While most of the attention has understandably been drawn to the dramatic
expansion of the ECB's balance sheet this week (as we explained they have opted
to become a massive "lender of last resort" rather than a "buyer of last
resort", as would have occurred under a QE€ program) it is important not to
ignore the continued efforts of the FRB to stabilize the funding lines between
Europe and the US.

This week's release of the FRB balance sheet shows that the CBLS has now grown
to $99,823 bln, an increase of just over $37 bln over the last week. As a result
of this activity the FRB's balance sheet is once more in expansion mode (we
have dubbed this "Credit Easing II" or "CE2" since the FRB is going back to its
playbook of late 2008) and has now grown its balance sheet by $512bln over the
last 52 weeks. The ECB's surge is somewhat larger at €721 bln (around $930 bln at
current €/$ rate). With this sort of heavy battery being brought to bear, we
would expect to see a distinct improvement in the money market measures that
have unnerved observes in recent weeks.

We (and most others) have concentrated on the 3 month USD LIBOR (red line on
chart) and the 3 month €/USD swap rate (black line). The latter has shown some
improvement in recent days while LIBOR has continued to track steadily higher
into the end of the year (although it was unchanged this morning for the first
time in 30 days). We would expect that the start of the new year will free up
enough marginal liquidity in the banking system to cause a significant
improvement in both measures by the end of January, and that the FRB and ECB
will continue to add liquidity until this process is clearly underway. -
frbecb.gif - cblsliboreuroswap.gif

The November 2011 Pending Home Sales report is another very solid set of data
from the housing market. The headline index rose 7.29% to 100.1 (January 2001 =
100). If we exclude the artificially boosted figures from March and April 2010
and August - October 2009 (when the housing tax credit was in effect) then this
is the best reading since activity collapsed in early 2007.

One note of caution we would sound is that the headline index is seasonally
adjusted data and that November to January is traditionally a very quiet time
of the year for home sales. As the attached chart shows, the NSA index (blue
line) fell by 10% to 81.1 in November, and therefore the headline index
reflects a much smaller DROP in activity from October to November than would
typically occur rather than an actual INCREASE. What we really need to see is
better sales during the February - June peak months of activity, but there is
surely a better chance of this occuring if winter activity stays well above
that of recent years. - D-USPHTOTL_Index.gif

As most readers will be aware gold has suffered a sudden collapse in the last
days of the year. We had highlighted gold's breach of its 150 day ma a couple
of weeks ago and therefore are not surprised at the subsequent decline. Our
suspicion remains that the ill-fated launch of numerous "gold series" by Hedge
Funds is at least partly to blame, since this means that any year end
redemptions following a poor overall year for many funds will result in a spike
of selling pressure for gold during the redemption window.

In any case, whatever the cause, gold's decline has trimmed its YTD gain to
7.81%. Although this still beats many other assets it now actually lags the
total return of the Dow Industrials Average (INDU index). In a classic re-run
of "the tortoise and the hare" the INDU has steadily accumulated gains in
recent weeks and has seen a 5.49% increase in price boosted to 8.35% including
dividends. As we have noted before, the INDU index is now the world's best
performing large equity index, a fact that should have garnered more attention
than it has in recent weeks. The idea that this index would beat gold's return
in 2011 would have seemed fanciful back in the summer (gold was 26.36% ahead on
August 31st) but it would seem that with less than two sessions to go the
spoils will go to the steady once again. - goldvsindu.gif

It has often been noted that financial scandals tend to be unearthed as an
investment boom turns to bust. India has certainly followed this path in recent
months with allegations surrounding rigged auctions for broadcasting bandwidth
licenses pretty much marking the record high in the SENSEX.

As can be seen in the attached article, it would now appear that significant
problems in the veracity of recent IPO documentations has come to light. This
is reminiscent of the aftermath to the 1929 crash (which led directly to the
regulation of IPO documentation via the 1933 and 1934 Securities and Exchange
Acts) and the technology bust (which led to the Sarbanes-Oxley regulation of
corporate statements). We would expect similar problems to be unearthed across
the emerging market complex in the coming months and some heavy handed
regulatory "resolutions" to follow in their wake.

We have now entered the holiday period for Initial Claims (this week's data
covers the period ending December 23rd), which tends to make the data somewhat
more erratic than normal. This means that we will refrain from drawing any deep
conclusions from the data until we are into the 2nd week of January, but we
would still expect to see the distinct improvement in the data carry through
this period.

This week's estimation of Initial Claims was 381K, slightly above consensus of
375K. Last week's report was nudged 2K higher to 366K and therefore goes into
the books as an excellent report. As a result of this week's report, the 4 week
ma of claims (see chart) dropped sharply to 375K (the November 25th print of
404K dropped out of the average) and this emphasizes the power of the drop in
claims which has taken place in December. The question as always will be how
this ties in with the December non-farm payroll report, which will be released
in 8 days time, since although we ourselves rely much more on the weekly claims
data the market as a whole (and the financial media) tends to prefer the much
more erratic monthly report. - initalclaimsdec292011.gif

Attached is a link to an interview with Michael Shaoul, broadcast on BBC World
Service, regarding the state of large emerging markets (the interview ends at 3:40 minutes).

http://downloads.bbc.co.uk/podcasts/worldservice/wbnews/wbnews_20111228-2339a.mp
3

It is always hard to place too much trust in the quiet holiday week but this
does not necessarily mean that we should simply ignore the machinations of the
market in the final days of the year. One thing we did notice yesterday is that
58 of the SPX constituents recorded new highs, which is the highest single
day's total since the market entered its corrective range in late July (see
chart). This does not itself guarantee that we will break out of the range this
time but it does increase the likelihood that we will and also suggests that
new money is chasing 2011's winners in the closing sessions of the year. -
spxhilo.gif

This morning saw the publishing of the updated ECB balance sheet following last
week's massive auction of collateral funding for local financial institutions.
The results are predictably impressive. The overall ECB balance sheet grew by
€239 bln to reach €2313 bln (ex gold holdings). This means that the ECB's
balance sheet has grown by €721 bln (or 45%) over the last 52 weeks. No
purchase of sovereign credit was made by the ECB last week with the Long Term
Financing Operation increasing by €335 bln from €368 bln to €703 bln. Short
Term deposits also ballooned by €207 bln to €411 bln, while overall lending to
Eurozone institutions rose €214 bln (32%) to €879 bln (note there is
considerable overlap between these categories). Suffice to say last week's
operation marked the beginning of a significantly expanded role for ECB as the
"lender of last resort". This is not the role of "buyer of last resort" that so
many were obsessing about in recent weeks in the clamor for "QE€" but it is
still a highly interventionist stance that has a decent chance of creating a
calmer climate for European governments to take the necessary fiscal steps.

Interestingly recent auctions for both Spanish and Italian debt has seen lower
clearing yields than prevailed in the secondary market prior to the auction.
This is a substantial change from the state of affairs a month ago. Tomorrow's
auction of Italian 2 - 10 year notes will provide interesting data as to what
the appetite for new issuance is at the current expanded yields. As the
attached "Eurostress" chart shows, overall stress levels have moderated in
recent sessions and we are hopeful that a decent Italian auction together with
the closing of 2011 at the end of the week will allow further improvement to
take place at the start of 2012. - ecbfrb.gif - eurostressdec28th2011.gif

Bloomberg © article on BRIC performance in which we are quoted.

The final Conference Board Consumer Confidence report for 2011 is a
surprisingly interesting set of data not so much for its overall headline
reading of 64.5, which comfortably beat consensus expectations of 58.9, but
because of some of the first signs in its sub-indexes that consumers are
starting to finally embrace the 30 month old recovery.

As can be seen on the attached charts, the Present Situation (blue on second
chart) index rose to 46.70, its best reading since September 2008. This is
interesting since it had failed to break out of its depression zone during
prior bounces in consumer confidence, which were much more reliant on boosts to
the Future index (green line on chart). The fact that consumers are finally
admitting that their conditions today are improving is a significant change in
our view.

Much of this can be traced back to the improvement in employment data since the
summer. The first chart shows how confidence metrics tend to follow the
release of employment data. As can be seen following the recent collapse of
Initial Claims to well below 400K, we have seen a break down in the "Jobs Hard
to Get" index (now at 41.80, the lowest level since January 2009) and a
break-out by the "Jobs Plentiful" index (now at 6.70, the best reading since
January 2009).

As we have argued before, the importance of Confidence data for predicting
consumer activity is generally overestimated, and so we do not see this
improvement as particularly important for future retail sales (which we already
expected to be robust). However, the importance of Confidence data for
predicting equity investment by retail investors is generally underestimated.
With the local US equity market comfortably out-performing other global markets
(and most of the commodity sector) we wonder whether 2012 will finally see a
reversal to the 5 year migration of retail capital away from the local US
equity market. According to ICI data, total cumulative outflows from US Equity
mutual funds has been approximately $460 bln (see chart) and have continued in
2011 despite constructive equity market performance. The marked improvement in
confidence metrics in recent weeks may suggest that this redemption wave may
finally be drawing to a close. - confidenceemployment.gif -
confidenceoverall.gif - presentsitflows.gif

November US New Home Sales came in exactly on consensus of 315K. October data
was revised very slightly higher to 310K. NSA actual sales for December were
22K, 2K above the dismal level of December 2010. As the attached chart shows,
this keeps activity firmly rooted towards the bottom of historic activity and
monthly sales have yet to pass through the trailing 36 month ma (blue) that
would be the first indication that a recovery in activity is taking hold. This
level is currently at 335K. On the other hand, it would only take a very modest
number of increased sales to accomplish this feat and the recent uptick in
NAHB sentiment data is consistent with a somewhat better spring selling season
than we have seen in recent years. Interestingly the 120 month ma (green) has
fallen to 791.5K, which is just above the 20 year average of 780.5, a level
that will be reached by January at the current pace of sales. Since this
average covers approximately 5 years of boom (2001-2005) and bust (2006-2011)
this shows that the collapse in sales has now fully compensated for the frenzy
that preceded it. This does not of course guarantee that a recovery will now
take place, but it does represent a useful fundamental backdrop.

