Following last month's dip below 50, the August ISM manufacturing report, which
is due to be released tomorrow will come under even more scrutiny than usual.
This morning has seen the release of a couple of regional surveys. The
Milwaukee NAPM, which came in at a very weak 46.7 compared to 60.2 last month,
but this has historically been a very volatile report with little predictive
ability for the national number (last month's strong Milwaukee number was not
reflected nationally and may itself have led to a surprisingly weak reaction in
July's report).

A more useful report came out from the Chicago PMI, a private sector survey of
local purchasing managers. This rose slightly to 53.7 from 52.9 last month,
edging above expectations of 52.5. While we would not make much of this modest
beat the July report does keep this measure comfortably in expansion territory,
and all seven sub-indexes came in above 50. New Orders (red) were 52.9,
Production (blue) 54.5, Inventories (olive) 52.6 and Employment (pink) 53.3. A
repeat of this data (or something close to it tomorrow) would be well received
by the market. Of course there is no guarantee that a decent Chicago PMI report
will be indicative of a strong ISM number since the surveys are conducted by
different organizations with a regional vs a national sample.

One fact which may help the headline report, is the potential for a strong
rebound in the Prices Paid sub-index. This hit a very low reading of 37 last
month, since which time a strong rebound in many commodity input prices will
have taken place. We would therefore expect to see a number somewhere north of
50 for Prices Paid, which would help the overall index hold up in value. -
chicagopmi.gif

As was expected by most observers, the RBI elected to keep India's Repo cut-off
rate at 8.00% last night, where it has been since April's rate cut. This keeps
the cost of funding at a historically high level despite clear signs of an
industrial slowdown, signalling the RBI's concerns that inflationary pressures
remain significant for the Indian economy. Central to these concerns is the
very poor performance by the INR in recent months, which remained at 55.66 this
morning, uncomfortably close to the record USD cross of 57.33 recorded on June
22nd.

As the attached chart shows, although interest rates and the reserve requirement
have remained unchanged for several months, there has been a modest improvement
to the overall level of liquidity. The daily infusion of liquidity by the RBI
has averaged 750 bln INR over the last 50 days, about half the record required
in late March (when the fiscal year end maximized cash hoarding by
corporations). The 3 month interbank lending rate has also closed some of its
gap to the Repo rate, falling about 75 bp to 9.24% over the last 3 months.

This is still means that liquidity is at a premium, but perhaps not as scarce as
it was a few months ago. This is largely due to some of the regulatory changes
encouraging repatriation of exporters cash balances and also the persistent
inflows into Indian debt and equity markets (the latter are at a record $10.85
bln for the first 7 months of 2012). On the other hand, the level of interest
rates remain punitive for Indian borrowers, and one of the reasons why
liquidity has improved in recent weeks is that the demand for credit has
started to be choked off. This is likely to be reflected in further
disappointing economic data and corporate earnings later in 2012. -
D-RBICRR_Index.gif -

The China Business Cycle Indicator is a measure developed jointly by the
National Bureau of Statistics and Goldman Sachs. Unlike many Chinese economic
statistics, this index has both a reasonably long history (the data starts in
1991) and has fluctuated with credible regularity over its period of existence.
This makes it one of the few "large number" statistics worth following, at
least as a rough guide for the direction of economic growth.

As the attached chart shows June witnessed another decline by the index which
fell 2.98 points to 84.70, the lowest reading since June 2009. This takes the
index right to the boundary of where "Cold Conditions" are indicated (83.3) and
given that the index has fallen by 28.60 points over the last 12 months it
seems likely that "Cold Conditions" will be indicated later this summer.

Although investors may be correct in taking comfort from the strong words
issued by ECB President Draghi, the slowing of the Chinese economy has always
struck us as a far more direct threat to the average global portfolio than the
longer term fate of the Spanish or Italian sovereign credits. The former danger
has not lessened to any degree in recent days, and seems likely to remain a
potential cause of disruption for markets in the weeks ahead. -
chinabusinesscyclejun12.gif

An interesting article that discusses the possibility of the FRB cutting
interest on excess reserves (IOER). We included a discussion of this potential
policy shift in the last Weekly Speculator. At present the 2 year T-note yields
23.5 bp, and the 5 year T-note 65 bp. Should the FRB follow this course and
remove the 25 bp currently paid on reserves then we would expect a substantial
migration of capital into short term treasury instruments pulling the front end
of the curve even lower.

One big difference between this outcome and that of the ECB would be that the
switching of reserves into T-notes would cause a substantial shrinkage of the
FRB's balance sheet (under the ECB's program Euro-treasuries are simply put up
as collateral for new ECB loans keeping the ECB's balance sheet effectively
unchanged whereas in the case of the FRB reserves switched into treasuries
would simply disappear from the FRB balance sheet). Whether this would actually
represent a reduction of financial liquidity is open to question, given that
several hundred billion dollars of excess reserves would probably remain in
place, but it would cause a shrinkage of the monetary base and cause some havoc
in the measurement of money supply and the velocity of money.

We have a hard time understanding the actual benefit of changing the IOER,
which to our eyes would cause a disruption in short term funding markets out of
all proportion to the economic benefit. However, the FOMC, under pressure to
appear relevant and in control of events may beg to differ, and this week's
meeting will therefore be more interesting to follow than those of the last few
months.

