market may have bottomed
earlier this year. - D-NHSPA1_Index.gif - D-NHSPSTOT_Index.gif -

This morning's very poor Spanish 10 year debt auction, which cleared at 6.975%
with a weak coverage ratio of 1.54, shows the problem with restricting ECB
purchase activity to the secondary market. With France and Germany publicly
bickering about the size of a required rescue package there seems to be
remarkably little public discussion as to why it makes sense to intervene in a
secondary market via purchases of large amounts of bonds and then allow the
primary market to fend for itself, with predictable results. It would be far
more efficient to simply set a ceiling on auction rates and then let the
secondary market take its cue from a well bid auction, and this would also have
the effect of directly lowering the borrowing costs of the issuing nation.

Unfortunately this is monetary heresy within the ECB and much of Europe's
government (although we suspect that in the chaos many have simply not thought
about the option). This results in market action such as today with the Spanish
10 year note moving up to 6.78% before falling to 6.67%, some 33 bp below the
rate that notes cleared the auction a few hours ago. We assume that ECB
purchases in the secondary market have had a role in bringing note yields
lower, but this only underlines our point as to how silly this whole process of
"intervention without manipulation" has become.

Meanwhile we note that the Euro/USD 3 month swap (grey line, lower chart) has
quietly widened to a new all time high of 131bp, indicating that a flight to
safety out of Europe and into the US continues to take place. The introduction
of 3 emergency auctions to create additional USD liquidity has been overwhelmed
by market action and we would expect to see additional measures brought into
place in the near future, possibly involving the re-utililization of the FRB's
CBLS Facility. - eurostress111711.gif

Russia has done a good job of staying out of the headlines in recent weeks but
this massive injection of liquidity suggests that monetary conditions have
significantly worsened in recent weeks, even with energy prices rising
strongly. We note that in India the RBI was also forced to inject liquidity
into its banking system last night. In general it would seem that the emerging
market banking system is starting to feel the strain of both local
deterioration and Euro-contagion.

The NAHB Sentiment Index moved up to 20 in November, comfortably beating
consensus of 18 and taking this indicator right up to the top of the "dead
zone" that has contained readings since activity collapsed in late 2007.

Strength was seen across sub indexes with Present Sales moving up to 20, the
best reading since May 2010 when the expiring tax credit artificially boosted
activity. Ignoring this month, this was the best reading since March 2008 when
the collapse of BSC marked the start of the acute phase of the crisis. Future
sales rose to 25 (highest reading since March 2011) while Traffic hit 15, the
best reading since May 2010 and second best since September 2009. The only
negative surprise was a large drop in the West regional reading from 21 to 15
but this was made up for by much stronger readings elsewhere, most notably the
Midwest surging from 15 to 23. In our experience, the regional sub-indexes tend
to be very volatile (we suspect due to changes in participation from month to
month) and we would concentrate on the overall data.

In terms of what this means, the first thing we would say is that the data is
still extremely weak from a historical perspective. Nevertheless the hints of a
sustainable improvement in this industry are starting to become more credible.
We would expect to see the NAHB's bounce reflected in better New Home Start,
Permit and Sales data later this month, with the generous seasonal adjustment
at this time of year magnifying any underlying improvement in activity. With
the S&P 1500 Homebuilder index (S15HOME index) still down 12.86% for the year
the possibility of a turn in the cycle does not seem to be priced into this
sector at the current time. - nahbsurveynov11.gif

The US data rebound continues, with significantly stronger Industrial
Production and Capacity Utilization data being released this morning. To our
eyes, this reflects the seasonal adjustment process moving into the benign
period of the year rather than an actual acceleration in activity (similarly we
do not believe that activity deteriorated during the spring and summer) but it
does have the useful effect of pushing consensus back towards a more accurate
assessment of the state of the US economy.

