Following last night's SELIC cut to 8.5%, another set of poor Industrial
Production (IP) data was published this morning. Total IP was estimated to have
fallen -0.2% in April while consensus called for no change. This took the YoY
decline to -2.86%, below expectations of a -2.4% decline. We are not as
concerned about the shortfall in data (IP is quite volatile) as much as the
clear trend towards a shrinking industrial base. April is the 8th consecutive
month that IP has shrunk on a YoY basis and even though the cumulative decline
is still modest, this represents a substantial and unexpected setback for the
Brazilian economy.

Thus far monetary policy has been the major tool used to address this issue,
but we expect fiscal policy to follow. We were therefore interested to note
that reports surfaced this morning regarding a proposed stimulus package for
the ethanol industry (a heavily politicized industry in Brazil). This is precisely
the sort of measure we had been anticipating, and we would expect to see
other measures target consumer spending in the coming weeks. - brazilip.gif

Regular readers will know that we are very leery of using GDP data as a guide
for our analysis, but we do not deny that its publication is widely relied upon
by others when building assumptions that go into investment decisions. It is
therefore significant that India's GDP growth rate was estimated to have fallen
to 5.3% in Q1 2012, well below consensus estimates of 6.1% and is the slowest
growth rate reported in 9 years.

With rapid GDP growth pretty much the only story in town in favor of Indian
investment (India's unemployment rate, government deficit, trade deficit and
political governance are all arguably worse than Italy) a shortfall in official
estimates of GDP can be expected to be a significant blow to investors' psyche.
- D-INQGGDPY_Index.gif -

At the heart of Europe's troubled continent, its largest and most powerful
economy continues to show resilience. This morning saw publication of Germany's
monthly unemployment rate which fell to a new post-reunification low of 6.7%.
This is a full percent below where unemployment was in May 2010 at the start of
the European debt crisis and suggests that the German economy is flirting with
full employment. This provides a good back drop for retail sales, which have
recovered steadily from their 2008/9 collapse. The April seasonally adjusted
data showed a modest YoY increase of 1.43% (inflation adjusted) while the
trailing 12 month ma shows sales back to where they were in late 2004, leaving
plenty of upside expectations.

Against this backdrop of decent economic performance, Germany would normally
expect to be experiencing a tightening of monetary conditions. Instead the mess
on its doorstep has led to a massive monetary easing, which has been
exacerbated by a wave of "safe haven" flows which have taken the 10 year bund
yield down to 1.24%, and shorter term yields to zero. Clearly this can be
expected to further stimulate the domestic economy while exports should be
aided by the sharp drop in the EUR. We continue to believe that the domestic
German economy will survive the current turmoil intact, and that locally
focused equities should provide decent medium to longer term returns.

One open question is whether the robust shape of the German economy will make
their politicians more willing to shoulder a greater burden of any future
rescue or lead to a more internally focused "Germany first" approach. We do
not have the answer, but it is clearly an issue to focus upon in the weeks and
months ahead. - M-GRFRIA_Index.gif - D-GRUEPR_Index.gif -

The ADP Employment Report for May estimated that 133K net jobs were added to
Private Sector payrolls. This is slightly below consensus estimates of 150K,
but clearly within the error tolerance of this series. This takes the trailing
12 month ma up to 160.4K (the very weak May 2011 report dropping out of the
calculation), which maintains the current pace as steady but unexciting payroll
gains. We also take some heart from the fact that May tends to be a tough month
for seasonality (May 2011's estimate was a mere 47K additions) and we are happy
enough to get through the two toughest months of the year with minimal damage
to the longer term data. Attention will now turn to Friday's BLS report where
consensus calls for 150K Total and 160K Private Sector jobs to be added. These
look like reasonable figures (and tally closely with the trailing 12 month ma)
but that is no guarantee that the guesstimate supplied by the BLS will comply
with expectations. - adpsurveymay12.gif

When we predicted back in March that the SELIC would fall below 7.50%, this
cycle this was very much an extreme view amongst commentators but the abrupt
deterioration in both economic statistics and local financial asset prices has
led to a dramatic change of heart for most observers. Thus last night's
reduction of the SELIC to a record low of 8.50% was in line with consensus and
few think that the rate cut cycle has run its course at the current rate.

This is in line with our prediction that "Phase Two" of a three legged bear
market would be accompanied by a radical change in monetary policy.
Unfortunately what tends to happen now is that just as this change in policy
becomes accepted belief, its efficacy becomes diminished by the continued
drop in local asset prices and economic activity. Thus while last summer's cuts
helped spark a rapid recovery rally in both the IBOV index and the BRL (see
chart) the multiple cuts announced since February have taken place against
sullen markets and turgid data.

The next phase should therefore see a broadening of policy (particularly into
the fiscal arena) together with some concern that the authorities are "pushing
on a string". Although Brazil's leaders have been assiduous in their blaming
Europe for their woes, to our eyes a combination of domestic excess consumption
and investment and an over-reliance on China lie at the cause of the current
woes. Last night's cut will do little to address these issues and Brazil will
need to undergo a lengthy period of adjustment before its economic slowdown and
bear market have run their course. - selicibovbrl.gif

The US Pending Home Sales index fell -5.5% in April to 95.5, when consensus had
expected it to stay at March's level (this was also revised marginally
downwards). Although on the surface this would appear to be a significant miss
(and certainly has been treated as one by the public home-builders) drops of
this magnitude from month to month are quite normal even in strong housing
markets (for instance February 2003 saw a -6.05% drop and August 2003 a -4.59%
drop). Pending Home sales are extremely volatile month to month and in looking
at April's data we are far more focused on trend, which remains solidly on
track over a 12 month period, than on the single month's data see attached
chart).

Furthermore most of April's drop from March was a function of the tough
seasonal adjustment. The NSA index fell by -2.6%, and even so the NSA chart
still shows a powerful increase in Pending Sales during the key spring selling
season and are running at a pace over 14% above that of 2011. -
M-USPHNSA_Index.gif - M-USPHTOTL_Index.gif

We have focused a significant amount of attention on the EM FX complex in
recent weeks, where multiple currencies have declined to new multi-month lows
against the USD. One currency that we had not commented on up to this point is
China's Yuan (CNY). This heavily controlled currency has enjoyed a gentle but
persistent appreciation against the USD since the strict peg was loosened in
2005. Over the last 7 years the cross rate fell from the peg at 8.27 in 2005 to
6.85 in mid 2008 where it rested for 2 years. A further loosening of the peg
led to another steady decline in the cross rate to reach an all time low of
6.28 on May 2, 2012.

The last 4 weeks have seen a very different feel to the market. The CNY has
actually lost ground to the USD, with the cross rising to 6.35 this morning,
the highest cross since December 15th 2011. As the attached chart shows, this
takes the 13 week RoC up to 0.95%. Clearly compared to the rest of the EM FX
complex this move is negligible (the INR has dropped 13.6% over the same
period), but for the CNY itself the change of direction is telling and suggests
that the traditional strong flow of capital from trade, FDI and liquid
investments may be starting to be replaced by a less benign environment for the
local currency (we suspect that capital flight ahead of the political regime
change may at least be a partial factor). As ever it will take time for this
story to play out. May could prove to be a blip or an inflection point for the
CNY but we would question the widely held belief that the CNY is a one way
trade that can only appreciate. We would set 6.50 as the "make or break" level
on the chart going forwards. - W-CNY_Curncy.gif -

Attached is a front page article from today's NYT describing a number of issues
with the Indian economy that should be familiar to our readers (and follows a
similar article on China last week).

We believe that it is significant that the general media is finally starting to
recognize some of the issues that we have been detailing over the last few
months, since a public airing of these serious issues is likely to prove to be
influential as far as investor allocations are concerned. At least at the
upcoming quarterly and semi-annual investment committee meetings, there will be
the possibility that members have a sense of unease about the wisdom of
allocating yet more funds to what is now a very tired investment thesis.

http://www.nytimes.com/2012/05/30/world/asia/indias-economy-struggles-after-big-
hopes.html?_r=1&hp

As we described in the last Weekly Speculator, the last few months have seen a
substantial retracement of agricultural prices from the heady days of 2011 as
higher prices have prompted substantial increases in supply. Recent sessions
have seen a continuation of selling pressure with both Corn and Oats falling to
post December 2010 lows in Chicago, and Wheat falling sharply in sympathy.
Although a bounce in Soy Beans has lessened some of the damage, the effect has
been to depress the value of the overall complex, taking the S&P/GSCI
Agricultural index (SPGSAG index) down to 403.50 at the time of writing.