Inventory is also at a remarkably low level of 158K. Even at the current pace
of sales this has managed to drop steadily in recent months, demonstrating the
unwillingness of builders to anticipate any pick up in sales, and meaning that
should one occur it will require an immediate pick up of construction. -
D-NHSLTOT_Index.gif

This is a very interesting article that ties in closely with our expectations
of how the current cycle will play out in Brazil. We believe that the country's
secondary banks are likely to fare extremely poorly in the months ahead, while
major lenders see tremendous pressures on incomes, but do not become impaired to
the degree that major US and European banks have in recent years. Anyone who
wants to understand how this can play out should get hold of a copy of "The
Secondary Banking Crisis" by Margaret Reid who describes the 1973-75 collapse
of the UK's second tier banking sector in a very readable book. Lazier readers
can simply look up the Wikipedia posting:

http://en.wikipedia.org/wiki/Secondary_banking_crisis_of_1973%E2%80%931975

In terms of Brazil, the sudden acceleration of market share by the major lenders
is likely to come at a substantial cost to future delinquency. As a rule of
thumb, the later a loan is made in a cycle the worse it can be expected to
perform in the downturn (US mortgages issued post 2005 performed far worse than
those from earlier years). Smaller lenders on the other hand will feel the
double squeeze of much higher funding costs and significantly lower income from
new credit issuance. We expect this to become a significant issue for Brazil's
banking system sometime in 2012.

This week's release from the FRB showed that another $8 bln was added to the
CBLS facility taking the total up to $62,599 bln. As can be seen on the
attached chart, this facility has helped ease the cost of USD funding within
Europe (although its effects will have been small when compared to the massive
3 year funding auction that took place this week) but has not yet had a similar
effect on the USD LIBOR market. The 3 month LIBOR continues to climb slowly higher,
reaching 57.575 bp this morning. As we have written before, our hope is that part of
this climb is related to year end financing pressures that should ease in early
January. If this fails to occur we would expect to see a very aggressive
expansion of the CBLS. We also expect this facility to be employed in the event
that a rapid dislocation occurs in major emerging market currencies. One way or
another, the FRB looks likely to oversee a substantial "internationalization" of
its balance sheet, which ironically may take place just as its domestic duties
become far less pressing. - cblsliborandeuroswap.gif

Russia unexpectedly cut the Refinancing Rate by 25bp to 8.00% this morning but
kept the overnight Auction-Based Repo rate unchanged at 5.25%. Although the
latter is the more important rate for the local banking system this still sent
an important signal to the market that Bank Rossii has changed its stance from
one of monetary tightening to easing, in line with the majority of the emerging
market central banks.

As the attached chart shows, this easing cycle starts from a much lower level
than that of the prior cycle. Russia tightened far less in the 2010-11 period
than almost any other major emerging market, which helped its local equity
market outperform its peers from January 2010 to June of this year. Over the
last 6 months this has ceased to be the case and the local MICEX index is down
18.39%, close to the average EM performance. The RUB on the other hand has held
up much better than most other major EM currencies and has only dropped about
2% against the USD during 2011. As the attached chart shows this is partly due
to significant selling of local FX and gold reserves, which have fallen from
$544 bln in August to $501.3 bln as of last Friday. The danger for Russia
going forwards is that the move towards lower interest rates comes at the
expense of financial inflows. We would therefore watch the performance of the
RUB and level of reserves quite closely during the coming weeks. -
D-RUB_Curncy.gif -

http://www.bloomberg.com/video/83263836/

This week's initial jobless claims estimate came in at 364K, well below
consensus estimates of 380K and this took the trailing 4 week ma of claims (see
chart) down to 380.3K, the lowest reading since June 2008. This arguably marks
the point at which the Initial Claims data has moved out of its 42 month crisis
range and we would hope to see further improvement during Q1 2012. Should this
data manage to establish itself below the 350K level, this should be
accompanied by significantly better non-farm payroll data, which in turn should
create a fairly decisive shift in economic sentiment. In general the best time
to invest in a market is the period in which data is improving and opinion is
skeptical. Once opinion has shifted to a more bullish stance market conditions
tend to be overbought and vulnerable to correction (the last two spring and
summers being good examples of this phenomenon). We therefore would not wait to
commit additional capital to the US market until the mass of economic opinion
has embraced the recent improvement in data. - D-INJCJC4_Index.gif

Even though we think its efficacy is somewhat overrated, we do keep an eye
on the weekly AAII investor poll as part of our tracking of market sentiment.
Looking at this week's data we were struck by an unusually high Neutral
reading, with 38.04% of polled investors choosing this stance, the
highest weekly reading since April 2005. This is very interesting since it may
indicate that retail investors have finally grown weary of responding to the
market's movements and have resigned themselves to a range-bound market that is
probably more hassle than it is worth to participate in (the collapse of the
VXO index indicates that something similar may be happening in the
institutional world). Given the tendency of extreme readings to serve as
contrary indicators, we cannot help wonder whether a surge in Neutral answers
will presage the end of this 5 month trading range, with our money being on an
upside breakout if one were to occur. - D-AAIINEUT_Index.gif -

We were quoted in a NY Times article this morning which discussed the
restatement of existing home data by the NAR. See yesterday's note for an
expanded discussion.

In one of the more embarrassing statistical snafus that we can remember, the
NAR has been forced to release radically updated estimates of Existing Home
Sales data going back to 2007. Sales going back to 2007 have been revised down
by an average of 14% with 2007 sales trimmed by 11%, 2008 by 16%, 2009 by 16%
and 2010 data by 15%.

From our perspective none of this really makes any difference to our analysis.
We have always treated the "shape" of data across the cycle as far more
important than the actual level, particularly when considering the pace of
sales that took place 24 or 36 months ago. It is undeniable that housing
activity collapsed from 2005 onwards and that for the existing home market
activity appears to have bottomed 18 month ago. The effect of the adjustment is
to take the current pace of sales back to where it was in 1996/97 rather than
1998/99. It is not a positive change but nor does it fundamentally alter an
appreciation of where we are in the housing cycle.

Meanwhile a far more interesting adjustment has been made to the inventory
data. This has been slashed following the adjustment process. Total Single and
Condo inventory is now down to 2.580mm units and is very close to falling below
the 2.5mm level that we would consider the upper limit of "normal". The
estimate of Single Family inventory is down to 2.3mm units, the lowest level
seen since May 2005. Even allowing for "shadow" inventory still in the
foreclosure pipeline, we appear to be much closer to dealing with the overhang
of unsold homes than precious estimates. In the Condo market we can now
actually talk about "tight" conditions in certain markets, with a total
inventory of 277K the lowest since March 2005 and the trailing 6 month ma down
to 400K, a level last seen in April 2006.

In summary this data has hardened our belief that 2012 will be a year of good
recovery for the US housing market. - M-ECSLHAFS_Index.gif - D-EHSLSL_Index.gif
-

Brazil's November Personal Loan data continued the trend of resilient credit
growth and deteriorating delinquency. This is interesting since most metrics of
actual consumer and industrial activity have decelerated sharply in recent
months, which suggests that the reliance on bank lending for economic activity
has become more prevalent during 2011.

Total Private Sector loans grew by 1.16% to a new record of 1131.16 bln BRL.
The annual growth rate has slowed to 16.44% from a pace of approximately 20.5%
this summer, but this still keeps credit growth well above the overall pace of
economic activity. Housing credit continues to grow much faster than other
categories, increasing by 2.97% in November to 195.25 bln BRL, up 46.24% over
the last year.

Meanwhile loans which are 90+ days delinquent rose to 7.30%, the highest rate
since January 2010. This metric has risen by 1.40% over the prior 12 months,
which is very close to the speed of deterioration recorded from April 2008 -
March 2009 (1.49%). The much deeper (for Brazil) recession of 2001-2 saw a
maximum one year pace of 2.66%. Given the very fast pace of new credit creation,
we find the increase in delinquent loans as a percentage of total credit to be
quite alarming and we would not be surprised to see this particular cycle crest
with delinquent credit metrics breaking well above the levels seen in 2002 and
2008. - D-BZLNPTOT_Index.gif - D-BRCDDEFT_Index.gif

We never like to draw assumptions from any individual day's activity,
particularly in these volatile times, but today's strong move higher has been
accompanied by a sizable reduction in the level of implied volatility as
measured by the VXO index. As the attached chart shows, the VXO has fallen to
22.78, losing touch with strong resistance at 25 and the 200 day ma (25.32).
This marks the first time since the end of July that the VXO has fallen below
23. Back then the SPX was breaking down from its first half trading range with
the -4.78% collapse of August 4th down to 1200 marking the start of a prolonged
period of heightened risk premia for US equities. It may well be that we are
now moving out of this phase as participants distinguish between an often
violent but ultimately range-bound market and a truly dangerous one. Should the
SPX finally manage to establish itself above the current range then perhaps
another leg down by the VXO below 20 could take place, signaling the change to
a more bullish stance by market participants. - D-VXO_INDEX.gif -

This week saw the ECB expand its balance sheet by another €32.99 bln (1.62%)
allowing it to reach a new all time high of €2,073 (excluding gold holdings).
Once more, repo lending to local financial institutions was the key to this
process. Direct purchase of sovereign credit was relatively modest at
approximately €3.5 bln. This means that over the prior 52 weeks the ECB's
balance sheet has risen by €463 bln (just over $600 bln using a $1.30 exchange
rate), while the FRB balance sheet has increased in size by $492 bln.