As to this morning's data we are more interested in the Capacity Utilization
figures than Industrial Production (these lag the far more useful ISM survey
and we have little faith in their accuracy). Capacity Utilization has long been
viewed by FRB economists as an important influence on monetary policy since it
indicates the degree of slack present in the US Manufacturing Sector. As the
attached chart shows at 77.8 the current index is only just below its long term
(25 year) average of 80.0, and has risen by a healthy 2.09 points over the last
12 months. Interestingly, Cap Utilization is now higher than it was back in June
2004 (77.2) at the time the FRB commenced its last rate hike cycle. We do not
suggest that the FRB is about to change course, but it is starting to become
clear that current monetary policy is extremely accommodative, at least with
regards to the portions of the US economy that did not bear the brunt of the
2008 collapse. Should the FRB stick to its word and keep interest rates
anchored to zero for the next 18-24 months, the Capacity Utilization would
probably be close to 80 at the time that they started hiking rates from a
record low level. Already the seeds of longer term economic mismanagement are
being sown, but in the meantime portions of the US domestic economy should be
able to take advantage of the FRB's generous policy. - caputilizationoct11.gif

It is our belief that a number of large emerging market economies have
commenced significant downturns and that their local equity markets have
moved from a bullish to bearish stance. One of the many signs that this
may be the case is the notable underperformance of EM small cap equities
during the strong recovery rally that have taken place since early
October. As can be seen on the attached chart, the MSCI Emerging Market
Index (MXEF) enjoyed a far sharper rally than its small cap equivalent
(MXEFSC). The large cap index bottomed at 824 and bounced as far as 1014
for a 23% gain, before falling back last night to 969 for a 17% recovery
from the October 5th low. For the small cap index, the low came in at 815
and the peak recovery at 956, a gain of 17.3%. This has now been trimmed
to a recovery of 12.2% at last night's close of 916. In terms of YTD
performance the MXEF is down 15.8% while the MXEFSC has fallen 23.3%.

This underperformance of small cap equities is typical of an early stage
of economic deterioration since smaller companies tend to be much more
sensitive to economic and monetary conditions. With regards to the latter
the sharp increase in local interest rates in a number of countries,
together with other restrictive policies such as increasing bank reserves,
has led to a much sharper rise in borrowing costs for smaller borrowers
than their larger counterparts, who generally have the option of borrowing
at more attractive rates through debt issuance. We view the failure of
emerging market small cap equities to reverse the majority of this
summer's collapse to be an important warning sign that more problems lie
ahead for the overall emerging market complex. - D-MXEFSC_Index.gif -

Those looking for any contagion from the Euro-zone crisis should look to
some of the weaker members of the EM complex, which has failed to recover
fully from the abrupt decline in both local asset prices and currencies
that took place this summer. Turkey is a prime example of this phenomenon,
and this morning's very poor 2 year note auction has led to a surge in the
yield of this instrument to 10.93% (up 28 bp for the day). This compares
with a yield of under 8% in early September and of 7% at the start of
January. As can be seen, the collapse of the Turkish Lira (TRY) preceded
the deterioration of the local debt market, no doubt since it has
interfered with foreign investor flows that had helped create the very
accommodative environment of early 2011. Conditions look to be much
tougher today, with an economy that has become very credit dependent
now seeing local borrowing costs move sharply higher, while the issuance
of USD or EUR denominated credit is made impossible (or at least unwise)
by the instability of the TRY. Meanwhile the early attempts to use reserves to
bolster the TRY simply led to a sharp reduction in reserves without pushing the
TRY back down to its level of early 2011.

This is very much the scenario that we expected when we turned our attention
to Turkey earlier this year and the dangers of an abrupt failure of the market's
nerve should not be underestimated. - D-GTTRY2YR_Govt.gif -

More good US data was reported this morning in the form of Total Manufacturing
and Trade Inventories and Sales. Total Inventories were unchanged for the month,
while Sales grew by 0.6%. At $1209.73 bln, Sales are now a mere $2.11 bln
(0.175%) below their 2008 all time high, and given that sales have been
positive each month since July 2010 (with the exception of May 2011) they can
be expected to pass this milestone sometime within the 4th quarter, following
retail sales into blue sky territory. Inventories remain some distance below
their 2008 peak, allowing the Inventory/Sales ratio to remain tight 1.267. The
US Manufacturing industry would therefore appear to be in middle of solid
recovery, which is underpinned by the steady improvement in US retail sales (see
earlier note). - M-MTIB_Index.gif -