As can be seen on the attached charts this takes the index down to key support
at the 400 level. With the exception of a brief trip down to 398.23 in mid
December 2011, this level has not been violated since it was surpassed in the
violent run up of agricultural prices that took place in anticipation of QE2
back in the autumn of 2010. Looking at a very long term monthly chart, the
importance of this support becomes even more apparent. Over the 42 years of
this index, the agricultural complex has gone through a number of violent booms
and busts. The danger that the 2011 peak marked a major secular change in the
direction of agricultural prices should not be underestimated. Even if this
proves to be a "multi-month blip" along the way the chart suggests that the
ground between 350 and 400 offers very little in the way of support. A full
retracement of the June 2010 - March 2011 rally would take the index down to
281, which does not seem fanciful from our perspective. - M-SPGSAG_Index.gif -
D-SPGSAG_Index.gif -

China's monthly Business Cycle Signal Index is jointly developed by the
National Bureau of Statistics and Goldman Sachs, and while this is no guarantee
of its accuracy, it does make it a statistic that can be expected to shape both
official and private sector opinion regarding the state of the economy.

April's reading took the index down 4 points to 87.30, the 4th consecutive fall
in the index and it is now 10 months since a positive reading was registered,
during which time the index has fallen by exactly 30 points from 113.30. This
drop cuts across the vast majority of the "Normal Conditions" range, which runs
from 83.3 to 116.7 (the index is "Hot" above 116.7 and "Very Hot" above 136.7,
a level which has not been reached since the early 1990's). Any further
deterioration would therefore place the current Business Cycle into "Cold"
territory.

The sudden deterioration of Chinese economic statistics has started to focus
the market's attention on the possibility of a significant stimulus package.
Over the weekend news was released regarding an extension of credits for
household items that consume low amounts of electricity, together with a
renewal of a "cash for clunkers" program. This morning then saw a the Xinhua
News Agency publish a denial of any intention to introduce "another massive
stimulus plan" such as that of 2009/10.

Our view remains that in the end China's slowdown is likely to reach the point
that significant stimulus is applied, with no greater success than that of the
Bush led fiscal stimulus introduced in the middle of the 2000/3 bear market. To
reinforce the relationship between stimulus and equity markets, we have included
a new chart that shows the path of the SPX index between 1999 & 2003 (orange)
together with a count of the number of news stories containing the term
"STIMULUS" (white). As can be seen, the hubbub regarding "stimulus" in late 2001
was enough to spark a bear market rally of considerable duration, but not to
overcome the impulse of the market to force its way significantly lower in 2002
as the economy failed to respond in the manner expected.

Should China in the end follow the path of fiscal stimulus we would expect a
roughly similar pattern to emerge. - chinabuscycle.gif - spxstimulus.gif

Brazil's banking industry continues to churn out new credit despite clear
evidence that economic conditions are starting to deteriorate. In our view this
meaningfully increases the odds that credit performance (which is already poor)
will deteriorate significantly later on in the economic slowdown.

April's data showed total Private Sector loans growing by 0.71% to 1169 bln
BRL. This keeps annual loan growth up at 13.35% although it should be noted
that the last 6 months have only seen loans growing by an annual rate of 9.2%,
suggesting that banks are finally starting to tighten lending conditions.
Housing Credit (red) continues to grow much faster than other categories at
2.29% for April and has grown by 42% over the last year. Again the 6 month
growth rate annualizes to a lower 37.8%. All other categories of credit grew
in April.

Meanwhile, loan quality continues to deteriorate. As we expected, March's tick
down in the Personal Loan Default rate (loans 90+ days late) proved to be
ephemeral and the rate returned to 7.6% in April. Delinquency (30-90 days late)
remained at 6.8% and so this creates a new cycle high of 14.4% for total late
Personal Loans and is the highest reading since August 2009 when credit quality
was in the middle of a rapid recovery. We would expect to see the 2009 high of
15.76% comfortably surpassed during this delinquency cycle and would suggest
that the 15% level is probably the magic number that sets the alarm bells
ringing. At the current rate of deterioration we could cross this level by the
end of summer.

Corporate Defaults remain much lower at 4.1% (unchanged) and Delinquency at
2.3% (unchanged). This is not surprising since corporate delinquency typically
takes place much later in the cycle than personal credit. We would expect
Corporate Credit quality to start to deteriorate in the next 3-6 months, adding
to pressures on local bank earnings. - D-BZLNPTOT_Index.gif -
D-.BRAZDEF_Index.gif - D-BRCDDEFT_Index.gif -

We have rarely seen as good an example of consumer confidence at extreme
readings being a contrary indicator for investors than in the case of Brazil in
recent months. As we noted last month, April's consumer confidence index hit a
new all time high just as the local equity market was showing the early signs
of a steep correction. May's readings only show a moderate change in
confidence, with the headline SA survey coming in at 127.1 and the NSA data at
124.9.

This still keeps confidence at a very high level suggesting that Brazilian
consumers are still largely unaware of (or at least unmoved by) the significant
decline in their local equity market and currency. Given the speed of
deterioration this is not that surprising, but it does perhaps suggest that the
declines have a few more weeks to go before then end of this current corrective
phase since confidence generally collapses around market bottoms. This is in
line with our own thinking about Brazil's equity market currently being in the
middle of the second phase in what should prove to be a protracted bear market.
- brazilconsumerconf.gif

One of the predictions we made last December was that the LTRO would make
German ABS an extremely attractive debt instrument for European financial
institutions to hold. This article is the first evidence we have seen that this
is proving to be the case.

The implications of this are that German borrowers are likely to be
aggressively targeted over the coming months, with a domestic credit boom
highly likely to develop. German car and housing loans are the two most obvious
candidates, since both are large markets with volumes sufficient to create a
steady pipeline of ABS product. Consequently the odds of strong auto sales and
an acceleration of home sales and underlying prices have been increased in line
with our expectations.

An excellently argued piece which outlines the fallacy in what the author calls
"GDPism", namely an excessive trust in the veracity of Chinese data and the
ability of authorities to produce smooth and powerful growth.

Bloomberg TV Interview with Tom Keane concentrates on US, EM and commodities.

http://www.bloomberg.com/video/93374409-global-economic-cycles-out-of-synch-shao
ul-says.html

Brazil's Current Account and FDI data continues to suggest that the strong net
funding position that Brazil enjoyed for much of the last decade is under
threat of erosion.

April's current account deficit widened to -$5403 mln, significantly worse than
estimates of -$4000 mln and -$1800 wider than April 2011. This takes the 12
month cumulative CA deficit to -$51.593 bln and this number has bounced around
the -$50 bln level for several months. Up until recently FDI was robust enough
to comfortably cover the CA deficit and still provide a funding surplus.
April's data was somewhat less helpful, with FDI of $4669 mln missing
expectations of $4900 mln and dropping from March's $5887 mln. Therefore for
April alone FDI was smaller than the CA deficit. The 12 month cumulative FDI
has now dropped to $63.213 bln, which is still $11.6 bln greater than the CA
deficit, but this cushion was far higher in the early years of Brazil's
economic boom when FDI was less but the CA was still in surplus.

Given the sharp decline in the BRL together with local asset prices, the danger
is that import costs may drag the CA lower while greater financial risk may
deter FDI. Brazil still has some leeway (at least in the annual data) but is in
a far less comfortable position regarding its funding position than many
suppose. - D-BZCA12MO_Index.gif

Since we finally have a quiet session in terms of news we will take the
opportunity to publish a chart that we have been mulling over internally for
the last few weeks. It compares the number of active rotary oil rigs (measured
by the Baker Hughes index that is published each week {bakeoil index} to the
current DOE stocks of crude oil.

As can be seen the oil rig count has soared from a low of 179 in June 2009 to a
30 year record of 1382 (the electronic data only goes back to 1987 but Baker
Hughes were good enough to supply earlier data in hard copy format). Even if
one uses the 2008 peak of 442 rigs as the starting point, this would still
represent a 212% increase of rigs in operation of a 42 month period as
production has started to rapidly ramp up in the newly discovered shale oil
fields. Nor is there any sign that we have reached the peak at the current time
and given the large amounts of project financing poured into this area we would
expect to see further projects come on line.

Unsurprisingly this large increase in rigs has resulted in considerably more
oil being produced, and even though demand has remained steady it has been
overwhelmed by supply. This can be seen in the surge of DOE crude oil
inventories which are currently at their highest level since mid 1990, when oil
was about to record a peak price of $41.15 on October 10th, a price that was
not matched until May 2004.

As we have noted a number of times in recent weeks the decade old commodity
bull market is starting to be threatened by a glut of new supply at precisely
the time that its "secular" underpinning of relentless emerging market growth
comes under threat. The clear risk is that this will be resolved by sharply
lower prices in the coming months, and crude is a clear example of this
phenomenon. - W-BAKEOIL_Index.gif -

A useful riposte to those who believe that the answer to EM's problems is more
infrastructure spending.