There are some signs that this massive program of ECB lending combined with the
FRB's CBLS has had a stabilizing effect on Euro-stress in recent days. All
readings remain extremely elevated (see chart), but there has been an
impressive recovery from the levels seen a couple of weeks ago. Importantly
this remained true after today's auction of Spanish 3 and 6 month T-bills,
which were well subscribed at much lower yields (1.735% and 2.435%) than last
month's auction. This is also reflected in the market for Spanish 10 year debt
where yields have fallen back to just over 5% (red line on chart). This is
quite an important development since it shows some willingness of participants
to start to sensibly handicap the clear risks present in the Euro-sovereign
market and to distinguish between the issues at stake. We will be very
interested to see what difference the ending of this year will make, since we
suspect that there may be a little more latent demand waiting until the New
Year to express itself without having to build positions for public scrutiny on
a December 31st 2011 balance sheet. - ecbfrbdec162011.gif -
eurostressdec162011.gif

It is becoming increasingly clear that a new construction cycle has finally
emerged from the rubble of the US housing market. At the present time this is
very much dominated by multi-family construction, most of which is directed
towards very strong local rental markets. As such, it may prove to be more
important in the short term for building materials and employment rather than
the homebuilding sector (which is dominated by single family homes being built
for sale), but this does not diminish its importance for the current US
economic expansion.

November's data estimated total Housing Starts at 685K, just below the April
2010 level of 687K when the housing tax credit was still in effect. Excluding
this somewhat artificial print, this is the best level for starts since October
2008. This is still extremely weak data in historical terms, and only 30% of
the peak activity recorded in January 2008, underlining the extent to which
residential construction has been a drag on the early stages of this economic
cycle. Multi Family family starts were 238K, the best reading since September
2008 and the strong rise in the 12 month ma of this data (now 168K) shows that
this is no single month freak report.

Single family home construction remains much more subdued. Monthly permit data
(which we prefer for single homes) rose to 435K, the best reading since
December 2010 (a print which was aided by very favorable seasonal adjustment).
We would describe any reading below 600K as being extremely weak in historical
terms. The one positive sign is that permits have finally broken through the
declining 36 month ma (red on chart), which is a sign that activity has finally
bottomed this cycle. We would expect that an improvement in sales for new
single homes would lead any increase in building activity this cycle. Some
encouragement in this regard can be drawn from the last 3 months' readings from
the NAHB Sentiment survey, but it may still be another 60 or 90 days before we
see clear evidence that the New Home sales market is stumbling back into life.
- D-NHSPSTOT_Index.gif - D-NHSPSM_Index.gif - D-NHSPA1_Index.gif -

The November estimate for Brazil's CAGED Job Creation Index (which estimates
the total net change to employment in a given month) came in at 42,735 this
morning, well below consensus expectations of 80,000 and a drop of over 95K
from November 2010. Ignoring December data (the data is not seasonally
adjusted) this is the weakest month for job creation since February 2009 and
therefore offers more evidence of the extent to which Brazil's domestic economy
has slowed during 2011. We emphasize that this deceleration has been caused by
local issues and not by the continued struggles of the European sovereign debt
market. If there has been any knock-on effect from Europe it has been in the
IPO market for new corporate debt, which after posting its strongest ever 6
months through June 2011, has effectively shut down. Again we would point to
some mistakenly aggressive local monetary policy from the Bank of Brazil in
causing this dislocation as much as any exogenous factor, but whatever the
cause, Brazil's economy seems to be ending 2011 in much worse state than it
started and most observers expected. - brazilcagednov11.gif

The refusal of UK to commit funds today the major reason behind the shortfall
from the original €200 bln proposal. UK to consider setting a participation
level in early 2012. No doubt this will be used as a bargaining chip in
discussions surrounding the role of non-Eurozone countries, particularly if the
UK remains outside of a treaty agreed to by the other 26 EU nations.

The NAHB Homebuilder survey posted another encouraging set of data in December
with the overall index rising to 21, only the 2nd time since August 2007 that
the key 20 level has been breached (the other was May 2010 at the peak
influence of the ill-judged housing credit). Present Sales rose to 22, the best
reading since May 2010 and also the 2nd best since August 2007. Of course
December comes at a very quiet time for sales, so we would need to see this data
replicated or better in March and April to indicate a more significant boost in
the Spring selling season. Some encouragement for this comes in the Traffic
sub-index which at 18 is at the highest level since May 2008. This addressees
perhaps the biggest hurdle to Home-builders, which is how to even get US
home-buyers to consider purchasing a new home. Any further improvement in
Traffic would therefore be very encouraging. Home-builders themselves remain
quite cautious at projecting this spike in Traffic into Future Sales, where the
sub-index reached 26, a level beaten repeatedly in 2009 and 2010 and which was
equaled in March 2011. It may well be that after 6 years of deteriorating
conditions the NAHB respondents have become unwilling to predict any
improvement in conditions will be long lasting, and that this month's survey
therefore understates the improvement which has already taken place and its
importance for future activity. - nahbsurveydec2011.gif

USD 3 month LIBOR rose once more at this mornings BBA meeting, reaching 56.69
bp. As can be seen Barclays has now joined the group of French banks indicating
funding costs above 60 bp. All 3 US banks remain under the official LIBOR rate
with BAC at 55bp, C at 53.5bp and JPM at 51 bp. The tightening of interbank
lending conditions is reflected in the US commercial paper market where the 30
day A2/P2 commercial paper yield has risen by approximately 15 bp since the
start of the 4th quarter if one uses a 21 day ma. The daily rate has been
considerably more volatile, with readings as high as 58 bp on November 16th and
53 bp last week, although it should be stressed that the current yield remains
extremely low in historical terms.

Thus the initial $52 bln of USD liquidity injected via the FRB's CBLS facility
has had little beneficial effect, although it may have stopped things from
deteriorating at a faster pace. Looking at this situation, we are reminded of
one of the more curious episodes that took place during the dramatic weeks
following Lehman's collapse. One of the key planks of Chairman Bernanke's
"Credit Easing" policy was the Commercial Paper Funding Facility (CPFF), which
saw the FRB step into the gridlocked CP market that had failed to function at
anything like normal rates of turnover (yields fluctuated between 5.50% and
6.50% even after the FDTR was slashed to 1.00% in October and 0.25% in
December). By late December the CPFF had reached over $330 bln and although the
best rated A1/P1 CP had started to see yields decline, the lower rated (but
still extremely high quality) A2/P2 market remained gridlocked.

As the attached chart shows, the problem was solved by the calendar. On December
31st 2008, the A2/P2 yield collapsed 324 bp to 3.01% and declined steadily
thereafter. Clearly year end positioning had made participants unwilling to bid
for this paper but once 2008 was on the books and 2009 was in effect, the
additional yield offered by lending high quality corporations for 30 days
proved too good an opportunity to miss. Looking at the LIBOR market today we
cannot help but wonder if we are watching a mini-version of the same process at
the end of 2011. We would therefore not be surprised to see LIBOR track
modestly higher through the rest of December, even if the FRB pumps more funds
down its CBLS pipeline. The action of this market in early 2012 will prove
instructive as to whether we have entered a liquidity spiral (which in any case
would be aggressively addressed by the FRB) or if year end pressures are to
blame for the initial reluctance of funding markets to respond to the generous
injections of liquidity from the CBLS and ECB's massive collateral lending
program. - D-US0303M_Index.gif - D-H15S030D_Index.gif - D-H15S030D_Index1.gif -

Following on from our comment earlier today regarding the FRB's expansion of
its CBLS facility, we note that NY Fed President Dudley appeared in front of the
House Oversight and Government Reform subcommittee today. At that hearing
Dudley was questioned over the possibility of the FRB purchasing Euro-zone
sovereign debt (the first time to our knowledge a Fed official has been
publicly asked about this matter):

REP. MCHENRY: Mr. Kamin, would the Fed consider purchasing
sovereign debt held by U.S. banks to prevent this further
deterioration of the European situation?

Argentina appears to be treading a path familiar to anyone who has watched this
country's history of lurching from boom to bust. We described a few weeks ago
how the local Badlar deposit rate (which covers deposits greater than 1 mln
ARS) had forced their way back up to a new 3 year high in the run up to the
election.

Following the reelection of the Kirchner administration corporations were
immediately required to start repatriating foreign earnings. This did help
local liquidity improve allowing the Badlar to drop from 22.875% to just under
19%, but further progress proved to be far more difficult. The government
therefore took further steps, including meeting twice with the leaders of local
banks and urging them to lower deposit rates, the second meeting being this
morning. The local media reports that a reduction of 100 bp was agreed to by
local lenders, which would still keep the rate at almost 18%, while lending
rates would be set off the Badlar as a floor (it performs much the same
benchmark function as LIBOR in the US)

One of the main reasons for a shortage of deposits is the decision of
Argentinians to seek to send money abroad. We described a few weeks ago the
decision to require website registration prior to an FX decision (we do not
know if the website has now started to function efficiently). Meanwhile the ARS
has continued to depreciate steadily, weakening 7.8% YTD. This pace would no
doubt have been far quicker without the liberal use of reserves, which have
fallen by $7.33 bln (14%) to $44.8 bln over this period. This week saw a drop
of almost $1.7 bln, but this included a payment due on the GDP warrants issued
as part of Argentina's last bond default settlement.

This hardly represents a stable situation, particularly given the large foreign
flows which found their way into Argentinian corporate credit in recent months.
Should investors start to redeem these investments, there is a likelihood of an
acceleration of Argentina's pressures (we have included a long term weekly
chart that shows how things spiraled out of control between 2001-2). The local
central bank, as ever, is well prepared, announcing the introduction of a new
100 peso bill this morning, the previous high denomination being 50 pesos. -
W-ARRVIRFS_Index.gif - D-ARRVIRFS_Index.gif

It would appear that the Reserve Bank of India (RBI) is finally starting to
recognize the serious damage that tighter monetary conditions is causing to the
local economy and in addition to bringing in restrictions over FX forwards (see
yesterday's note) the RBI elected to keep the Reverse Repo Yield at 8.50% last
night, a decision which was expected by most observers.