Our weekly monitoring of the ECB Balance sheet shows that the ECB has
grown its balance sheet on 13 of the last 15 weeks (the exceptions being a
small €4 bln drop 2 weeks ago, and a €5 bln drop on August 26th). This
week's data (through 11/11/11) shows the balance sheet growing by €14 bln
(0.79%) to a new all time high of €1923 bln (more than €380 bln larger than
the balance sheet at the start of August). As we discussed earlier today
this has not been enough to stabilize sovereign credit market in the wave
of liquidation that has followed the collapse of MF Global, but it has
almost certainly been a key factor in the relative stability of
non-sovereign (and non-financial) credit markets in Europe in recent days.

The great shame is that this expansionist policy is being carried out
under an "omerta". In fact all public pronouncements by the ECB suggest
that a full sterilization of EFSF sovereign credit purchases is being
followed (this is partly true, but ignores the fact that the ECB has
allowed other assets to balloon at the same time). We cannot help but
wonder how much better behaved sovereign credits would be if the ECB had
publicly announced a program similar in size to QE2 and was approximately
two thirds of the way through implementing it. The balance sheet would
look roughly the same but the message to the markets would have been
entirely different. This contrasts most unfavorably with the transparency
of the Bernanke led FRB which has been open about its large interventions
into credit markets and explicit as to its intentions of manipulating
rates back into stability. One may argue with the wisdom of the policy but
it is hard to fault the honesty with which it has been followed, as
opposed to the ECB which has talked tough and acted timid since the height
of summer. - W-.ECB-GOLD_Index.gif -

In these troubled times the domestic US economy has become the most reliable
source of positive news flow, in part because expectations are so modest, but
also because the recovery process seems to be quite robust, particularly within
the domestic portion of the economy. October Advance Retail Sales continued
this trend coming in at 0.5% compared to expectations of 0.3%. Advance Retail
Sales less Autos were 0.6% compared to expectations of 0.2% (September was
revised down by -0.1%). As can be seen on the attached chart, official retail
sales data has been rising very steadily in recent months, in fact sales have
shown a much more robust and reliable increase than in the last 2 recoveries.
This was to be expected during the "V shaped" recovery from the 2008 collapse
in activity, but it has remained true even as this data has pushed into
uncharted territory. We would suggest that this is a function of the still
ongoing replenishment of goods whose use life was extended during the 2008
slump (the 36 month ma of sales is still $5 bln lower now than it was at the
September 2008 peak), but also the fact that consumer expenditure on housing
has been sharply diminished in recent years, freeing up discretionary income
for retail purchase. Whatever the cause in an increasingly uncertain world, the
US consumer has proved to be reliably resilient. - retailsalesoct11.gif

The Eurozone leadership have shown the qualities first exhibited by Emperor
Nero two millennia ago, with the result that a local conflagration has now
started to spread throughout the Euro-zone sovereign credit market. Clearly one
of the problems in recent days has been the sudden dawning by the global "risk
management" industry that a concentrated and leveraged portfolio of weaker
sovereign credit can lead to an abrupt destruction of capital. Unfortunately
the repercussions of MF Global's messy demise appears to be a rush to the exit
for all tainted sovereign credit (in large part encouraged by a flurry of
information requests by investors and counter-parties as to a firms direct
exposure). Thus even relatively light exposures have been cut rapidly in recent
days into a marketplace that had few willing buyers outside of the limited
program conducted by the ECB in the secondary market.

As we have pointed out before, this leaves the primary auction market out in
the cold, with the result that weak auction participation feeds through
abruptly to the secondary marketplace. This dynamic was seen with Italian
credit two times in recent days and this morning's failure of the Spanish 12 &
18 month T-bill auction (€3.16 bln sold versus a target of €3.5 bln) led to an
abrupt surge in the Spanish 10 year note yield to 6.30% (red). Perhaps of even
more concern to the Euro-leadership is the fact that the French 10 year yield
(blue) has now also broken out to 3.67%, creating its own "jaw of dislocation"
with the German Bund down at 1.76%. The France/Germany spread is now a
remarkable 190 bp, meaning that France now pays over twice the rate of Germany
to borrow for 10 years.