It has been a while since we have updated the relationship between silver's
2011 boom and bust and that of the NDX a decade ago. Attached is a chart of
silver (blue) together with the NDX rescaled by a factor of 0.01 (this matches
both highs at around $50). As can be seen, a broadly similar pattern has emerged
since silver topped out a year ago, provided one allows for shifts of time of
several weeks in either direction. If silver continues to follow the NDX's path
it is overdue a steep leg down to below $20. Looking at the current chart, this
makes $26 key support, since this is where the metal bounced at the end of
December ($26.16 is the precise low recorded). At $27.34, the metal has a 5%
leeway before support will be reached, which given silver's inherent volatility
can take surprisingly little time to cross. Prior to $26 silver should also
have support at $26.80 where the metal bounced last week, but we really view
that level as simply a pre-test of the far more important support 80c below. -
silverndx.gif

Census Bureau estimations of US New Home Sales came in at 343K in April, a rise
from March's 332K (revised up from 328K). This is a solid report in the middle
of the key spring selling season and this is the first time that normal
seasonal patterns have emerged in six years (excluding the tax credit boost of
2010). At 343K, sales remain above the trailing 36 month ma indicating that the
bottom is in place. They would need to extend above 415K to reach the 60 month
ma (not shown) and 765K to match their 120 month trailing average. This leaves
plenty of room for progress in the months ahead and we would note that actual
sales reported by public home-builders are running some distance ahead of
Census Bureau estimates.

NSA sales were estimated at 33K for April alone, which is the highest number of
homes sold in a month since October 2009 (when tax credits were in effect) but
still well below the level of April 2008 (49K), 2007 (83K) not to mention peak
April sales of 116K in 2005. May is traditionally a slightly stronger month for
sales and so we would hope to see NSA sales between 35-40K for this month's
data. - D-NHSLTOT_Index.gif - D-HSMNTOT_Index.gif

Interview focuses on emerging markets, Europe and US equity market.

http://media.bloomberg.com/bb/avfile/News/Surveillance/vlJ.yjrpKKpg.mp3

Japanese export data for April was disappointing overall with total exports
growing 7.9% YoY compared to expectations of a 11.8% boost (note April 2011 saw
exports very depressed by the earthquake and tsunami that hit in March).

Interestingly the main reason for slippage appears to be exports to China,
which fell -13.6% from March's level to ¥995 bln. This represents a drop of
-7.1% on a YoY basis, and is the 7th consecutive month that Japanese exports to
China have fallen below their level the year before. We view this data as
further confirmation that China's economy is far less robust than the consensus
view believes to be the case.

Exports to the US on the other hand, remain in a strong recovery trend after
plummeting in 2008. This recovery was interrupted in 2011 (car production and
exports in Japan were very curtailed last spring and summer) but now seems to
be re-exerting itself. Japanese exports to the US grew to ¥959 bln, less than
5% below exports to China. It would seem highly probable that the US will usurp
China as Japan's major export market by the end of 2012, and will to an extent
ameliorate the pain felt from the shortfall in Chinese demand, at least at the
aggregate level. Since very different goods and services may be involved
in exports to the US and China this will be much less true at the individual
company or sector level, with some clear winners and losers depending
on which export market is being relied upon for sales. -
japantrade.gif

An interesting article which supports our view that energy supply is starting
overwhelm demand in the US. We are increasingly of the view that natural gas
has led the way downwards for the overall energy sector over the coming months.
Similar patterns of overproduction are stating to become visible in both
agricultural and industrial commodity markets and weigh on price performance of
the entire complex.

If we are correct then although this may lead to sharp losses in portfolios
weighted towards the commodity complex, it will help keep inflationary pressures
moderate and benefit users of commodities including much of the industrial and
consumer sectors. The key as ever will be to adjust allocations to benefit from
this change in conditions, an exact reversal of the actions required a decade
ago.

The April Existing Home Sales report is a solid collection of data that
supports the view that a sustainable recovery of activity is underway. Total
sales were estimated at 4.62mm, matching consensus (4.61mm) and up from March's
rate of 4.47mm (revised slightly lower by 0.01K). This takes sales back up to
their January 2012 level, but this is now happening in the middle of the key
Spring selling season meaning that there has been a sustained surge in actual
transactions at the most important time of the year. This is the first time
that the US home market has exhibited "normal seasonality" since 2006 (we
ignore the stimulus distorted boost to sales in 2010) and even though total
activity remains depressed, the change in trend is very encouraging. At the
current rate of improvement total sales could be expected to breach the 5mm
around the turn of the year.

Looking at Single Family homes in isolation we can see that sales reached
4.09mm, keeping the data well above the trailing 60 month ma. The trailing 12
month ma is pointing upwards indicating decent momentum behind the increase in
sales. Inventory grew substantially to 2.24mm homes, but oddly enough we take
some encouragement from this since it indicates a willingness of owners to put
homes that had been mothballed onto the market (particularly foreclosure
inventory) as the Spring selling season shows signs of strength. At this point
in the cycle availability has started to limit transaction in markets that have
attracted a substantial amount of financial buyers, and new inventory will help
keep activity moving higher.

Condo sales were somewhat stronger than Single family sales, and are up 10%
over the last 12 months to 530K. As we have noted before, Condo inventory has
declined much further than Single Family homes, and there has been much less of
a seasonal bounce in condo inventory (which is typically held off the market in
the winter and then listed aggressively in the Spring) than we have seen in
other times. This may suggest that overall shadow inventory in several regions
may have become substantially depleted in recent months, which would in turn
suggest that price appreciation may start to become more obvious going
forwards. - D-EHSLSL_Index.gif - M-ECSLHAFS_Index.gif -

In our experience a typical bear market takes place over 24-36 months and is
composed of 3 distinct phases:

First Phase: Local economic and corporate data look extremely strong but
financial asset prices start to sag as local liquidity becomes squeezed by
tight monetary policy, excessive supply of assets and bloated market caps. This
can be said to have been reached in Brazil last summer, with an abrupt collapse
in equity values causing an equally abrupt shift in local monetary policy. On
a historical basis it also describes the events in late 2000 through mid 2001
in the US. In both cases strong recovery rallies took place over several months
(see chart) as participants assumed that cutting interest rates would quickly
restore boom conditions.

Second Phase: After a period of several months local economic and corporate
data starts to deteriorate markedly. A second wave of liquidation forces local
asset prices lower, while a reversal of foreign inflows puts the currency under
pressure. In response the local administration and Central Bank start to
address the threat of a sharp slowdown.

Right on cue Finance Minister Guido Mantega announced a liberalization of
reserve requirements for automobile loans (see links {NSN M4EL161A1I4H <go>} or
http://www.bloomberg.com/news/2012-05-21/brazil-stimulates-banks-to-boost-car-le
nding-as-sales-slump-1-.html). We have highlighted a slowdown of local auto
sales in prior notes and also noted the significant uptick in local loan
delinquency, much of which has been centered around auto loans (where fraud has
started to become endemic due to lax lending practices, reminding us of the
sub-prime credit cycle in the US 5 years ago). Given the saturation of local
demand for autos and poor quality of credit it is far from clear whether this
policy will have the desired effect, but it is likely to be followed by further
fiscal and monetary easing in the coming weeks in response to weakening equity,
bond and FX markets.

This is reminiscent to the experience of the US in late 2001 when in response
to the 9/11 attacks (and collapsing equity market) the "Bush era" tax cuts that
are still with us today were ushered in. Needless to say once the market had
thoroughly washed itself out (something we do not think has been completed yet
in Brazil) another multi-month recovery rally broke out. This was fueled by the
hope that fiscal and monetary stimulus would quickly restore order, ignoring
the fact that significant time would be needed to address the buildup of
inventories and mis-allocation of capital in the prior boom.

Third Phase: By mid 2002 (and we assume late 2012 to mid 2013 in Brazil) local
economic conditions were still poor and corporate data started to deteriorate
alarmingly. At this point corporate credit started to perform very poorly as
default rates soared, while equities ceased to discount any likelihood of
recovery and management started to sing the blues on quarterly conference
calls. Of course it was roughly at this time that monetary policy was finally
starting to have an effect, although it took several months of bouncing along
the bottom before the local equity market noticed. We therefore believe that
the bear market in Brazilian (and most EM) equities still has another year or
so to run, although this period will include many months of rallying or
sideways markets along the way. - brazilspx.gif

A very interesting article that describes the sudden shift away from CNY
Deposits towards USD accounts. As the attached chart shows, China's FX Deposits
have surged from $275 bln at the end of 2011 to $364 bln at the end of April.
To put this in perspective, this represents about 2.6% of Chinese M2 (currently
$14,000 bln) and a much larger 8.3% of Chinese M1 ($4,600 bln). In other words,
the money shifted away from CNY and towards USD deposits are meaningful in
terms of the Chinese monetary system and can be considered to be an important
influence on local monetary conditions.

As the article describes, although the PBOC can counter these flows by selling
its own USD deposits for CNY, this action would itself be a drain on local
liquidity at a time when monetary conditions have already tightened
dramatically. On the other hand doing nothing risks a breakout of the CNY cross
(as the attached chart shows this is currently just below its 200 day ma),
which would then encourage greater flows into FX deposits, in turn further
weakening the currency.