Their statement announcing this decision sought to place much of the blame on
exogenous factors noting that "the recent EU summit agreement did not assuage
negative market sentiments" but also noted that "On the domestic front, growth
is clearly decelerating. This reflects the combined impact of several factors:
the uncertain global environment, the cumulative impact of past monetary policy
tightening and domestic policy uncertainties". Most importantly they signaled
that a change in policy is being considered "From this point on, monetary
policy actions are likely to reverse the cycle, responding to the risks to
growth".

Frankly a change in tack cannot come quickly enough for the local equity
market. The SENSEX responded to the RBI's statement by falling over 2% (in a
generally positive overnight session for other Asian markets), closing at a new
2 year low of 15,491, the lowest close since November 2009. The INR on the
other hand rallied following the banning of new FX forward contracts, closing
at 52.74, a recovery of 2.8% from the peak reading of 54.30 recorded on
Thursday. Our view is that this policy will restrict the flexibility of local
corporation while failing to insulate the currency from a reversal of powerful
investment flows in 2012. We would not rule out the imposition of capital
controls in 2012, making divestment much harder if the INR continues to
depreciate in value. The Reserve Bank of India never made a full transition to
a deregulated, developed central bank in both its rules and philosophical
leanings and this should be remembered at the current time. -
D-SENSEX_Index.gif -

The scale of the FRB's intervention into the USD liquidity market became
apparent on Thursday afternoon with the publication of the weekly change to the
FRB's balance sheet. Total Bank Credit increased to $2.86 bln, an increase of
$69.17 bln or 2.47%, the largest weekly percentage increase since November 2009.

The vast majority of this increase came in the Central Bank Lending Swap
facility (CBLS) facility, which grew by a little more than $52 bln. This marks
the first significant involvement of the FRB into the Eurozone quagmire, and
even though the FRB had indicated a willingness to fire up the CBLS and use it
to supply USD liquidity into the Eurozone, the scale and speed of their actions
is likely to catch most observers by surprise. Thus far there is little sign
that these funds have had any meaningful effect. The 3 month €/$ spread remains
very wide at 140 bp, while European banks continue to push the official 3 month
LIBOR rate higher (Societe Generale currently have the high offered rate of
60.25 bp, compared to the official fix at 55.92 bp).

As the attached chart shows at $54,335 the CBLS is still only approximately 10%
of its peak 2008 size. Back in 2008 the money was split between the ECB, other
developed and 5 key Emerging Market central banks. All we can say is that
evidence of a shortage of USD liquidity is starting to appear across a wide
array of funding markets in Europe and emerging markets. We doubt that the FRB
will be willing or politically able to supply liquidity on the heroic scale of
2008 (an intervention that most EM central banks quickly forgot in their orgy
of self congratulation of how they weathered the crisis), but having started so
powerfully we would expect that greater use of this facility will be made in
the weeks ahead. As such the FRB has arguably embarked on "Credit Easing II" or
"CE2", rather than "QE3", but this is still a very significant action at the
current time. - D-FARBCBLS_Index.gif - frbbalancesheet.gif

As outlined in the story India's RBI did both intervene in the FX market last
night and has taken the somewhat draconian step of banning new currency
forwards from this point on. Existing contracts will be allowed to expire but
this move, while curbing the short term pressure on the INR will leave Indian
corporations being more exposed to the FX market.

Attached is a very interesting summary of a meeting between Chairman Bernanke
and key Republican senators regarding the potential role of the FRB in the
Eurozone crisis.

Reading this story we are reminded on Bernanke's testimony during the TARP
hearings during which he answered all questions with his usual courteous
honesty (under the most trying of circumstances) and yet failed to volunteer
the information that the FRB had already massively increased the size of its
balance sheet (a fact reported on the FRB's website at that time, but which
went unnoticed by his interrogators and their staff).

In yesterday's meeting we note that Bernanke ruled out the direct bailing out
of a European financial institution and the FRB contributing funds to the IMF.
However, a number of more pertinent avenues appear to have been unexplored by
his inquisitors. For instance there is no mention of the possibility of a
radically expanded CBLS facility in the even of an acute shortage of USD
liquidity (the likeliest response to this scenario by the FRB in our opinion).
Nor was the direct purchase of European sovereign credit (which was included in
Bernanke's list of emergency tools to fight deflation in his 2002 speech) ruled
out. Instead we note that Bernanke was reported as saying that "he doesn't have
the legal authority to loan money to European banks." which is something else
entirely. We still doubt that the FRB would take this extreme step in anything
other than the most desperate of circumstances, but it is interesting that the
senators failed to question Bernanke on this matter.

The weekly Initial Jobless Claims report has finally supplied the sort of
upside surprise that we have been looking for in recent weeks, although we will
need to see this data confirmed in future reports in order to be sure that
it has taken a decisive shift towards the 350K level that would start to
represent a healthy employment market. This week's estimation of Claims was
366K, the lowest reading since May 2008 (or between the collapse of Bear
Stearns and Lehman). There were no unusual factors reported by the BLS in this
week's data and it has taken the 4 week ma down to 387.8K, which just beats the
prior 2011 low of 388.5 recorded on March 11th and is the lowest reading since
July 2008.

The rapid decline in Initial Claims is starting to look a little like that of
1992/3 when the data rose during the summer (sparking fears of a "W shaped
recovery" and reached almost 450K in August 1992 prior to collapsing in a
straight line down to 330K in early February 1993. We doubt the pace of repair
will be quite as powerful this time around, but with the seasonal adjustment
process at its most favorable, we would not rule out further sharp improvement
in this data. Clearly a rapid improvement in the US employment data would be a
potential game changer for the way in which the current situation is understood
by the vast majority of commentators and participants, but as ever we will need
further confirmation from data going forwards. - D-INJCJC4_Index.gif -

See attached story from DJ Newswires. We suggested that something like this
might start to occur across EM in this morning's Speculator summary. The
creation of new USD liquidity is likely to become a key focus of global central
banks in the weeks ahead. This morning's move (and the look of heavy
intervention in the overnight INR cross by the RBI) is the first suggestion
that we will be proved correct.

-------------------------------------------------------------------------------

Back in May, shortly after silver completed its parabolic move to $50, we
started to compare silver's move to that of the NDX index in 2000 - 2001. As
the attached chart shows although the paths have occasionally diverged for a
few weeks silver has followed roughly the same course that the NDX did 11 year
ago. Indeed 7½ months after its peak silver has declined from $51.32 to $29.24
(-43%) which compares closely to a decline by the NDX from 4816 on March 24th
2000 to 2890 on November 10th 2000 (-40%).

Should silver continue to follow the NDX's path then the metal should continue
losing ground in the weeks ahead. It seems reasonably likely that the current
move will extend down to around the $25 level and should be followed by a
powerful bear market rally. The fact that silver has slipped off everyone's
radar screen (without being liquidated from portfolios) actually makes this a
more dangerous time for silver than in its senior brother gold, where the
recent more modest collapse is currently driving headlines. - silverndxindex.gif

We continue to see significant pressures in the USD funding market. 3 month
LIBOR moved up to a new high of 55.51 bp at this morning's fix, while the 3
month €/USD swap rate has widened back out to 147 bp, only 15 bp away from the
record spread of 162.5 bp recorded 2 weeks ago.

Looking at the individual bank LIBOR readings, we can see that the French
lenders continue to report paying a higher price than the overall BBA
community, with Credit Agricole just breaching the 60 bp level. However, we
note that BAC's reported borrowing costs (pink) have also started to move
higher in recent days, and at the current pace could move above the "trimmed
average" that is reported in the daily fix. This suggests that the scramble for
USD (reflected in a much stronger DXY index and strong appreciation against EM
currencies) is having some effect even within the US funding market.

Interestingly, yesterday's FRB statement was silent on this matter (the word
LIBOR does not even appear in the text). Should USD tightness start to become
more apparent (and we would be as alert to what is happening in the EM FX
market as we would be to Europe) it remains possible that the FRB will be forced
to take a more proactive role in the current crisis, most likely by utilizing the
"Central Bank Liquidity Swaps" facility. This remains at a mere $2.3 bln, a
fraction of the peak reading of $583 bln recorded exactly 3 years ago. -
D-EUBSC_Index.gif - D-US0303M_Index.gif

Attached is a news story that hardens our belief that monetary conditions in
India are one of the main factors behind the sudden weakness of the price of
gold. The Bombay Bullion Association now estimates gold imports will be 800 to
850 tonnes versus their original estimate of 1000 tonnes, the reason for the
slippage being the high cost of gold for local buyers now that the INR has 
collapsed in value. This together with a much tighter level of local liquidity and
higher cost of capital has made it increasingly difficult for Indians to purchase
gold at the prior record pace. We could add to this list sharply lower agricultural
prices since India's farming class has been a massive buyer of the metal.

One of the metrics we have used to track the affordability of gold for an
Indian investor is to take the USD price, convert it into INR and then multiply
this by the local 3 month interest rate (a generous choice since any private
speculator borrowing funds to purchase gold would pay a sizeable spread above
this rate). Using this rough measure the cost of financing a single ounce of
gold for one year has risen from approximately 2050 INR in August 2009 to over
8400 INR today (this could also be called the "opportunity cost" of purchasing
gold with savings). Even allowing for the "reverse price elasticity" of
financial goods, there comes a point where price crowds out demand. This is
particularly true when money becomes tight and the asset is a fungible source
of liquidity. The collapse of the domestic real estate and equity market will
undoubtedly have put significant strains on many household financing and the
"rainy day" that gold was originally purchased for appears to have arrived
somewhat sooner than expected. Unless a new source of global demand can be
found quickly (and we doubt this will prove to be the case) lower prices should
follow, putting significant pressure on other holders to liquidate.