A more substantive and less constrained implementation of policy by the ECB
appears to be a requirement of the marketplace. In particular, some form of
quantitative easing and the freedom to purchase bonds directly at issuance would
seem to be particularly important. Both would require a substantial change in
the stance of the current governance of this institution, which itself requires
a political mandate that has been lacking this far into the crisis. About the
only good thing to note is that outside of sovereign credit other risk markets
have been remarkably patient (although there are signs of European equities
fraying in recent days). The Eurozone leadership should not take this patience
for granted. - eurostressnov152011.gif

In an interesting move, Brazil's Central Bank has repealed a number of its
"macro-prudential" measures, which were aimed at restricting credit to
consumers. It would appear that the repeal of these brief curbs came in
response to much weaker than expected consumer data, particularly in automobile
sales. Although most observers have attempted to link this to the ongoing
turbulence in Europe, it is interesting to note that US consumers showed no such
reticence to purchase cars in October.

Moreover, consumer credit has continued to grow strongly in Brazil over the
summer, so it is not clear that the curbs being repealed had meaningfully
crimped demand and we do not expect their repeal to suddenly reverse the
deterioration in trend. As a general rule, the worst time to be investing in a
market is when a central bank starts to shift from a restrictive to looser
stance, since almost invariably, this shift is forced upon it by a sudden
deterioration in local economic conditions that continues in the face of each
incremental loosening. We expect to see this pattern confirmed in Brazil and a
number of other emerging markets in the months ahead.

India's Industrial Production data continued to show a sharp deceleration in
September with the annual growth rate falling to 1.9%, the lowest reading since
September 2009 when India was recovering from the collapse in activity during
2008. This report pulled the trailing 6 month ma down to 5.1%, the lowest
reading since December 2009.

Since this data is for September, it reflects activity in a period that has
already been covered by companies reporting 3rd quarter earnings. Nevertheless
the deterioration in trend seems real enough, and with the RBI still in a
tightening mode it seems likely that Indian IP will turn negative in the coming
months. - indiaipsep11.gif

The University of Michigan Consumer Sentiment index had a bigger than expected
bounce to 64.2 (consensus was 61.5) in November, but this still keeps the index
in the "deep recession" range and below the trailing 12 month ma of 67.8. On
the other hand, by bouncing 9.1 points since August this almost certainly
indicates that a major low in Consumer Sentiment has been put into place, and
this itself is very significant since major lows in Sentiment often mark
important inflection points in equity market performance. Although the SPX went
on to make a slightly lower low in early October, many non-financial equities
made their low in early August, particularly those focused primarily on the
domestic US economy. With the vast majority of recent US data suggesting that
the summer's "data-panic" was unwarranted, it seems likely that the further
progress in both domestic equities and Sentiment can be expected in the weeks
ahead. - uofmichigannov11.gif

Chinese monetary data showed significantly stronger growth than recent months
in October, although in large part this appears to be a compensatory bounce
following very weak September data. Total M2 grew by 3.73% in October (0.85% in
September), keeping annual growth at 12.90% (red line on chart). M1 grew by
3.52% (after falling -2.23% in September) but still saw its annual growth fall
to 8.40%. Total New Loans came in at 586 Bln CNY, well above expectations of
500 Bln. Even so the trailing 6 month ma fell slightly to 547 Bln (see 2nd
chart).