One further factor to consider is the sudden depreciation in other EM
currencies. This has had the effect of considerably reducing the competitive
position of Chinese exports (which have in any case reached a size that makes
further growth quite difficult to achieve). Under these circumstances the will
of the PBOC to defend the current CNY rate may be somewhat less than most
imagine.

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

Flight From Yuan Spurs Jump in Dollar Savings: China Credit
2012-05-21 03:35:30.408 GMT


By Bloomberg News
May 21 (Bloomberg) -- Dollar-denominated deposits in China
are rising at the fastest pace in at least five years and
government debt is rallying, reflecting waning confidence in the
world’s second-biggest economy.
Foreign-currency deposits increased $89.4 billion in the
last four months to $364.5 billion, the biggest jump in data
going back to 2007, People’s Bank of China figures show. Chinese
banks sold a net 60.6 billion yuan ($9.6 billion) of foreign
currency in April, reflecting capital outflows, according to a
separate PBOC report. The government’s benchmark one-year bond
rallied the most in six months last week, driving its yield down
34 basis points to 2.42 percent, as property prices and foreign
investment fell.
China’s currency has dropped 0.5 percent this year and
waning expectations for appreciation have prompted investors to
sell yuan-denominated bonds in Hong Kong, driving yields to a
four-month high. Dim Sum debt lost 2 percent in the past year as
U.S. Treasuries gained 8.9 percent, reflecting increased
appetite for dollars amid Europe’s debt crisis. Yuan deposits in
Hong Kong fell a record 34.21 billion yuan in the first quarter.
“Demand for dollars is rising and the central bank even
has to sell dollars in the market to meet such demand,” said Li
Wei, an economist at Standard Chartered Plc in Shanghai.
“People’s interest in holding yuan assets will decline further
because the worst of the economic slowdown is not over.”

Bond Risk

Investors are increasing purchases of insurance against
default on China’s debt by the most among the BRIC nations as
exports slump and industrial production cools. The net amount of
credit-default swaps on Chinese bonds rose by $189 million, or
2.1 percent, to $9 billion in the two weeks through May 11,
according to data published by New York-based Depository Trust &
Clearing Corp.
The annual cost of protecting China’s debt for five years
jumped 25 basis points this month to 138 basis points, the
highest since January, according to CME Group Inc. prices. A
basis point equals $1,000 a year to insure $10 million of debt
from default. Swaps pay the buyer face value in exchange for the
underlying securities should a borrower default.
The yuan strengthened 0.07 percent to 6.3240 per dollar as
of 11:25 a.m. in Shanghai, following a 0.28 percent decline last
week, according to China Foreign Exchange Trade System. Twelve-
month non-deliverable forwards rose 0.09 percent to 6.3850,
according to data compiled by Bloomberg. The contracts are 1
percent weaker than the spot rate, having traded at a premium of
as much as 1.2 percent in January.

Near ‘Equilibrium’

“As depreciation expectations grow, the central bank can
sell dollars in the interbank market to prevent depreciation in
the short term, but the operation can’t last long because it’s
actually a tightening measure,” said Liu Yuhui, director of a
financial research office at the government-backed Chinese
Academy of Social Sciences in Beijing. “The central bank will
find it difficult to continue this operation from 2013.”
Premier Wen Jiabao said on March 14 that the yuan’s
exchange rate may be near an “equilibrium,” after allowing the
currency to rise 31 percent since a dollar peg was scrapped in
July 2005.
China’s current-account surplus, the broadest measure of
trade in goods and services, surged to 10.1 percent of gross
domestic product in 2007 as the trade surplus widened. The
excess dropped to 2.8 percent last year, a reversal that was
“sharper and more persistent than expected,” The International
Monetary Fund said last month.

Stronger Dollar

“The yuan’s one-way appreciation is over,” said Shi Lei,
head of fixed-income research in Beijing at Ping An Securities
Co., a unit of the nation’s second-biggest insurance company.
“Depreciation expectations may strengthen as China’s
international payments become more balanced and the dollar
advances against major currencies.”
The Dollar Index, which tracks the greenback against the
currencies of six major trading partners, rose 1.3 percent last
week, its biggest gain in more than two months. It fell 0.3
percent today.
Signs the economy’s slowdown is deepening has boosted
demand for safer debt. The yield on 10-year government bonds in
Shanghai dropped 13 basis points last week to 3.36 percent,
according to Chinabond, the nation’s biggest debt clearing house.
China’s exports grew 4.9 percent in April from a year
earlier, the slowest pace in three months, while imports rose
0.3 percent, the customs bureau said on May 10. Industrial
output increased 9.3 percent, the smallest gain since May 2009,
statistics bureau data showed on May 11.

Slowing Growth

Standard Chartered’s Li forecast China’s economic growth
will be as slow as 7.7 percent in the second quarter, before
rebounding to 8.2 percent in the third quarter. The first-
quarter expansion of 8.1 percent was the worst performance since
mid-2009. Li predicted the yuan will strengthen 1.8 percent to
6.21 per dollar by the end of this year because the government
won’t tolerate depreciation.
Liu Dongliang, a senior analyst at China Merchants Bank Co.,
the nation’s sixth-biggest lender, said the central bank may
tolerate “moderate” depreciation this year to aid exports. He
forecast the currency will weaken as much as 1.2 percent to 6.4
per dollar by the end of December.
“There is a high probability that the yuan will depreciate
this year as the European debt crisis worsens and the U.S.
economy recovers,” said Shenzhen-based Liu. “After all,
depreciation will be good for the economy. At the moment, I
can’t see when the economy will really bottom.”

For Related News and Information:
Top currency news: TOP FRX <GO>
News on China’s currency: TNI CHINA FRX BN <GO>
Top World Stories: TOPWW <GO>
China economic snapshot: ESNP CH <GO>
China OTC monitor: OTC CNY <GO>

--Judy Chen. Editors: James Regan, Sandy Hendry

To contact Bloomberg News staff for this story:
Judy Chen in Shanghai at +86-21-6104-3043 or
[email protected].

To contact the editor responsible for this story:
Sandy Hendry at +852-2977-6608 or
[email protected]
- chinafxdeposits.gif - cnyrate.gif

China's real estate data continues to resemble the US in early 2007, and indeed
the aftermath of countless other real estate booms which overstayed their
welcomes. Last night saw the publication of official price data for 70 major
Chinese cities and this has deteriorated significantly from the already
troubling data published in March.

As the attached charts show, the number of cities with new home price
appreciation over the last 12 months has fallen to 23, the lowest number since
the data starts in 2009. Falling markets have risen to 46, which means that
prices are falling in 23 more markets than they are rising. Home prices have
fallen by over -5% YoY in 4 cities, Wenzhou (-12.3%), Hangzou (-9.2%), Ningbo
(-5.5%) and Jinhua (-5.3%). The one month data showed price falls of greater
than -1% in 4 markets, Wenzhou (-3.6%), Hangzou (-3.4%). Ningbo (-2.1%) and
Qingdao (-1.6%)

The existing home data was significantly worse, showing that prices have risen
in only 12 cities and have fallen in 56. This is a negative spread of 44
cities, which qualifies China for a national sale price decline on the basis
that more than half of the major markets are now experiencing falling prices.
We would expect this data to further pressure sales activity in the country,
and for construction to start to fall meaningfully in response to this (see
yesterday's note on Caterpillar machinery sales data). - D-.CHREPINC_Index.gif
- D-.CHEPINC_Index.gif -

An informative article that describes sluggish growth and accelerating
inventories are putting pressure on local car dealers in China. This is yet
more evidence that China is experiencing the sorts of cyclical pressures that
take place at the start of an abrupt slowdown of overall activity.

With both the automobile and housing market in retreat (the two "large ticket"
items for consumers) it is a reasonable assumption that other retail activity,
particularly at the luxury end of the spectrum, will start to show signs of
weakness later this springtime.

Given the poor quality of official statistics in most emerging markets (which
are even worse than our own dismal collection), we have suggested tracking the
public statements of large multinational exporters in key cyclical industries
such as automobiles. Caterpillar, which dominates global sales in construction
and mining equipment is a good example of a target company, and they are
helpful enough to provide monthly updates on global sales broken down into key
regions. This is provided in the form of a YoY percentage change of a 3 month
rolling average of sales, which is a sensible way to view the data since it
smooths individual monthly fluctuations.