Coming at the end of the year, this pressure could not be worse timed for those
in the HF industry who have elected to issue "gold classes" of shares to their
investors. Up until this point this has been a very successful strategy that
has either increased gains or (in most cases) significantly cut back losses
incurred in 2011. Gold is still up 14.45% YTD, but this figure was over 30% in
early September, and there are still two long weeks remaining for this trade.
The remaining support range between the 200 day ma ($1619) and the $1600 level
is therefore unusually important at the current time.

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

Gold Imports by India May Decline as Rupee Plunges to Record
2011-12-13 05:14:39.826 GMT


By Pratik Parija
Dec. 13 (Bloomberg) -- Gold imports by India, the largest
consumer, may decline as much as 16 percent from a record as the
rupee’s plunge to an all-time low boosts local prices, deterring
jewelry buyers, according to Bombay Bullion Association.
Purchases may fall to 800 to 850 metric tons this year from
958 tons in 2010, Prithviraj Kothari, president of Bombay
Bullion Association, said in a phone interview from Mumbai
yesterday. That’s less than the record 1,000 tons he predicted
in August.
A decline in Indian demand may help cool bullion prices,
set to rally for an 11th year, as investors seek to protect
their wealth from volatility in stock markets, depreciating
currencies and the threat of inflation. Gold priced in rupee
jumped 39 percent this year, more than double the 17 percent
gain for the metal priced in dollars.
“Tight liquidity and high inflation is also a problem for
people to invest in gold,” Kothari said. “Banks are also
offering good returns. Investors would like to save money in
banks instead of buying gold.”
India’s central bank has raised the key repurchase rate by
375 basis points since the start of 2010, to 8.5 percent, in the
fastest round of increases since the central bank was
established in 1935, according to data compiled by Bloomberg.
Inflation rate has exceeded 9 percent every month this year.
Gold imports may total 100 tons in the three months ending
Dec. 31, compared with 200 to 220 tons in the preceding quarter,
Kothari said. Rajesh Exports Ltd., the country’s biggest
exporter of gold jewelry, said Nov. 22 overseas purchases may
total 170 tons in the fourth quarter. Imports were 281 tons a
year earlier, according to the World Gold Council.

Bucking Trend

“Demand out of India appears to be bucking the seasonal
trend this year, as physical buyers are hindered by a weakening
rupee,” UBS AG said in a report on Dec. 5.
Rupee fell to a record 53.3450 per dollar today as a
government report showed factory output fell for the first time
in more than two years. The currency dropped 0.9 percent to
53.3150 per dollar as of 10:25 a.m. in Mumbai, bringing its
decline to 16 percent this year.
Bullion for immediate delivery fell 0.7 percent to
$1,655.28 an ounce at 10:30 a.m. in Mumbai. The metal for
delivery in February declined as much as 0.2 percent to 28,780
rupees ($540) per 10 grams on the Multi Commodity Exchange of
India Ltd. in Mumbai today. Bullion reached a record $1,921.15
an ounce on Sept. 6.
“There is no demand for jewelry or for gold in the bar
form,” Kothari said. “Marriages are also less in number
compared with last year. Everyone is selling, scrap sales are
also happening and there are lot of stocks still in the
vaults.”
Overseas purchases dropped to 200 tons in the three months
ended Sept. 30 from 250 tons a year earlier, the council said on
Nov. 17. Demand for gold jewelry dropped 26 percent to 125.3
tons, while purchases of coins and bars for investments declined
18 percent to 78 tons, it said in report.

For Related News and Information:
Top India news: TOP IN <GO>
Top metals news: METT <GO>
Collector-coin prices: CCEX <GO>
Commodity arbitrage calculator: CARC <GO>
Gold market reports: NI GLDMARKET <GO>

--Editors: Thomas Kutty Abraham, Ovais Subhani


To contact the reporter on this story:
Pratik Parija in New Delhi at +91-11-4179-2032 or
[email protected]

To contact the editor responsible for this story:
James Poole at +65-6212-1551 or
[email protected]

- indiagoldcost.gif

Attached is a Forbes article on the current thoughts of 15 "Key Thinkers"
outlining the key issue for 2011 and their thought for 2012. My own ideas were
included following a rigorous selection process (knowing the author quite well
was a help as well).

Brazilian retail sales data is just as unreliable as its US counterpart on a
month by month basis (see earlier note) but again, this still allows a sensible
consideration of trend to be made.

Attached is a chart of monthly total sales. As can be seen, this data is not
seasonally adjusted, with December by far the most important month for sales.
We would therefore hold off making any definitive pronouncements until data for
official retail sales is released in mid-February (by which time we should have
ample data from public retail chains). Even so, a marked deterioration of the
pace of the increase in sales seems to be taking place. At 4.3% the YoY
increase in sales is the lowest since March 2011 and the second lowest since
May 2009, while the 6 month ma of this measure has slipped down to 6.03% in
October 2011 from 10.64% in October 2010. At the trough of retail sales growth
in 2008/9, this metric reached 4.15%, which seems to be a realistic target for
the first half of 2012. - M-BZRTRETA_Index.gif -

The Census Bureau estimation of US Retail Sales came in at +0.2% for November,
somewhat below the consensus estimate of 0.6%. October Sales were revised up by
0.1% to 0.6%, but this still leaves November's data on the light side.

Fortunately actual sales reported by public retail chains have already painted
a somewhat rosier picture for the Thanksgiving period, while all the
indications are that total retail expenditure over the holiday period will be
similarly robust. The same can be said about automobile sales (which included
in the headline data) since we already know that November saw the best pace of
sales (excluding cash for clunkers) since the summer of 2008.

The Census Bureau data is no more than an estimation. It is useful for
following trend but should not be seen as an accurate picture of any particular
month, since as can be seen on the attached chart, it tends to oscillate from
stronger to weaker data even when a strong trend is in place. At their current
level, The Census Bureau estimates sales to be at a new all time high and to
have grown by 6.7% over the past 12 months. This can only be described as a
very encouraging state of affairs, no matter what November's estimate of sales
may be. - usretailsales.gif

We continue to monitor the ECB's balance sheet, with the surge in assets held
taking on new meaning following last week's announcement that collateral based
loans to the banking system would now have a term of up to three years. This
means that the roughly €500 bln increase of assets held since the springtime
can be considered to be a "permanent" facility (as we like to say, nothing
lasts as long as an "emergency" policy response) that has been a key source of
liquidity for the Eurozone banking system.

This week's data shows the overall balance sheet growing by €25.125 bln
(1.25%), reaching a record €2,040 bln (ex gold holdings). As the attached chart
shows, over the last 12 months the ECB's balance sheet has grown by €423 bln
($570 bln at a 1.35 $/€ exchange rate), compared the the growth of the FRB at
$446 bln over the same period. In nominal terms the ECB has therefore been a
slightly more generous provider of liquidity although it should not be
forgotten that the FRB actually steps in and PURCHASES assets (over the last 12
months this has meant treasuries), while the ECB has mostly expanded its
balance sheet via its repo LENDING facility (which covers a very wide spectrum
of asset based paper).

Even so in terms of the net effect to local liquidity, we would argue that there
is not a great deal to choose from. The difference of course is that US
Treasuries remain in massive global demand (the 30 year bond is 2012's best
performing major asset with a total return of almost 30%), while large portions
of European sovereign credit are considered toxic constituents of a portfolio.
Whether or not the use of the IMF to provide the missing bridge between
liquidity provision and stable sovereign debt markets remain to be seen, but we
do think that this philosophical fudge is potentially viable, while local
European liquidity (at least in EUR) is somewhat more abundant than most people
realize. - ecbfrb.gif

We do not think it is a coincidence that gold finally broke key support
yesterday as India and China, its two biggest physical metal markets, saw their
local equity markets test (in the case of India) and break key support (in the
case of China).

For China's SHASHR index, support just above 2400 had been an important factor
since mid 2010 and this was decisively taken out this morning with the index
closing at 2355, the lowest closing level since March 17th 2009 (by comparison
the SPX index closed at 778.12 on that day). We had noticed two weeks ago that
China's equity market failed to respond to the small loosening of reserve
requirements by the PBOC, unlike the rest of the emerging market complex which
greeted this move with wild enthusiasm. This was a good indication that local
conditions are actually deteriorating much more rapidly than the PBOC has
admitted.

Evidence of a genuine problem in local real estate is mounting (last night saw
the release of estimates by Soufun that YoY sales were down by between -14%
(Shanghai) to a remarkable -43% in Changsha in major cities, while at least 4
smaller cities have seen sales collapse by -60%.

Perhaps more troubling is the first signs that weakness in real estate is
starting to be reflected in broader economic activity. Attached is the latest
quarterly Manpower Employment Survey for Q1 2012, which shows hiring intentions
for over 4000 Chinese Employers. Although the data is still positive, only 18.6%
of Employers surveyed stated that they would hire additional workers. This
compares to an average of 24.17% in the last survey and 38.17% for the survey
of one year ago. We would expect to see significantly looser monetary policy
followed by the PBOC in 2012, but for this change in stance to have a
surprisingly weak effect upon the troubled portion of the local economy and
financial asset markets (after the inevitable appreciative bounce).

One area of employment that is still apparently robust is the demand for high
end personal servants. We could not help but notice the attached story on the
soaring demand for English butlers in China, Russia and other emerging markets.
This does not strike us as a bullish trend for the countries involved.

For the last few weeks we have noted that Gold has performed quite poorly given
the wholly favorable news-flow (from gold's perspective) that has been
contributed from Europe. Since peaking in early September at $1,921.15 gold has
been trapped in a well defined down-trend, while receiving key support at its
150 day ma (green line on charts). The only time this line has been violated
was during the overnight session of September 26th when it would appear that
Chinese margin selling caused an abrupt collapse. On that occasion the 200 day
ma came to the rescue and gold rebounded strongly during the US trading session.