It is too early to say whether this is simply a fluctuation in data or a sign
of easing by Chinese authorities (although we lean towards the former). From
our perspective an actual shift in monetary policy would only come into play
after the Chinese central bank had seen clear evidence of distress in one or
more key industries and we doubt this has yet reached the critical mass
required to shift policy (certainly not in the form of the official data).
Nevertheless even after October's bounce the trend of liquidity creation and
credit formation remains resolutely negative, with predictable consequences for
the portions of the economy that benefited most from the liquidity binge of
2009. - chinam1m2.gif - chinanewloansoct11.gif

With all eyes on Europe, this morning's initial claims data still bears
watching. Claims were estimated at 390K, somewhat better than the expected
400K. This has reduced the trailing 4 week ma (see chart) to exactly 400K,
which we view as a fairly important demarcation in employment conditions. Note
that back in March this indicator fell as low as 388.5K, and we would probably
have to fall below this figure to force a reappraisal of consensus regarding US
employment. Given that seasonal factors are now quite strongly favorable for
the headline data, we would hope that we reach this milestone sometime towards
the middle of Q1 2012. We continue to believe that US employment is improving
at a fairly normal pace, and that the frustration with the speed of this repair is
equally normal. - initclaimsnov102011.gif

Although today's trading saw a moderate decline in the Italian 10 year yield
(black) to 6.92% following a successful auction of short dated paper this
morning (if a clearing yield above 6% can be termed a success), a sharp rise in
French yields has removed any sense of relief. The French 10 year note now
yields 3.43%, up 23bp from yesterday's close. With the German Bund (green)
remaining stable, this has caused the France/Germany spread (pink) to move out
to 168bp, meaning that France now pays almost twice as much as Germany to
borrow for the same period. We have long predicted that a breakdown in the
relationship would finally force a more flexible mandate for the ECB, although
we would have thought that things were bad enough to cause some movement a
couple of weeks ago. We have no insight as to what the "magic number" that will
have to be reached to force a reconsideration of Euro-zone monetary policy is,
but the market is starting to hone in on the most critical bilateral relationship
in the Euro-area, greatly raising the pressure on all parties to pursue a
meaningful change in policy. - euorstressnov102011.gif

As all readers will be aware, the "jaws of dislocation" opened ever wider this
morning as Italian yields shot higher while the flight to safety to the Bund
pulled German yields lower. In the case of Italian sovereign credit, we have now
created a "bids wanted" marketplace with the yield of bonds simply a function
of how much pain a forced seller is willing to endure in order to be relieved
of the bonds. While we assume that last week's burst higher was at least partly
caused by MF Global's portfolio liquidation, the last 48 hours looks like a
simple dumping by investors of all stripes in what could be termed a vote of no
confidence in both Berlusconi and whoever takes the poisoned chalice in the
event that he does actually resign after passing a new budget.

Whether this morning's yield of 7.48% marks the peak or is just an interim high
remains to be seen, but the market is clearly looking for a more credible
response by Europe's leaders and the ECB. The latter for instance, could start
to intervene in primary markets (i.e. auctions of new Italian bonds) rather than
limiting its large purchases to the secondary market where it has been quite
ineffectual, although this would require an "emergency" suspension of its
charter limitations on doing so.

Adding to the pressure is the continued widening of the France/German spread,
now at a humiliating 147 bp, close to 85% of the total yield of the German
Bund. Again one wonders what it actually takes to create a determination to
deliver a credible plan to the marketplace.

If there is any good news it is in how narrow this crisis remains. Italian
Industrial credit remains well bid with ENI 2019 bonds still yielding under 4%
(see chart). Meanwhile in the US despite a sharp decline in equities (but only
within a well defined trading range) the overall marketplace remains quite
stable. The Bloomberg Financial Conditions Index widened to 1.16% today,
dropping a relatively large -0.318 but keeping the index well above a crisis
reading of -2. The (unreleased) Bloomberg Eurozone Financial Conditions Index
by comparison hit -5 this morning, although as we note the stress is almost all
located in Financial and Sovereign credit markets. - bfciusnov92011.gif -
eurostressnov92011.gif - italyeni.gif

India became the second large emerging market to announce disappointing car
sales in October with total sales falling 16.5% from September to 138.5K units.
Note that this data is not seasonally adjusted, but historically October has
been a slightly stronger month for sales than September. Sales dropped 24% from
October 2010, which we believe was roughly the period that marked the peak for
India's local economy and equity market. Some of the sharp drop in October's
sales is due to a strike at Maruti Suzuki India, which is estimated to have cost
up to 40K units of production (not all of which would have resulted in October
sales) but sales had been deteriorating for several months causing industry
estimates of sales to be reduced twice already since the springtime. The sharp
rise in local borrowing costs would seem to have had a marked effect on the
local demand for new cars, and this can be expected to feed back into an
already slowing industrial economy. - indiacarsalesoct2011.gif