This morning saw the release of April data, and as the attached chart displays
there is a stark disparity between the health of the North American business
(up 32% YoY) with that of Asia (+5%) and Latin America (-13%). Although YOY
changes can be misleading, the steady deterioration in trend in both Asia and
Latin America suggest that demand for heavy construction and mining machinery
in these parts of the world is coming under pressure. Meanwhile in the US a new
construction cycle has taken hold (most obviously in multi-family properties)
allowing North American sales to grow at a much more robust level. -
catsales.gif

Initial Jobless Claims were estimated at 370K this week just above consensus of
365K, while last week's data was revised 3K higher to 367K. This took the
trailing 4 week ma down to 375K, just below its level of a month ago. It would
therefore appear that the worst portion of the seasonal adjustment process is
behind us, although we believe that the next few weeks will still have a modest
headwind that will make it harder to make progress in claims back towards the 350K
level before the start of summer. Over the medium term we still expect Claims
data to resume its steady downward path, and to enter the healthy sub-350K
level sometime around the end of Q3. - W-INJCJC4_Index.gif -

Russia's Industrial Production data for April showed a sharp contraction of
-5.4% from March, which translates into a 0.1% gain on a seasonally adjusted
basis. This took the YoY growth rate down to 1.3% from 2.0% in March, well
below expectations of 3.2%. Since Industrial Production in Russia includes both
Mining and Energy, it really encompasses a large portion of the Russian economy
(much larger than the same data series in a country such as the US) and the
source of earnings for the bulk of local equities.

It is therefore unsurprising that Industrial Production and the local equity
market tend to be strongly correlated (see attached chart). In line with other
emerging markets, the local RTSI$ index has performed very poorly in recent
weeks, and has fallen another 4.60% this morning to 1310.56. The index is now
down -5.14% YTD and 28.32% over the last 52 weeks and only has round number
support at 1300 between the current price and the 2011 low of 1200.34. Given
the obvious trend of deceleration in IP data, we would imagine that the index
will trade below this level, although support may be strong enough to allow for
one or more bounces as the index approaches 1200. Up until this point the bulk
of the losses in the USD based RTSI$ index have been caused by equity prices,
but from this point on we would expect the RUB to start to move sharply lower
lower in response to equity declines. - D-RUIPRNYY_Index.gif -

The FOMC April meeting minutes hold few surprises see link:
http://www.federalreserve.gov/newsevents/press/monetary/fomcminutes20120425.pdf

The 2 day affair would appear to have involved yet another series of
presentations and discussions that delve into arcane aspects of the FOMC's
remit but ultimately keep the view and policy unchanged. Ironically for a body
which has set its current policy around doing nothing for the next 2½ years the
one decision of note made was to extend all future meetings for 2 days rather
than have some shorter 1 day sessions.

Citigroup's US Economic Surprise Index has become a much followed indicator
since we first started using it in mid-2010 and it is partly because there is
now a greater understanding that data itself is cyclical that we have seen more
patience with the recent ebb of US data than the "data-dips" of 2010 and 2011.

Citigroup also publishes regional surprise indexes, which include the Citigroup
Emerging Market Surprise Index (CESIEM). Since this index aggregates data from
multiple countries, it is a much less sensitive indicator. This means that most
of the time it does not provide much of a signal either way, but when it does
it normally means something interesting is going on.

As the attached chart shows, the CESIEM recently collapsed to a 3 year low
reading of -33.60. The main cause for the abrupt decline was Chinese data
being released on Friday (the index fell 25 points following this release, but it
should be noted that weak Indian IP data was also released on the same day),
but the index had already been in steady decline for several weeks. The trailing
10 week ma (which we generally use as a more reliable signal) has now fallen into
negative territory and should track sharply lower over the next few weeks.
Although this indicator is capable of delivering false signals in a growth
period (see 2003 and 2005), it is now delivering a clear signal that overall EM
data is starting to disappoint.

At the current time most investors, commentators and financial media are either
ignoring this fact or farcically choosing to blame it on the influence of
Greece. This is despite the fact that recent performance by emerging market
equities (particularly those of the BRIC nations) and currencies has been
awful. The market has a habit of forcing investors to concentrate on the
correct issue and we would therefore imagine that price disturbance in the EM
arena will reach a level that generates rather more attention before this
corrective phase is complete. - W-CESIEM_Index.gif -

The Census Bureau estimation of US Housing Starts for April offers further
confirmation that the long awaited recovery in the home construction industry
started earlier this year. Overall Housing Starts were estimated at 717K, above
expectations of 685K, which is the strongest reading since October 2008 (when
construction activity collapsed). Significantly, the March data was revised
strongly higher to 699K, suggesting that April is more than a flash in the pan.

Once more it is the Multi-family series that showed the most strength, reaching
225K and leaving the trailing 12 month Multi-family starts now 198K, which is
about 60% of its pre-crisis level. Multi-family starts are dominated by rental
housing (demand for which is very high), but will also include some
condo-projects in more robust regional markets. Single Family starts were more
muted at 492K, but at least have not suffered the sort of seasonal decline that
we have seen in prior years. We would characterize this data as showing that
starts continue to bounce along the bottom, which tallies with the fact that
the inventory of New Homes have continued to fall to new all time lows as sales
picked up pace this Spring.

Permit data was also robust. Total Permits were 715K, a little under consensus
of 730K. This shortfall was compensated for by a large revision (+22K) to the
March data (now 769K). As the attached chart shows, this keeps Total Permits
just below the trailing 60 month ma, which we would use as a signal that
overall residential construction has entered a period of sustained expansion.
Single Family Permits rose to 475K from 466K, the second highest reading since
March 2010 (when tax credits were in place). This data is now solidly above its
36 month ma, which itself has turned. We interpret this as a signal that the
bottom is in place for Single Family construction. The data still needs to
force its way through the trailing 60 month ma (currently 523K) to signal a new
construction cycle is underway, but we are hopeful that this can be achieved
later in 2012. - D-NHSPSTOT_Index.gif - M-NHSPATOT_Index.gif -
M-NHSPA1_Index.gif

Interview with Michael Shaoul on HK Radio 3 show "Money for Nothing",
which aired Tuesday May 15th (Monday night US time). The interview starts 9
minutes into the audio clip and concentrates on emerging markets, Chinese
monetary policy and US corporate profitability.

http://programme.rthk.hk/assets/contentindex/asx/radio3_5126_178363_19021.asx

When we pointed out the sharp weakening by the BRL last week, we suggested that
it was likely that the local equity market would follow suit. This is certainly
how things have played out with the IBOV index falling over 6% over the last 5
sessions to just over 56,500. This wipes out the entire 2012 gain for local
investors and leaves the index down over -10% for the last 52 weeks. The next
clear support level for the index comes in at 55,000 but while this level held
back in October and November 2011, it was passed with ease during August's
collapse (which frankly the current move is starting to resemble).

Unfortunately, there also is no sign that the BRL has bottomed, and at the time
of writing it is flirting with the 2.00 level, a breach of which would not only
be psychologically devastating but would also be likely to trigger further
losses in structured products (which tend to be struck at obvious round
numbers). Once currency losses are taken into account, a USD investor in the
IBOV is down -7.51% for 2012 (compared to a 6.42% gain in the SPX index) and
over -30% for the last 52 weeks. The IBOV is within 7.5% of its 2011 low
measured in USD terms (26,241 compared to the current price of 28,301) and we
believe there is a decent chance of surpassing this low during the current
corrective move. - ibov-brl.gif

May's NAHB survey more than repaired the damage from April's surprising (and in
our opinion misleading) report. The overall index rose to 29, equaling the
levels reached at the turn of the year in a far more important month for home
sales (the data is seasonally adjusted). Future sales (red) were strong at 30,
while Present Sales (blue) reached 34 and Traffic (green) recovered to 23. The
sum of these 4 indexes reached 116, the highest reading since March 2007, at
the start of the collapse in mortgage availability. We maintain our view that
the New Home market has commenced a new cycle which should remain in place for
several quarters.

Underpinning this recovery is the extreme affordability of US Homes (both NEw
and Existing). At the same time as the NAHB data was released the quarterly
update to the NAR Homebuyer Affordability index was issued. This showed the
index reaching a new record of 205.90 (when the index measures 100, a family
earning the median income has exactly the amount needed to purchase a
median-price resale home using conventional financing). - M-HOMECOMP_Index.gif
- nahbmay2012.gif

Although the headlines (and much of the commentary) may look the same, the 2012
Eurocrisis is taking a somewhat different path to that of 2011. Within debt
markets the damage is currently isolated within the long end of certain
sovereign markets with far less stress evident in wider credits or even the
short end of the Spanish and Italian curves. It can therefore be argued that so
far the LTRO has succeed in its primary aim of stabilizing broad financial
credit markets, even in the face of dislocation in specific sovereign markets
(time will tell if this continues to be the case).

The other striking difference in recent weeks is the change in the perception
of the German economy. As we argued in late 2011 the emergence of Germany as
Continental Europe's true "super-power" was likely to be the most important
long term effect of the crisis. We suggested that the ECB's provision of
generous liquidity and lower rates were likely to further stimulate a robust
German domestic economy. Although Q1 GDP of 0.5% hardly counts as powerful
growth it is far better than that seen elsewhere major Eurozone economies,
while German unemployment remains at a 20 year (and post re-unification) low.