This morning has seen a potentially more damaging breach of this support since
it comes at the start of the US session. Gold traded through its 150 day
($1,667) and hit a low of $1,663 this morning but has subsequently bounced up
to $1,669. Given that this support has been in place for almost three years we
would build a margin of error of at least 2% into a breach, meaning that it
would take a close below $1,630 to signal a definitive breakdown. We would mark
"last ditch" support at $1,600 where gold bounced repeatedly in September and
October (at the time this coincided with the 150 day ma). Nevertheless the
warning signs are clearly in place that gold's powerful 2009/11 move peaked in
September and given the concentrated ownership of gold in both the emerging
market retail (particularly China and India) complex and a number of high
profile US hedge funds (a combined ownership that has suffered severe losses
elsewhere in their portfolios during 2011) the ability of gold's supporters to
withstand a further assault must be in question. - D-GOLDS_Comdty.gif -
D-GOLDS_Comdty1.gif -

India's Industrial Production data for October came in substantially worse than
expectation of -0.7% YoY. Instead the report showed a drop of -5.1% YoY and
even allowing for the high error rate associated with this monthly report it
seems clear that Indian Industrial activity has slowed more sharply in recent
months than most observers have realized. The reaction of capital markets was
predictably sharp, with the SENSEX index falling 2.12% to 15,870, less than 2%
above key long term support which we estimate comes in around 15,700 on a
closing basis. If anything the reaction of FX markets was more severe, with the
INR falling 1.52% to reach a new all time record of 52.835 against the USD.


Interestingly there is still no sign of substantial outflows of capital from
foreign investors in the Indian equity market. Current data shows YTD flows of
-$147mm, which is a trivial outflow compared to 2010's record inflows of
$29,320mm. Given the YTD performance for the SENSEX is -22.62% in local terms
and -34.37% in USD, which the BSE Small Cap index is down -38.36% in INR and
-47.72% in USD this patience by foreign investors is starting to get extremely
expensive. A significant deterioration of economic data could therefore provide
a catalyst to re-consider the stubborn belief in the desirability of remaining
exposed to this awful absolute and relative performance. - W-SENSEX_Index.gif -
M-INPIINDU_Index.gif -

We have grown weary of commenting on China's non-changing economic data in
recent months and so we were interested to see that the November Industrial
Production data did show a marked shift downwards to 12.4% from 13.2% in
October. As the attached chart shows there is now a distinct change in trend
taking place and the loss of some strong early 2011 data in the series should
cause the headline YoY number to continue to shift lower.

Even after this report, China's Industrial Production data still remains much
stronger than other countries in the EM complex, where data has slowed
considerably and in some cases actually started to turn negative.
We therefore continue to believe that China's Industrial Production data
meaningfully downplays the deterioration in local conditions that has taken
place in recent months.

This down-shift in emerging market industrial activity has taken a toll on
the emerging market metals and mining sector, as can be seen by the performance
of the Dow Jones Emerging Market Metals and Mining Index (DJEMT). This has
fallen by -32.86% in 2011, significantly underperforming the overall MXEF index
(down -17.70%). Any further evidence that Chinese activity is slowing faster
than expectations (we would primarily look for this in statements made by
public companies supplying China rather than the official data) can be expected
to place more pressure upon this group. - D-CHVAIOY_Index.gif -

The University of Michigan Consumer Confidence Index came in at 67.7 this
morning, beating consensus estimates of 64.1, and just beating the 12 month ma
of readings (67.2). This follows the strong rebound seen in the Conference
Board data a couple of weeks ago (in contrast the weekly Bloomberg Consumer
Comfort Index has remained much more gloomy, which has been true since the 2008
collapse).

As we explained when the Conference Board data was released, a multiple month
surge off a deep low in typically a reliable indication that an important low
has been made in the US equity market. In the case of the University of
Michigan data we hit 55.7 in August, only just above the 55.3 reading recorded
in November 2008, which struck us as a massive over-reaction to poor employment
data and a sharply declining equity market. Since that time the poll data had
recovered by 12 points. As can be seen on the chart, we are still at a
historically low level of confidence, but if employment data continues to
improve and the equity market makes its way out of its current multi-month
range, we would expect to see significantly stronger readings into 2012. We
would hope that the recovery peak of 77.5 recorded in February 2011 can be
exceeded. At a certain point surging confidence will become a problematic
signal of short term excess and a change in the stance by the FRB typically
coincides with readings in the mid-90's by this metric, but this seems a long
way off at the current time. - michigansentimentdec11.gif

We have added a new line to our "Euro-stress" chart, which now includes the new
Bloomberg European Financial Conditions Index (BFCIEU), which follows the same
methodology as the BFCIUS index (each integer being 1 standard deviation away
from "normal" for the basket of risk metrics). This appears in a separate panel
at the bottom of the chart and at its current reading of -4.88 still indicates
an extreme level of stress (frankly we would not trust an indicator that did
not show this right now). Interestingly this measure made its low in early
September, underlining the fact that the pressures that led to the blow out of
sovereign credit yields in late November was very much concentrated in that
particular market rather than the entire spectrum of European credit.

The reason for this limited spread was the willingness of the ECB to radically
increase its collateral based lending to Euro-zone banks. As we have described,
the ECB's balance sheet has grown by over €500 bln since the springtime, the
majority of this increase being accounted for by collateral lending. The
announcement yesterday that the ECB would expand the eligible securities to
those keeping an A rating from the 2nd lowest credit agency and grant loans of
3 years duration without limiting the size of this facility is a very
significant back-stop to the liquidity of the European banking system. This may
not be "QE€" or even the "Credit Easing" used by the FRB in 2009 (which
involved the outright PURCHASE of credit instruments) but it is a VERY generous
lending facility that should have a meaningful palliative effect.

The second big win for the banking system came with last night's announcement
that the IMF's rules on credit loss would be followed. As we have explained
before, the imposition of German will over Europe meant that the ECB would not
be allowed to enter the sovereign fray directly, other than through the limited
EFSF. Instead a typical Euro-fudge has been followed, whereby the continent's
central banks fund the IMF instead of the ECB and the IMF intervenes in
sovereign credit markets. This has two distinct advantages:

1. The IMF can buy debt directly from a government and therefore, unlike the
ECB, can bid in bond issuance auctions. As we explained in November this was a
key deficiency of the ECB's attempt to stabilize markets.

2. IMF rules state that governments alone take a hit from any credit loss
incurred in their intervention. This is a huge let off for private sector
bondholders who would surely have been required to take a "voluntary" hit if
the ECB were to suffer the same losses.

Perhaps the best news is that this deal has not been greeted with any wild
enthusiasm (see attached charts). This reminds us of the underwhelming response
the US market gave Chairman Bernanke's introduction of "Credit Easing" in early
2009 (which had started in an ad-hoc fashion several months earlier). Despite
the skepticism of market participants and commentators this policy very much
stabilized US credit markets over a period of months.

As for the announcement of the proposed treaty on budgetary prudence, as ever,
the devil will be in the detail. We were relieved to see the UK excuse itself
from this process and contrary to most people, see this as a very positive step
for their economy. After the last 48 hours Europe seems less likely to suffer a
catastrophic melt-down but it also is taking a large step away from embracing
the path of growth and instead embracing that of regulation and public sector
intervention. - eurostressdec911.gif

Over the last few weeks we have argued forcefully that the most interesting
aspect of the Euro-crisis is likely to be political rather than purely
economic, and that it marks a radical change in the post-war relationship
between France and Germany. Attached is an excellent article that echoes our
beliefs and correctly dates the start of this process to the Franco-Prussian
war of 1870. It strikes us as a much more useful article to read and absorb
than the countless "real time" reactions to what threatens to be a very long
weekend following the posturing of Europe's politicians and Central Bankers.

http://www.bloomberg.com/news/2011-12-07/franco-british-alarm-of-1989-comes-true
-as-merkel-drives-eu-crisis-plans.html

As we move away from the Thanksgiving holiday distortion, Initial Claims have
fallen sharply and were estimated at 381K through December 3rd, the lowest
reading since February 25th 2011 and the 2nd lowest reading since July 2008.
This was well below consensus of 395K and the modest revision of last week's
data from 402K to 404K does not take the gloss off a very good report, which
takes the 4 week ma of Initial claims down to 393K, the best reading since
April 1st (see chart).

This improvement in Initial Claims is fully reflected in the Continuing Claims
data, which fell to a new 3 year low of 3583K. As can be seen Continuing Claims
have dropped by 543K over the prior 12 months and the recent improvement seems
to represent a fairly decisive break below the plateau around 3750K that had
contained the data over the summer. Although the connection between Continuing
Claims and the Unemployment Rate is not as close as one would imagine (they are
calculated via different methodologies) they do tend to follow each other over
the course of a cycle. We therefore imagine that the surprise drop of the
Unemployment Rate down to -8.6% in November will be followed by further
improvement over the course of the coming months. - D-INJCJC4_Index.gif -
continuingclaims.gif

Yesterday afternoon saw the release of the monthly US consumer credit data and
the report continued the recent trend of demonstrating moderate consumer credit
growth. Overall consumer credit grew by $7.645 bln, above consensus
expectations of $7 bln while September's data was revised almost $500 mm lower
to $6.88 bln, making this an in line report. As the attached chart shows
overall consumer credit has now grown by $57.98 bln (2.41%) over the last 12
months, which is almost identical to the nominal change recorded in the 12
months ending December 1993. Total credit is now approximately 4.8% lower than
it was at its peak of $2581 bln recorded in July 2008.