As Italy's sovereign debt yield barrels higher, it is interesting to note that
the opposite is true for the debt of ENI, Italy's largest public company. The
attached chart shows the 10 year generic sovereign yield (red) together with
that of ENI's 4.125% note due in September 2019. As can be seen, at issuance
this (originally 10 year) note yielded slightly more than the Italian sovereign
note, but since late 2009 the note has yielded significantly less. Nevertheless
until recent weeks, movements in the 2 yields were in the same direction. Over
the course of the summer ENI's yield ceased to respond to the spikes in Italian
sovereign credit and the latest surge back over 6.00% has been matched by a
sharp fall in ENI's note yield in something of a flight to safety (for obvious
reasons this is not true of large financial corporations' credit). This
underlines the importance of understanding that the problems of Italian
sovereign credit are more remote from those of the industrial economy than may
be supposed. It is a particular form of Italian credit being shunned by the
current marketplace rather than the entire scope of the Italian economy. -
italyeniyield.gif

Brazil's October Car Sales is the latest piece of data to suggest that a marked
slowdown in that countries domestic economy has taken place in recent months.
Total sales fell from 308K in September to 286K in October (the data is not
seasonally adjusted) for a pace of sales that is -7.46% below that of a year
ago. The trailing 12 month ma has also rolled over from a peak of 308K to 306K.
Given that car sales data is quite volatile on a monthly basis would not draw a
definitive conclusion that car sales have moved into negative growth, but it
does appear that the very rapid gains of prior years has at best moderated into
a far gentler pace of increase. - brazilcarsalesoct11.gif

A weekend's rest has done nothing to soothe the nerves of the Euro-sovereign
marketplace with a surge higher by Italian yields coming in response to the
perceived impotence of the Berlusconi administration and a further blowout of
the France/Germany spread (pink lower chart). We have reverted back to a longer
term (20 year) weekly chart to demonstrate the current state of affairs since
the breakout by the Italian 10 year yield to 6.62% deserves to be put in some
historical context.

As can be seen, the "jaws" of dislocation have been moving ever wider in recent
weeks but still remain somewhat tighter than their pre-Euro extremes when
investors also needed to consider the rapid depreciation of underlying
currencies such as the Lira and Peseta (the latter fell from 90 to 150 between
September 1992 and July 1993) although this made outright default far less
likely to occur. On the other hand, pre-Euro crises had a habit of reversing
suddenly once they had run their course (see 1994 - 1996 on attached chart)
and as complete as investor aversion is to Italian debt today, we would not
rule out a transition to a more stable environment should a clear mandate for a
more austere fiscal policy emerge in response to the surge higher in yields.

What we do not expect to see is a return to the total equivalence of Euro-zone
yields (barring a fiscal union). This is as true as the relationship between
French and German yields (currently the spread is the widest seen since 1990)
as it is of weaker members of the union. Thus the best case scenario is a
stable but wide difference in borrowing costs for the various members of the
union. Although this may be tenable from an economic perspective (and quite
stimulative for the stronger nations such as Germany) it is likely to be a
massive political bone of contention, particularly across the key Franco-German
axis. - eurostressnov72011.gif

The attached story describes exactly the sort of funding squeeze amongst
secondary Brazilian banks that we have been anticipating since the EM new
issuance market for bonds effectively shut down in the summer. Brazilian banks
were not alone in using this marketplace, but they were amongst the more
aggressive. We would expect to see more signs of difficulty emerge in the weeks
ahead.

October's Non-Farm Payroll report showed total Payroll gains of 80K vs. 95K and
Private Sector gains of 104K vs. 125K. However, any disappointment from this
small shortfall in October's report was more than made up for by another large
revision to August and September data. These were increased by a total of 102K
jobs. This is the second revision to August's original report of 0K gains (the
"data shock" that launched President Obama's push for an emergency jobs plan).
2 months later the, BLS now estimates August's gains as a far more normal 104K,
tepid but hardly disastrous data. We recall that our original challenge of the
veracity of August's data was described as "hogwash" by one media outlet, but
it now appears that this description should have been used for the data itself.