The effect of this change in perception can be seen in the performance of the
DAX index. This participated fully in the 2011 collapse and actually lost
ground to the DJ Euro Stoxx index (SX5E) over the summer. Last summer Germany
was expected to be the the true loser of the Euro-crisis, being presented the bill
for the bail out of peripheral nations and seeing lower exports to its European
trading partners. In the event, none of this transpired.

At the present time, Germany is more correctly viewed as the Eurozone's best
hope of growing its way out of the crisis. In particular, Germans feel far
better about their own local prospects than they did a year ago (as this
morning's ZEW poll made clear). As a result, in 2012 the DAX has managed to
outpace the gains of the S5XE during the Q1 rally and decline by less during
the current correction. The DAX has pushed its way to a new all time high
against the S5XE (data goes back to 1987) and although we would expect
the DAX to participate in any further Euro-zone losses, it should continue
to outperform during the correction and offer leadership in the rally that
follows. - D-DAX_Index.gif -

China's FDI fell in April to $8.4 bln, a drop of -0.7% from its level of April
2011. This is the 6th consecutive month that FDI has dropped on a YoY basis and
it is starting to become clear that FDI flows into China have peaked for the
time-being. Lower FDI will increase the pressure on local sources of capital at
a time when they are already stretched by local monetary policy.

It is not yet clear whether the reduction in China's FDI is a reflection of
growing unease about China itself or simply an outcome of risk retrenchment
across emerging markets as a whole (particularly by European banks). We suspect
that it is a little bit of both with some of the recent financial and political
scandals making China appear to be a somewhat less attractive venue for FDI
than investors assumed a year or two ago. Whatever the cause, the moderation of
FDI is a negative force on a local economy that is already struggling to meet
the lofty expectations placed upon it. - chinafdiapril2012.gif

Although Europe is hogging the headlines given the exposure of the average
global portfolio, it is the emerging market complex which is currently
delivering the pain to investors. We are therefore concerned that insufficient
attention is being paid to the rapid decline in both currencies and local
equity markets, and the fact that this EM decline is being ignored is a sign
that we have further to go.

As the attached chart shows, what started as weakness in very specific markets
(primarily the BRL and INR) has now spread across the EM FX complex. In
particular we would note that the ZAR (olive) has started to move sharply lower,
since this is always one of the more sensitive currencies once flows reverse
and this currency now leads losses suffered since the start of 2011 at 23.7%.
Going forwards we would keep an eye on the TRY (purple), since this currency
clearly has the potential to catch up with the ZAR and it should be remembered
that Turkey spent almost 20% of its FX reserves defending the TRY in 2011 and
has only rebuilt these back up by $5 bln to $80 bln in 2012.

With a number of currencies now threatening to move into negative territory for
2012 (or already down sharply in the case of the BRL), we have reached the point
at which FX returns are starting to reduce local currency bond returns. This
category of credit never truly recovered from the mauling it received in 2011,
with new flows solidly favoring USD bonds so far this year. The danger is that
a further round of losses will start to create redemption pressure in one of
the most crowded and least liquid trades we have seen in recent years. -
emcurrencies.gif

Over the weekend the PBOC announced a reduction in the Reserve Ratio (RRR)
Requirement to 20%, taking the RRR down to its lowest level since March 2011.
No doubt the decision to lower the RRR was in part a response to a marked
deterioration in Chinese economic data. As we outlined last week, trade data
and Industrial Production have started to decelerate while real estate activity
has started to actually shrink at an alarming rate. Furthermore there is
growing evidence that liquidity, at least at the level of narrow money (M1) is
growing at a very low pace (just over 3%), which is simply insufficient to
fuel the growth rate to which China has become accustomed.

Although dropping the RRR to 20% is a step in the right direction, it is still
only a baby-step, and leaves the RRR 400 bp above its level in 2010 before the
tightening cycle commenced, and 1200 bp above the level in mid 2006. We
therefore doubt whether this latest step will do much to change the direction
of economic activity, which seems likely to deteriorate further before the PBOC
starts to take the sort of radical action that will ultimately be required. In
this sense they are acting no differently to any other central bank facing the
late cycle dilemma of the risks of overheated asset markets on the one hand and
an ugly breakdown of an (over) investment cycle on the other. This puzzle has
proved beyond countless other lauded central banks in the past and we believe
the faith many place in the power of the PBOC to buck this dismal track record
will prove to be misplaced. - chinareserverequirement.gif

Indian Industrial Production for March came in at -3.5% YoY, well below
expectations of 1.7% growth and since March is seasonally one of the most
important month's for this data this is a significant miss. As ever the real
story is in the trend rather than a single report, and this is shown to be one
of rapid deterioration on the attached chart. The trailing 12 month ma of
growth is now 3.0%, down from 8.3% in March 2011 and there is no sign that this
down-trend has been completed. We continue to take a negative view on the
Indian economy, and expect to see further losses recorded in both local asset
prices and currency. - indiaipmarch2012.gif

Several months ago China changed the methodology of its monthly economic data,
reducing the role of local party employees in gathering data and relying more
on direct surveying of corporate activity. This would appear to have led to at
least a partial window onto reality being opened, since China's data now
actually moves from month to month and generates surprises in a manner unseen
in recent years.

Unfortunately, these surprises have generally been negative, and the April batch
of economic data is significantly worse than expectations. Chinese Industrial
Production slowed from 11.9% YoY to 9.3%, the slowest growth since May 2009 and
well below expectations of 12.2%. Retail Sales and Fixed Asset Investment also
lagged, but by statistically insignificant amounts. In the case of the latter,
the story is not so much the current level, which at 20.2% is still remarkably
high, but the fact that this growth rate has started to fall sharply in recent
months, dropping 4.8% since April 2011.

The poorest data released this morning came from the beleaguered real estate
sector. This is the one portion of the Chinese economy, which is now actually
shrinking, with April Residential RE sales down -14.9% from April 2011. As the
attached chart shows this is the 3rd consecutive monthly sales decline and
there is no sign that this string will be broken anytime soon. Meanwhile
massive amounts Residential Construction is edging towards completion. April
saw a 30.1% increase in the area of Residential real estate completed, much of
which will now inevitably fight for the diminishing number of buyers. We would
expect to see a sharp increase in the amount of unsold and vacant units in
China from this point on in the cycle, and growing evidence that this is
weighing on prices. We would also expect to see a sharp slowdown in the pace of
new projects, which should feed into other Chinese economic metrics (and more
importantly ACTUAL demand for industrial commodities) later in 2012. -
D-CNRSACMY_Index.gif -

China released a large amount of monetary and economic data last night and due
to the complexity of the material, we will divide our comments into two separate
notes, the first surrounding monetary conditions and the second looking at the
economic data, which has started to suggest an abrupt deceleration is underway.

April's report of money supply and loans suggest that local monetary conditions
remain very tight (at least when measured against recent Chinese norms). Both
M1 and M2 shrank during April. In M2's case this is only the 3rd time this has
happened since October 2004, and even though some of this can be attributed to
a reaction to the March surge in lending it is a clear signal that liquidity is
tightening. April's -0.67% decline in M2 takes the YoY index down to 12.80%,
and we expect to see this measure push lower in the coming months. Narrow
money, measured by M1 continues to be much tighter. This shrank by 1.08% in
April, the 4th monthly decline since July 2011. On an annual basis M1 is
growing by 3.10%, a growth rate which is substantially less than nominal growth
in the Chinese economy and lags even the official CPI rate of 3.40%. It should
be noted that M1 has been under pressure for several months, with the 6 month
ma of annual growth now a mere 5.10% and the 12 month ma 8.03%. Neither of
these is sufficient to allow M1 to keep pace with actual economic activity.

It should further be noted that loan growth remains brisk, with a total of
681.8 bln CNY issued in April and although this was below expectations of 780
bln CNY, it is in line with the trailing 6 month ma. What has happened is that
the cumulative effect of the spurt in growth brought on by China's period of
"monetary madness" means that a level of loan issuance sufficient to power
activity and keep liquidity buoyant 2 years ago now lags the dual requirement
of the Chinese economy. As we mentioned yesterday when discussing China's trade
data, it is the law of large numbers which seems to be China's biggest issue
today, and this normally requires a period of painful retrenchment and
adjustment once it comes into play. - D-CNMS1YOY_Index.gif -

In response to the sharp weakening of the INR (which reached a record closing
low on Wednesday), the RBI today introduced a new measure reducing the maximum
amount of "foreign income" that an exporter can hold from 100% down to 50%.
(see link http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=7196&Mode=0)

This follows a measure taken in late 2011, which restricted the use of
derivatives by exporters to hedge currency exposure (a move which has merely
served to increase currency risk for the Indian corporate sector). Although not
as draconian as the measures taken by Argentina in late 2011 forcing
repatriation of foreign deposits, this is an unwelcome reminder of the fact
that India never made a full transition towards an open capital system. Indeed
that attached release specifically points out that :

"This facility is not intended to enable exchange earners to maintain assets
in foreign currency, as India is still not fully convertible on Capital
Account. Accordingly, EEFC account holders henceforth will be permitted to
access the forex market for purchasing foreign exchange only after utilising
fully the available balances in the EEFC accounts. ADs may, accordingly,
obtain a declaration while selling foreign exchange to their constituents"

Although the immediate effect of this measure has been to spark a small rally
in the INR, we believe that the increase of FX risk for the corporate sector is
likely to undermine the benefit to the currency. Any further fall in local
equity valuations is likely to put great pressure on foreign holders (already
down over 28% over the last 12 months in USD terms) to divest their holdings,
with a predictable effect on the value of both the SENSEX index and the INR. -
sensexinrrbirepo.gif

China Trade Data continues to suggest that a substantial deceleration in this
portion of the economy has taken place in recent months. Total Exports were
$163.3 bln, a rise of 4.89% over April 2011. This compares to expectations of
an 8.5% rise. Import growth was even more sluggish at 0.3%, well below
expectations of a 10.9% boost. This import lag led to a larger than expected
trade surplus of $18.43 bln, almost twice the anticipated level. However, as
the attached chart shows this is still a relatively "normal" level for the
trade surplus in any given month.