Interestingly the entire gain over the last 12 months has been recorded in the
category of "non-revolving" credit, which is dominated by student and
automobile loans rather than credit used for retail purchases. Revolving credit
(see attached) is still slowing moderately over the past 12 months, shrinking
by -$9.21 bln (-1.14%), although this drop is heavily back-loaded to early
2011. Revolving credit seems likely to move back into positive annual growth by
early 2012 and to start to repair the 18.5% drawdown from peak outstanding
credit recorded in September 2008.

To our eyes the overall credit data suggests that consumers have been much less
reliant on credit usage for retail purchases than in the prior economic cycle
(when refinancings and HELOC's were also very much in vogue). This actually
suggests that the rise in retial activity is more sustainable this time around,
and could also accelerate as consumers start to return to a more normal trend
of credit usage. - revolvingcreditoct11.gif - totalconsumercredit.gif

An interesting development ahead of the week's Euro-zone summit. The move to
higher Clearing Deposits was one of the key destabilizing factors for Italian
yields but this does not mean that lowering the requirement will automatically
lower yields it will free up funds for current debt holders.

An interesting article that correctly uses US Tax receipts to dispute the
commonly held assumption that the US consumer is relying on savings to sustain
current spending habits.

We have spent much of the last year outlining our growing concerns regarding
the state of the Indian economy and the likelihood that the corporate credit
cycle would start turning negative. We were therefore intrigued by the attached
story which describes the entry of the CDS structure into the local Indian
marketplace. It is hard to think of a less opportune time to start writing CDS
on Indian corporate debt (although we have no comment about the particular
issue involved in this transaction) and we are reminded of the fact that the
first large, liquid derivatives allowing investors to bet on US residential
housing credit were issued a matter of months before things got very ugly in
that marketplace.

Brazil's domestic economy continues to show signs of slowing down with November
Car Sales dropping by 23,825 (-8.3%) compared to their level of November 2010.
Total Car and Light Vehicle sales (the headline data) were a little better,
dropping by 6913 units (-2.1%), which suggests that the Brazilian consumer is
cutting back somewhat faster than the average corporate customer. This ties in
with our belief that Brazil's consumer boom peaked several months ago.

Clearly the monthly data is quite volatile, but equally clearly car sales are
no longer growing strongly. December is traditionally the strongest month for
sales (although overall seasonality is much less of a factor in this data than
in most countries car sales) and so we would wait until next month's data
before drawing any definitive conclusions, but this is a poor report at the
level of passenger cars and probably the key metric to follow at the
current time. - M-BZVLTOTL_Index.gif -

Over the last couple of weeks we have been moderately troubled by the
persistent rise in the US 3 month LIBOR rate since this move runs against our
prevailing narrative that the US is a safe haven in these troubled times due to
its almost uniquely accommodative monetary conditions. We had hoped that last
week's coordinated intervention into European money markets by 6 central banks
would have allowed LIBOR to work its way lower but after dropping for a single
session LIBOR has started to edge higher again, reaching 53.775 bp this
morning, just below the June 2010 peak of 53.925 bp.

Since this continued widening of LIBOR comes in the face of a sharp improvement
in the EUR/USD 3 month swap (see attached chart and earlier note today), which
was presumably the prime target of last weeks move, we would not call the
intervention a failure, but it does leave LIBOR's further rise taking some
explaining.

It should be remembered that LIBOR is fixed at a daily meeting of the British
Bankers Association, which, despite its name, is made up of 18 international
banks, each of whom offers to lend funds to the interbank market at its own
chosen rate. The daily LIBOR fix represents the trimmed average of these
submissions (see http://www.bbalibor.com/bbalibor-explained/the-basics for
further details). In normal times there is no significant difference between
submissions but in times of stress we typically see significant strains
appear in specific regions and individual lenders.

Attached is a chart showing the 3 month LIBOR submissions for 7 of the major
participants in this process. As can be seen the surge towards higher LIBOR has
been led by European banks in general and by French lenders in particular.
Since early September the highest daily rate has been submitted by Credit
Agricole (currently 59.5 bp), with Societe Generale currently in second place
at 58.75. Both are comfortably above the official LIBOR fix of 53.775bp. US
lenders on the whole have been some distance behind the daily fix. At the
current time BAC (pink) is offering at 52bp and JPM (purple) at 48bp, while
Citigroup (not shown) is offering at 49.5 bp. Interestingly non-Eurozone
European lenders do not look in much better shape than their Eurozone
counterparts. UBS is offering at 57.3 bp and Barclays at 56 bp. The real
outlier is HSBC which at 34 bp is offering to lend at 11 bp below its nearest
competitor (Rabobank).

This disparity of rates therefore shows that the funding crisis remains very
much of European origin and that there remains a significant lack of USD
liquidity in Europe even after last week's moves. US lenders are certainly
playing tag-along with their daily rates, but this is not necessarily
indicative of any actual strain being felt. This still has created a moderate
increase in the borrowing costs of all LIBOR based loans but does not raise
alarm bells about the state of liquidity within the US domestic banking system.
- D-US0003M_Index.gif - D-US0303M_Index.gif -

On seeing the news that S&P had placed the Eurozone on a Negative Credit-watch
our first reaction was to wish that they had simply gone ahead and downgraded
the various nations' credit rating such has been the positive response by the
US Treasury market to S&P's actions back in August.

As we argued back then, given the challenges that they have had in gauging the
credit quality of corporations, the ability of S&P to see further into the
political future than any other observer at the level of a country is open to
question. In any case, global capital markets have already thrown the validity
of AAA rating for a country such as France into question and have treated Italy
as if it were well below investment grade for several weeks. We also note that
for whatever reason, S&P has been consistently more aggressive on developed
nations' credit ratings than the other main rating agencies, while showing a
similar alacrity to upgrade emerging market credit. Their actions therefore
seem to be driven by an internal philosophical leaning that is mirrored in the
portfolio allocations of many investors at the current time, which of course
makes it no more likely to prove to be correct.

As for the sovereign debt market themselves, these have snapped back nicely
after the brutal liquidation of late November in line with our expectations.
The Italian 10 year yield moved back below 6% this morning and the Spanish 10
year at 5.18% is closing in on the key 5.00% level. The France-Germany spread
is still very wide at 105bp, but this is a significant improvement on where
things stood two weeks ago, and much the same can be said about the 3 month €/$
swap rate at 116bp. None of these readings are in any way normal but they all
show improvement and a willingness to wait until the next Euro-zone summit
convenes at the end of this week. The market has shown a slight deterioration
following the S&P report and is unlikely to make further progress until news
from the summit is forthcoming.

Meanwhile, the ECB continues to be a major force in manufacturing stability
outside of sovereign credit, allowing its balance sheet to rise another €16 bln
this week to a new all time high of €2,435 bln. Ex-gold the balance sheet is
now over €2,015 bln for the first time in the ECB's history. Once more this
growth dwarfed the size of its weekly sovereign credit purchases and reflects
rampant use of its REPO facilities by Euro-zone banks. - W-.ECB-GOLD_Index.gif
- eurostressdec62011.gif

The past few weeks have seen one of the fastest swings back from below
consensus US economic data that we have seen in recent years. Last week's
concentrated release of positive retail and automobile sales, manufacturing and
employment data capped a process that began in late summer since which time
economic data has generally been significantly better than expected.

As can be seen on the attached chart over the last 6 months, the Citigroup
Economic Surprise Index (CESIUSD) has moved from a low of -117.20 bp on June
3rd (the worst reading since January 2009) to +85.70 at Friday's close. Over
the last 100 trading days (the index is not calculated for weekends) the index
has risen by 185.60 points (black histogram, middle chart), a pace which is
almost as high as was recorded during the "V" shaped 2009 recovery. During that
earlier period, the long end of the US Treasury curve moved rapidly higher as
the market re-calibrated the state of the US economy. The 100 day move for the
10 year Treasury yield (red histogram, bottom chart) moved 117 bp higher in
2009 as the CESIUSD reached peak momentum and this measure reached a peak of
over 155 bp. Over the entire move from its low on December 18th 2008 to its
peak on June 11th 2009, the 10 year note yield moved 197bp from 2.03% to 4.00%.
This time around the 10 year yield has FALLEN by almost exactly 100 bp since
June 2011 and the current 100 day move is -85bp.

The clear reason for this discrepancy is the massive "safe haven" flows that
have been switched out of Euro-zone sovereign credit and into US Treasuries (we
believe that the FRB's Operation Twist has been of only marginal impact).
Should Europe's crisis reach a more stable plateau (and there are signs that
this is taking place) or even more towards a tolerable solution, then we would
expect to see the long end of the treasury curve become more sensitive to a
sharply improved data environment for the US economy. Although we doubt that
the 2009 and 2010 high reading of 4.00% would be reached in this move, a 10
year yield somewhere around 3.25% would seem to be a reasonable target. -
cesisud10year.gif

Brazil's move towards looser monetary policy has created a great deal of
positive buzz this week (in addition to the reduction of the SELIC yesterday
saw the announcement of a planned repeal of several other restrictive measures,
including a tax on consumer goods and foreign inflows into Brazilian equities).
However, as is so often the case, news of looser monetary policy has been
followed swiftly by poor economic data. This morning's report of Brazilian
Industrial Production shows this to have shrunk by -0.6% compared to -0.2%
consensus. This is the third consecutive shrinkage in IP and the 7th month out
of the last 12 that the data has been negative. The YoY change is -2.7%, but
since this is the same as the drop over the last 3 months, and this would annualize
over -10%, we can anticipate a further drop in this metric (which is the
headline data) over the coming months. Indeed the attached chart shows a clear
break in trend below the 12 month ma, which has itself turned over. We remain
steadfast in our belief that Brazil has commenced a cyclical downturn of fair
magnitude and this week's policy easing will not reverse this process.