Given the inaccuracy of this data we have always argued that it can only be
interpreted using a relatively long moving average (at least 6 months although
we favor 12). By this measure Private Sector payroll gains have averaged 152K
over the prior year. This is equivalent to the level reached in the summer of
1993 and 2004. We would admit that in those prior periods there had been some
very punchy single month data points (none more so than March 2004's 300K
print) but the overall gains over the prior 12 months were identical to those
of today. Our view remains that we are in the middle of a long steady period of
employment repair in the US. It may be "frustratingly slow" for the politicians
and the Federal Reserve (not to mention those seeking employment) but it is not
a reason for investors to be disheartened. - nfpprivateoct11.gif

It would appear that the intense pressure coming from Euro-credit markets
earlier this session finally pulled the ECB into a more accommodative stance at
today's meeting with the Main Refinancing Rate being reduced to 1.25%. This
change in rate is far more important for its symbolic meaning than the actual
reduction in monetary pressure that will result directly from a small reduction
in rates.

We will be very interested to see whether any indication that the ECB is
considering the sort of quantitative easing measures (what we have called QE€)
that the Trichet led institution so carefully eschewed over the summer months
(although as we have shown the ECB did increase its balance sheet considerably
this summer). But the standoffish stance of ECB from this crisis would finally
seem to have ended with today's meeting and this is a very important change in
the overall environment. - ecbrefirate.gif

The backdrop for Chairman Draghi's first meeting of the ECB policy committee
could scarcely be less encouraging with the threat of Greek cession from the
Euro-zone pushing sovereign yield relationships to new crisis highs. Of primary
concern is the fact that the Italian 10 year yield (black) has now reached 6.33%,
indicating a renewed wave of liquidation that probably goes beyond the forced
unwind of the MF Global portfolio. It is interesting to note that Spanish debt
is substantially better bid at 5.60% and remains well below the level reached
prior to the implementation of the ECB purchase program. Meanwhile the
France/Germany spread (pink, lower chart) has blown out to a new Euro-era high
of 137bp as German yields collapse and the French 10 year yield moves slightly
higher. Unsurprisingly USD liquidity remains under pressure with the 3 month
€/$ swap at a very elevated 104bp (in this case we do think that the MF Global
liquidation may have had a major part to play since this will have resulted in
a substantial sale of EUR debt for USD delivery).

Whether this is enough to force the ECB into a more accommodative stance is
hard to say. Our assumption is that they will take no action today but perhaps
indicate a willingness to lower the base rate at a later date. This has more to
do with Draghi establishing his credentials as a "Good European" central banker
than the fairly urgent need for greater liquidity provision and lower rates,
but the whole sorry Euro-zone saga has been dominated by posturing rather than
clear thought and we doubt that this will change this morning. -
eurostressnov32011.gif

Today's FOMC statement ranks as one of the more confused communications in
recent months with the committee admitting that recent economic data had
strengthened (surprisingly from their perspective) but remaining alert for
renewed weakness. The comments regarding employment growth were unsurprising
but underline the extent to which the FRB will rely almost exclusively on the
official readings of employment (primarily the Non Farm Payroll report and
associated estimation of Unemployment) in judging the efficacy of current
monetary policy.

One can therefore already see the path that may be followed later in the
recovery should official employment gains lag other clear signs of accelerating
growth (should we be lucky enough to get this far), with the FRB choosing to
ignore the latter. But this is getting somewhat ahead of ourselves. At present
the FOMC is on hold in its current aggressively accommodative stance. We are
relieved that no further stimulus is being enacted since we do not see this as
warranted by the current conditions and the market does not seem to be overly
disappointed with the current state of affairs.

The ADP Payroll report for October came in at 110K, above expectations for
100K. In addition last month's reading of 91K was revised 25K higher to 116K,
making the net effect of this small positive surprise a little more
encouraging. This data pushes the 12 month ma up to 145.2K, equivalent to the
level reached in June 2004 and suggests that employment continues to be created
at a moderate but steady pace.