Trade data is one of the most volatile monthly series that we monitor,
therefore we are more focused on the trend than any particular monthly series.
As the attached chart of imports and exports show there is a clear trend of
deceleration in place over several months, but not yet a fall back into
negative territory. There is also little evidence that this is being driven by
"rebalancing" in the internal Chinese economy, or a collapse of demand
elsewhere (export growth is still positive). The likeliest explanation is that
Chinese trade is banging its head against "the law of large numbers", with the
surge of Chinese trade over the last decade simply unsustainable over the
longer term even in a healthy global economy.

The danger now is that investments in trade infrastructure (such as ports,
railways, shipping) have been made under the assumption that high double digit
growth was visible over the horizon, leading to substantial over-capacity in this
portion of the economy. - D-CNFREXP$_Index.gif - chinatradebalance.gif

It is becoming increasingly likely that a number of emerging market currencies
and equity markets have entered a new corrective phase in what we believe is a
multi-year bear market that started in late 2010.

One distinct change in the current move compared to that of 2011 is that a
number of EM currencies have exhibited weakness in advance of local equity
markets breaking support. We suspect this is due to a combination of lower
provision of liquidity from European lenders and also a substantial supply of
local currency denominated fixed income issues that finally overwhelmed the
massive appetite shown by global investors. Indeed it is notable that EM
currency weakness has been led this year by the BRL (light green on currency
chart), which up until very recently was at the top of everybody's shopping
list, but closed yesterday within 1% of its 2011 low of 1.955.

Going back to the start of 2011 the weakest EM currency we track is still the
ZAR (olive), which is down 21% over this period. The INR (black) seems likely to
take this mantle and also to reach a new all time low. The TRY (purple) has
thus far been somewhat more stable in 2012 than 2011, but we would expect it to
fully participate in any broad correction. Other Eastern European and
Mediterranean currencies have done better (we include the HUF, PLN and ILS),
which is a reflection of the fact that they have somewhat different flows. The
one standout is the RUB (dark blue), which has not lost any value since the
start of 2011. This is no doubt a function of very positive energy revenues,
which would come under pressure if commodity prices follow EM equities lower.

The effect of sharply weaker currencies can be seen on the MSCI EM Index (which
is USD based). This morning saw the e-mini future based on this index (Bloomberg ticker: 
MES1 Comdty) break its remaining support at the 200 day ma (see chart) taking the
future back into the middle of the 2011 corrective range. Interestingly, there
is little evidence that an EM sell-off has been anticipated. Short interest in
the widely traded EEM ETF was a mere 6% of shares outstanding at 53mm shares,
well below the levels seen at market bottoms. With most market commentary
focussing on Europe we maintain that it is the EM complex that poses the
greatest risk to the average global portfolio at the current time. -
W-..EEMSI_Index.gif - D-MES1_Comdty.gif - - emcurrencies.gif

With recent US employment data missing consensus estimates, today's publication
of the monthly JOLTS (Job Opening and Labor Turnover) index for March gives
some useful comfort that there is a strong trend in place for a recovery in US
employment.

March saw the Total JOLT index rise to 3,737K openings, the largest number
since July 2008. More importantly (given the underlying volatility of single
monthly reports) the trailing 12 month ma shows a strong trend of improvement,
rising to 3362K (up from 2945K in March 2011). This month's data estimates that
548K more openings are present than a year ago, an increase of 17% and the 
current number of openings is similar to that of early 2005.

Interestingly, Manufacturing openings have recovered somewhat quicker than the
overall statistic. March saw a spike in Manufacturing openings of 55K (20.3%)
from February, which took the total up to 326K, the highest since November 2007.
Although we would expect to see some "give back" in April (when the seasonal
adjustment will be much less favorable) both the overall and Manufacturing
indexes paint a picture of steadily increasing demand for US labor.

We have been calling gold's chart "not bullish" for a number of weeks and have
highlighted the importance of the metal remaining above the $1,600 level. As
can be seen, this morning's decline has taken gold right down to this level, a
breach of which would indicate a retest of the December 2011 low. We remind
readers that gold has not had a single down year since 2000 (it is highly
unusual even in the strongest bull market to have 11 consecutive winning years)
and our bet would be that 2012 sees the end of this run with $1,563 being the
starting point for 2012.

Interestingly gold equities have already anticipated sharply lower gold
prices.The XAU index traded down below the 150 level this morning for the first
time since February 2010 (when gold was around $1,100) and is now down almost
17% for 2012 and over 25% since May 2011. Gold equities remain strongly favored
by global investors (including a number of prominent hedge funds) as the
correct way to hedge against monetary debasement. We have argued many times
that the logic behind this trade is far from flawless, and the recent
performance of gold equities will have put great pressure on investors to
reconsider their stance.

We had warned that a breach of the 17,000 support level by the SENSEX index
would be likely to be followed by sharp losses. In the event the original
breach on Friday was reversed on Monday by twin policy back-tracks. The
unpopular gold jewelry levy was repealed and the proposed implementation of the
GAAR tax avoidance legislation was pushed back to April 2013. This allowed the
market to bounce strongly and recover a portion of Friday's losses, but not to
regain the key 17,000 level.

Tuesday's session then saw a more considered response. As welcome as the
push-back of the intrusive GAAR legislation may be, it once again highlights
the impotence of the current administration to legislate effectively. With a
growing budget deficit already undermining confidence in the rupee the
inability to tighten fiscal policy sends a worrying message. Similarly the gold
levy may or may not have been "fair" but it represented an attempt to address
the massive trade deficit that is fueled in part by large imports of precious
metals.

As selling pressure increased, the SENSEX fell by 2.17% to 16,546, its lowest
level since January 18th. Although this still keeps the index up 7.06% for the
year, the vast majority of 2012 purchases are now underwater. As can be seen,
net YTD inflows are still $8.9 bln, but were only $1.4 bln on January 18th and the
danger remains that foreign flows will now start to turn negative dragging the
index lower. We mark current support at 16,500 (where the index bounced this
morning), while resistance at 17,000 should be fierce. A breach of support would
open the way for the index to retest the 2011 low at 15,135, although there
should be considerable support in a range between that level and 16,000.

Interview on Bloomberg TV Monday, May 7th. Focuses on Emerging Markets and
Energy. Web-link for non-terminal users below.

http://www.bloomberg.com/video/92162715/

US Consumer Credit posted a much larger than expected gain of $21.35 bln
(consensus $9.8 bln), while February's data was revised up from a gain of $8.735
to $9.267 bln. This is the largest gain since November 2001 and is not the
first very strong report that we have seen in recent months.

Although we welcome any data which supports our belief in the fundamental
strength of the US consumer, it should be understood that a difference of $12
bln is quite small when compared to an overall $2,500 bln of outstanding
credit and the fact that the data is seasonally adjusted also tempers our
excitement. What is more interesting is the fact that there has been a sharp
change in the trend over the last 2 years. In mid 2010, outstanding credit was
falling by around 5% per annum, in mid 2011 it was roughly flat and now is
growing at just over 5% per annum. We doubt that this pace of improvement will
be sustained, but it does seem conceivable that credit growth of around 7.5%
could be achieved given that outstanding credit shrank substantially from
2008-11.

Thus far, essentially all the improvement has taken place in the "non-revolving"
portion of consumer credit. This is dominated by the student loans (which we
view to be largely unproductive) and automobile loans, and has surged to a new
high of $1,739 bln, up 6.75% over the prior 12 months. Retail credit and credit
cards are covered by the "revolving" credit series. Here growth is a much more
modest 1.36% over the prior 12 months, while the annual drawdown reached over
10% in 2010. Total outstanding revolving credit is still around $170 bln (over
17%) less than in 2008, meaning that there is still plenty of room for
consumers to "lever up" in the coming months.