Perhaps more interestingly the longer term 60 month ma suggests that Brazil's
IP has fallen into a much slower path of growth in recent years compared to
that seen in the 2002-2008 expansion. In that earlier period IP grew by between
15-20% over 60 months while this metric today has fallen below 10%, an
annualized gain of no more than about 1.9%. This is hardly consistent with the
widely held belief that the Brazilian economy is a source of vibrant long term
industrial growth. - M-BZIPTLSA_Index.gif -

Given the pace of this week's news flow, November's Non Farm Payroll report was
mercifully close to consensus. Estimated Total Payroll gains were 120K vs. 125K
consensus while October's print was revised 20K higher to 100K and September's
print was revised 50K higher to 210K. It should be recalled that September's
figure was already revised from 103K to 158K when October's data was released
and so it now appears that the original estimate was off by over 100K jobs, a
100% error rate (bad even by the standards of the BLS although to be fair the
Verizon strike did complicate calculation in August and September, for which
the initial figures proved to be light by over 200K jobs in combination).

This underlines the point we make each month, that it is pointless using this
data in real time to estimate the state of the overall US economy, let alone
the correct level for the equity and bond markets.

For this reason we have always used the 12 month ma of Private Sector Payroll
gains, which while a much less exciting measure in terms of movement, does at
least reliably give a sense of trend. Private Sector Payroll gains were
estimated at 140K, just below the consensus of 150K, almost identical to the
trailing 12 month ma of 154.75K. As we pointed out last month, this is roughly
where things stood in the summer of 2004 and 1993, although overall
unemployment was much lower on both occasions.

Speaking of unemployment, the real data-shock of this report was contained in
the Unemployment Rate, perhaps the most dubious of all the figures produced
each month but of course the one that garners the media headlines and dominates
political debate. This fell sharply from 9.0% to 8.6% due to a large spike in
the Household Survey Job Creation estimate (a separate survey from the one
which goes into the Non Farm Payroll calculation) and a downward revision of
the Participation Rate. As the attached chart shows the Unemployment Rate had
stayed extremely high compared to the weekly Continuing Claims data (again none
of these data series share the same methodology so we are comparing guesses to
guesses) and had failed to follow the latter lower in recent months.

Even after the sharp drop to 8.6% the Unemployment Rate estimate remains
historically high relatively high to Continuing Claims and the explanation
given is that far more people are dropping out of the Claims data without
finding work. No doubt this is true to an extent, but we also suspect that the
Unemployment Rate stayed unrealistically high over recent months and that the
sharp revision downwards is an overdue adjustment that proved a whole lot
cheaper and more effective than President Obama's emergency jobs legislation. -
D-NFP_PCH_Index.gif - D-USURTOT_Index.gif -

November Car Sales followed the recent pattern of stronger than expected US
economic data coming in at 13.59mm units on a seasonally adjusted annualized
basis. This comfortably beat expectations of 13.40mm and the October reading of
13.20mm. Indeed ignoring the steroid-enhanced "cash for clunkers" surge
November was the strongest month for sales since June 2008. November's data
brings the 12 month RoC up to 10.8% and should this pace be kept up sales would
be over 15mm units in November 2012 and closing in on the pre-crisis normal
level of sales. In the meantime sales at the current level will require
production increases at most manufacturers, helping to underline the extent to
which the US Manufacturing industry suddenly finds itself in a better condition
cycle wise than the vast majority of emerging markets (where car sales in many
cases have been notably weak in recent months). - uscarsalesnov11.gif

We have attached two charts to this post, one of which tracks the monthly
number of news stories monitored by Bloomberg's News Trend function that
mention "Soft Landing" "Recession" (as separate terms) for 1999-2011 and the
second which shows the term "Soft Landing and China" (in the same article) for
the period 2005-2011.

We have always argued that the scariest two words for an investor is "soft
landing". The phrase "This Time It's Different" is often cited in the same way
but this normally coincides with the climax of a bull market while money is
still being made and is used to explain why pure greed should be considered a
prudent investment. "Soft Landing" on the other hand generally gets rolled out
after asset price performance has started to decline in the most popular
investment arena for a cycle, and peaks just as data makes its first lurch
lower. As can be seen within months, it is knocked off the charts by the use of
the term "recession" (and in 2008 the term depression) as conditions worsen far
more than most expected.

We therefore note with interest that November 2011 has seen a record high for
articles that mention both "Soft Landing" and "China". At 203 this reading is
well above the mean of 38 stories and unlike the surge in July of this year
(when the vast majority of stories were written on the day GDP was published),
was a product of a steady accumulation of daily hits. To our eyes this is an
important milestone for the Chinese economy, and by extension the entire
emerging market complex. The belief in a "Soft Landing" and the need to employ
this metaphor in order to explain the clear deterioration in conditions in a
comforting manner is very reminiscent of the run-up into the US recession of
2001/2 and 2007/9. Fortunately for the US there are virtually no articles this
time mentioning a soft landing (recovery denial is still a far more popular
pastime). This time around the problems seem likely to emerge in the economy
that many people assume to be immune from the business cycle thanks to its
heavily curtailed private rights and heavy handed government intervention (or
what is more politely called a "command economy". We would rather trust in the
power of the metaphor, which is suggesting that a more difficult few months
than most suppose lay ahead for China. - softlandingrecession.gif -
chinasoftlanding.gif

The November ISM Manufacturing report shows that the US currently has one of
the most robust PMI readings amongst both developed and emerging economies. At
52.7 the reading is comfortably positive (the revised break even level has been
taken down to 42.5 by the ISM) and beat expectations of 51.8 and October's
reading of 50.8. It is the best reading since June (55.3) and the strength of
the November reading gains credibility from the fact that it absorbed a reading
of only 45 in the Prices Paid sub-index.

As the attached chart shows, the key New Order sub index (red) had a strong
reading at 56.7 (up from 52.4), the best reading since April 2011 (61.7). This
shows a solid pickup in orders took place over November. Production (blue) also
came in strongly at 56.7 (up from 50.1), the best reading since April (63.8).
Inventories (olive) remained in moderate drawdown at 48.3 while Employment
(pink) echoed the Chicago PMI report by coming in at a disappointing but still
positive 51.8. All in all, this is a very solid report for the US Manufacturing
Industry. - ismnov11.gif

One day after the coordinated action by central banks to ease USD funding in
money markets we can see that a substantial improvement in the EUR/USD swap
(black) has taken place with this measure falling from 160 to 118. This still
keeps the measure very elevated and it is interesting to note that the initial
attempt to address this issue back in September (by creating 3 emergency
auctions of USD liquidity over the following 90 days) took the spread down from
close to 115bp to 80bp, only to see things worsen almost immediately thereafter.

For central banks to feel they have matters under control they would want to
see this spread get below 90 and stay there for a prolonged period of time, but
they will be satisfied enough with the initial response. As for LIBOR (which is
of secondary importance at the current time) the benchmark 3 month rate stayed
somewhat higher at this morning's fixing than most observers would have hoped.
As can be seen, the 3 month rate fell by only 0.2 bp, but this is the first
decline since July 25th when the rate was 25.2 bp, under half this morning's
fix of 52.7 bp. As we saw in 2008/9, it can take some time for LIBOR to respond
fully to easier liquidity but we would hope to see some more meaningful
progress made in the coming sessions. - D-EUBSC_Index.gif -

With the emerging market central banking industry now in wholesale easing mode,
Australia's construction data gives us a glimpse of how in a downturn, economic
metrics tend to lead rates lower. Australia's Residential Building Approvals,
which were released last night, collapsed by 10.70% in October reaching their
lowest level since March 2009. On November 1st the RBA elected to reduce its
Cash Target Rate by 25bp to 4.50%. Clearly for the building industry the damage
had already been done and we doubt that a 25bp trimming of interest rates will
make much difference (although the October data may exaggerate the one month
decline in activity allowing some improvement in either November or December
data). Thus far, the overall Australian economy has been kept buoyant by its
extractive industries, but given that these are extremely reliant on continued
Chinese demand, it cannot be certain that this sector will provide the same
boost to activity going forwards, suggesting that Australia faces a difficult
period in the months ahead. - M-RBACTRD_Index.gif -

The official Chinese PMI report for November (calculated by the China
Federation of Logistics & Purchasing and National Bureau of Statistics) shows
this metric falling to 49 in November, the first sub 50 reading since early
2009 but close enough to stasis to avoid sending out any undue alarm.
Interestingly the HSCB/Markit PMI report (which is issued at the same time)
shows a a far larger drop to 47 this month, a level which suggests some
meaningful slowdown in activity is taking place. As ever we would not rely on
any single data point in a volatile series but there has been a decelerating
trend in place for most of the last 18 months and we have been expecting this
metric to fall into negative territory sooner or later. As we explained
yesterday the sudden decision of the PBOC to change the direction of its
monetary policy is the best indication that actual conditions have deteriorated
significantly in the last few months and we remain very cautious on the
portions of global asset markets connected most closely to China. -
D-CPMINDX_Index.gif -

In a widely anticipated move, Brazil's central bank lowered the SELIC target
rate to 11.00%, the third cut since August. Since that time Brazil has followed
the usual path of economic data deteriorating much faster than expectations,
necessitating further central bank easing. Although this weakening has been
blamed on the global economy (initially the US was singled out but recent data
has made Europe the scape-goat) it seems clear that much of the slowdown has
been created by the domestic business cycle cresting in the face of tighter
monetary policy.

Interestingly the central bank has so far concentrated on lowering interest
rates and has elected to keep the majority of its so called "macro-prudential"
(in reality mostly micro and foolhardy) measures intact. This means that local
conditions remain rather tighter than a simple glance at the SELIC would
suggest. We very much doubt whether the fall to 11.00% will alter the sharp
downturn in economic metrics and expect the bear market in Brazilian equities
and the BRL to remain in effect for a number of months, requiring a fairly
dramatic loosening of monetary conditions in response. - selicnov11.gif