As ever this does not mean that Friday's BLS data will follow suit. Consensus
calls for Private Sector gains of 125K which is a little less than the trailing
12m moving average of 148.25K. This is not a very demanding hurdle to beat,
particularly against a backdrop of generally favorable data, but anything is
possible with non-farm payroll. - adppayrolloct11.gif

US New Car Sales were in line with expectations at 13.20mm units in October,
even with the last weekend of the month disrupted by unusually difficult
weather conditions in the North-East of the country. New Car Sales have
recovered strongly from their post-tsunami dip this summer when the lack of
availability of Japanese models crimped sales and would appear to be back on
their recovery path with no signs of a double-dip in consumer demand. Sales are
still 3mm+ units below their pre-crisis levels and the trailing 36 month ma of
sales is 11.40mm units, almost exactly 5mm units below that seen in 2007. In
other words some 15mm less cars have been purchased over this period than would
have been in more normal times. Given that overall retail sales remain solid
and that the country's car fleet has aged considerably, we expect to see a
continued improvement in car sales in the months ahead and would hope to be
well over the 14mm level at some point in 2012. - uscarsalesoct11.gif

Brazil's Industrial Production fell by a surprising 1.97% in September which
took the 12 month RoC down into negative territory for the first time since the
2009 recovery took hold. This makes Brazil the first major EM economy to show
an annual shrinkage in this key part of the economy and underlines the degree
of internal economic distress that is starting to become visible in a number of
key EM economies. - brazilipsep11.gif

The "Euro Spring" of last week turned out to be a single sunny session for
asset markets, after which the storm clouds of the prior crisis moved in. Even
before this morning's news from Greece, the Italian 10 year yield was
misbehaving and today's session saw this yield move up to 6.19%, well into
panic territory. The one mitigating factor is the likelihood that MF Global's
demise may be causing some forced liquidation in this area, exaggerating the
market's aversion to Italian sovereign credit.

However, other measures of stress are also elevated, with the France/Germany
spread (pink) moving out to 118bp (at least this time French yields are
declining but by less than Germany's) and the cost of swapping from EUR into
USD for 3 months (grey) rising to 108 bp. All of this suggests that the market
is not yet satisfied with the body of measures proposed by the ECB and Euro
governments.

Ironically the ECB continues to do much more than it promises, with its balance
sheet expanding another 1.07% this week, making the 13 week increase 16.88%.
Perhaps if this expansionist stance was publicly admitted and made permanent
this would help calm some nerves, but in the meantime this injection of
liquidity has probably helped ameliorate the significant stress that has built
up in the Euro financial system. Financial stress continues to be much less
prevalent in the US where even after the messy failure of MF Global, the
Bloomberg Financial Conditions Index (BFCIUS) is just above -1.25. An
equivalent European Index was at -4 standard deviations last week and would be
considerably lower today. - eurostress11111.gif - ecbbsoct2811.gif

The ISM Manufacturing Survey for October came in just under expectations at
50.8 vs. 52. However, an investigation of the underlying data arguably shows a
slight strengthening of the prospects for US Manufacturing. This is because the
main cause of the shortfall was a collapse of the Prices Paid index (see
separate chart) which fell very sharply to 41 from September's reading of 56.0,
the lowest reading since May 2009. Although declines in this index have
sometimes preceded declines in overall activity, this time around the finger
can be pointed at financial flows reversing in the commodity complex in
September, resulting in sharply lower input costs. We do not believe this has a
predictive meaning for underlying Manufacturing activity.

The rest of the survey was similar to recent readings. New Order (red) moved
back into positive territory at 52.4 (49 in September) which we view as quite
positive. Production (blue) fell to 50.1 from 50.2, but this small drop in pace
led to a fairly sharp drawdown in Inventories (olive) which fell to 46.7 (52.0
in September). Finally Employment stayed positive and virtually unchanged at
53.5. In sum we view this as an acceptable report which shows no imminent risk
of Industrial contraction in the US economy. - ismoct11.gif -
ismpricespaidoct11.gif