Brazilian Car Sales for April 2012 fell a little more than 10% from their level
of April 2011, keeping in place a trend where sales have fallen YoY in 6 out of
the last 7 months. As can be seen on the attached chart, this has caused the 12
month ma to roll over, although at 299,600 it is still less than 3% below the
record level of 308K recorded in September 2011.

It is interesting to note that most of the recent deterioration of credit
performance has been in the automobile loan sector, which would suggest that
consumers were stretching their finances to the limit during the surge of sales
in 2010 and early 2011. The danger is that 2012 will witness something of a
hangover effect, with sales trending lower over the coming months. -
M-BZVLTLVH_Index.gif -

The ever treacherous Non-Farm Payroll report came in well below expectations
for April, although any disappointment was tempered by sharp upwards revisions
to the March data and an increasing understanding that seasonal adjustments
have been unreasonably unkind to April data (even Chairman Bernanke has started
to recognize this issue in recent comments).

Regarding the reported data, Total Payroll grew by 115K vs. 160K consensus,
while March was revised up from 120K to 154K. Private Sector Payroll looked
similar with gains of 130K vs. 165K consensus and a upward revision for March
from 121K to 166K. This keeps the trailing 12 month ma of Private Sector gains
(see chart) at 169K, which is in line with the data in both 2004 and 1993.
Manufacturing jobs grew by 16K vs 20K consensus with March's data revised up to
41K from 37K. This keeps the 12 month ma at 19K, which is the fastest pace of
growth since 1997. Finally the Unemployment rate fell again to 8.1%, which may
be the number that the general news media leads with. We would hope to see the
Payroll data revised higher in subsequent reports but overall see no great
surprise in the fact that April's data missed consensus given the erratic
nature of this series. - manufacturingpayroll.gif - nfpprivatesector.gif

Since February the SENSEX index has bounced off strong support at the 17,000
level several times. As a general rule, multiple tests are eventually followed by a
breach of some magnitude and support finally gave way this morning with the
index closing at 16,831, its lowest level since January 30th.

While the equity market had been holding support, the Indian Rupee (INR) had
been skidding to ever lower levels and this morning marked a new closing low of
53.86, just exceeding the prior record set in late 2011. The danger is that the
decline in the currency starts to destroy the confidence of foreign investors
in the local equity and fixed income markets, which has thus far stayed intact
(although April did see small net redemptions from equity investors).

All this follows the long awaited cut in the RBI Repo Cut-off yield made last
month. As we commented at the time, the initial stages of monetary loosening
tend to be quite destructive for investors, and thus far India has proved to be
no exception to this rule. - indiasensexinr.gif

Brazil's March Industrial Production posted another disappointing set of data
with the seasonally adjusted data falling -0.5% versus consensus of +1.2%. This
takes the annual change of the NSA data down to -2%, versus expectations of
1.2% growth. From our perspective, the key is not this month's data in
isolation, but the fact that it is the latest in a chain of poor data that
really suggests little or no growth in Brazil's Industrial sector has taken
place for several quarters.

We suspect that the overpriced local currency had at least something to do with
this slowdown of activity (although we would not ignore increasingly expensive
local labor and intrusive government policy). As we commented yesterday, the BRL
looks to be in the process of adjusting substantially lower and following the
release of IP data briefly broke above 1.93. The 2011 high was 1.955 and it
would seem that this level is likely to be exceeded in the near term. -
brazilipmar2012.gif

We are currently in the middle of "PMI Season" with a vast number of new
indexes attempting to measure global activity on a monthly basis. Most of these
surveys are simply too new to be relied upon (we would want to track their
performance across a full cycle to understand their sensitivity to changing
conditions).

One series with some pedigree is that produced by Australia Industry Group
(AiG), which has been around for almost a decade, giving us some confidence in
its utility. Attached is a chart showing the AiG Service Industry Index, which
slumped to 39.6 in April, the lowest reading in almost 3 years. Of particular
concern is the fact that the Sales sub index led the decline, falling to 33.8,
the third lowest reading ever recorded and only just above the nadir of
February and March 2009.

Even if we allow for the probable distortion of seasonal adjustments and error
sampling April's data is bad enough to suggest that Australia's service economy
(which would include RE sales) has started to slow down appreciably. This helps
explain the surprisingly steep rate cut of 50 bp announced by the RBA earlier
this week. Given the deterioration of service PMI we doubt that this is the
last cut we will see in 2012, making the AUD yet another high yielding currency
whose fundamental allure is under threat. - australiaservicepmi.gif

As most readers will recall the SNB forcefully defended the Swiss Franc/Euro
exchange rate last summer to prevent safe haven flows from causing any further
appreciation in the SFR. This policy required substantial selling of the SFR
which inevitably led to an increase in local liquidity, as did the safe haven
flows themselves.

Evidence is starting to mount that this liquidity, together with the remarkably
low rates of interest in a reasonably healthy economy, are starting to ignite a
local housing boom. Attached is a chart of the UBS Swiss Bubble index, which
uses 6 measures of the housing market:

The relationship between purchase and rental prices, the relationship between
house prices and household income, the relationship between house prices and
inflation,the relationship between mortgage debt and income, the relationship
between construction and gross domestic product and the proportion of credit
applications for residential income property by UBS clients.

Q1 2012 saw this index rise to 0.95, the highest reading in almost 20 years and
on the verge of "Risk" territory, which starts at 1.00. Based on the last time
the index forced its way into Risk territory in the 1980s, it could still be
several quarters before the local market surges to a peak, but there are
already clear signs of unhealthy excess. This will come as uncomfortable news
to the SNB, which finds itself boxed into a corner by last summer's policy and
the continued strong safe haven bid for local bonds. It would seem that the SNB
is likely to succumb to the allure of a local asset boom (with its attendant
risk of bust) rather than reverse last summer's policy. - ubsbubbleindex.gif

It is now 2 weeks since Brazil's benchmark SELIC rate was cut to 9.00% and as
can be seen on the attached chart, this move seems to have put the BRL under
much more pressure than most observers expected. Today's decline took the spot
rate to 1.924, the lowest value since September 2011, and the currency is now
only approximately 1% away from breaking last year's low-point.

Thus far the local equity market has managed to respect support around the
61,000, but as the attached chart shows the currency and local equity market
typically move with each other. Should the currency continue its decline and
break to a new 3 year low we would expect to see some further disturbance in
the local equity market. We would also be concerned that currency losses start
to eat away at the confidence of investors in Brazil's local currency debt,
with widening spreads effectively neutralizing the easing attempted by the
central bank for many local borrowers. As we stated at the time the SELIC was
cut, we have reached the point at which monetary easing no longer feeds bullish
sentiment in local financial assets. - brlibovselic.gif

Following the release of strong ISM Manufacturing data, the decent April US car
sales report suggests that this sector will remain in decent shape for a while
longer. Total sales were 14.38 mm, in line with expectations. This takes the
trailing 12 month ma up to 13.22mm, exactly where it stood in December 2008.
Over the last year total sales have risen by 1.24mm units or just over 9%.
Readers should note this is over double the pace of Nominal GDP growth,
underlining our point in today's earlier note on the ISM report.

In addition to more cars being sold, anecdotal reports suggest that discounts
and incentives have been cut back in recent months. There is also a growing
emphasis on more aspirational vehicles, not only at the higher end but also in
the mid-range where Chrysler's flashy 300 model has proved to be the great
success story of the current cycle. This reflects our view in retail as a whole
that we are witnessing not just an up-tick in activity, but something of a shift
in taste back towards colors and styles that reflect a sense of optimism and
well being. We are increasingly convinced that we may be witnessing the start
of a significant "replacement cycle" in everyday goods, with changes in fashion
proving to be every bit as important a driver as the wear and tear of existing
items. - uscarsales.gif

Since we are on a short trip to England (where our sense is that despite the
statistical double dip, things seem to have recovered nicely in recent months)
we have been following both the market and economic releases at a distance.

As all readers will be aware the April ISM Manufacturing Index was a strong
report across the board and while the nominal readings of this index are
somewhat lower than the heady days of 2010, the cumulative effect of 3 years
of persistent positive readings suggests that a really solid recovery has taken
hold in this portion of the economy.

Not that you would know this from nominal GDP, which displays a puny growth
rate of 4%. As the attached chart shows the breakdown of the relationship
between ISM data and GDP is something of a historical anomaly, leaving us with
a straightforward decision of which data series to trust. Our rule is to prefer
the simplest, most direct route to the actual generation of economic activity,
and while the ISM Manufacturing report may be narrow in its scope, it has
consistently shown its value over multiple cycles.

Furthermore, the fact that even the BLS estimates show that Manufacturing
employment has enjoyed its strongest 12 months since 1997 suggests that the ISM
reports have some basis in reality, as do corporate earnings which are posed to
once more surprise to the upside, as they have every quarter since the ISM
broke above 50 in 2009. Our view remains that those relying on the GDP reports
for their view of the US economy are getting a misleadingly depressed view of
the true growth rate of significant portions of the economy. -
ismgdpapril2012.gif