Although the headlines will reflect the fact that Pending Sales dropped -1.4%
compared to expectations of a 0.1% rise, the June Pending Home Sales report is a
generally encouraging set of data. As the attached chart shows, a deviation of
1.5% is meaningless given the underlying monthly volatility of the data and all
that really matters is that there remains a strong trend in place of improving
sales. At the current level, these have reached the state of the housing market
at the start of 2001, which at the time was treated as a normal but unexciting
market (of course New Home Sales remain far more depressed). Including this
month's data the 12 month trailing ma has risen to 95.2, approximating its
reading at the end of 2007.

What is not clear in the headline data is the true significance of a decent
sales report in the key spring selling season. The NSA data makes this clear
and June Pending Sales before seasonal adjustments were 117.8 (down from 117.9
in May). As can be seen on the attached chart, this has been the best spring
selling season since 2007 and the volume of homes sold would appear to have
made a significant dent in the inventory levels in a number of metropolitan
areas. With the 30 year mortgage rate falling to yet another all time low and
employment steady (at worst) we would expect to see further improvement in the
volume of home sales going forwards. - pendingsalesnsa.gif -
pendinghomesales.gif

Brazil's loan data for June suggests that the Private Sector banks have started
to rein back credit granting, but that State controlled institutions continue to
lend at an aggressive rate. Overall Outstanding Credit grew 1.46% in June to
2167 bln BRL, an increase of 17.8% over the last year. Private Sector credit
grew by a more modest 6.77 bln BRL (0.57%) and has grown by 11.3% over the last
year. Over the last 6 months Private Sector credit growth has been 3.85%,
suggesting an annual growth rate below 8% for 2012 as a whole. As the attached
chart shows, the percentage of total credit granted by Private Sector banks has
fallen significantly in 2012 and we would expect this trend to continue going
forwards, with the Private Sector looking to pull back from the increasingly
damaged consumer and automobile loan markets. Housing remains the one area
which maintains a torrid growth rate, with loans increasing by 2.82% in June
and 40.6% over the last year.

The increased reliance on State controlled banks should be viewed as a form of
closet stimulus but it should be understood that it cannot be assumed that the
credit granting will be made to the same borrowers as would have been the case
with Private Sector credit. We would also be concerned that by extending credit
at a time when Private Sector banks are pulling back, underwriting standards are
being compromised, with obvious negative consequences as loans season.

June also saw a modest pullback in Loan Default rates, with Personal Defaults
falling back to 7.8% (from 7.9%) and Delinquency (loans 15-90 days late)
dropping from 7.6% to 7.4%. Although this will no doubt be seized upon as
evidence of the much expected improvement in defaults for the remainder of 2012,
we would caution that it is hardly unusual for the default rate to bounce
around from month to month. There is still a powerful uptrend in the default
rate in place and it would take several months of significantly better data to
reverse this state of affairs. - D-BZLNTOTA_Index.gif - brazilloandefault.gif

It is starting to look as if the worsening of Initial Claims data a few weeks
ago was indeed a repeat of the last 3 years' seasonal pattern rather than a
genuine worsening of the employment situation in the US. July has seen a marked
improvement in the data, although as the BLS cautions, auto related layoffs make
estimating underlying claims unusually difficult at this time of year.

In any event this week's data showed Claims falling to 353K, well below
estimates of 380K. This took the 4 week ma down to 367.3K, its lowest level
since April 6th and the 2nd lowest reading since the employment recovery
started 3 years ago. Based on the experience of the last 2 years, we would
expect to see Claims push back up a little in August, but to remain well below
the key 400K level. The really interesting period comes after Labor Day when
seasonal adjustments start to turn rapidly in favor of the headline data.
Between now and then we would be happy enough to continue to tread water with
Claims consistently 30-40K below their weekly equivalent level of 2011.
Interestingly, the more widely followed non-farm payroll data does not mirror
this improvement in data. This could be explained by Claims only measuring
corporate firings while non-farm data also encompasses hiring, but it is also a
reminder that there is a completely different methodology behind the two sets
of data. It is in no way clear that non-farm payroll data is more accurate (in
fact we prefer Claims data) but it is certainly much more influential in terms
of changing market sentiment. - W-INJCJC4_Index.gif -

Census Bureau estimates for New Home sales for June 2012 were 350K, below
consensus expectations of 372K. Although this miss will no doubt cause concern
in the current hyper-reflexive marketplace, the shortfall is not statistically
significant, with the Census Bureau indicating a 90% Confidence that sales were
between 307K and 393K. Furthermore sales for the prior 3 months were revised
higher by a total of 33K (13K in May, 15K in April and 5K in March) and we
would not be surprised to see something similar happen to June's data in
subsequent months (contrary to general belief the Census Bureau does not
collect centralized data on actual sales, instead it follows an arcane survey
method, which includes physical drive-bys of actual housing developments).
Single month NSA sales were estimated at 33K, which is in line with the
headline data and keeps sales just below the trailing 60 month ma.

From our perspective it is hard to tally the sudden surge in the NAHB
Homebuilder Confidence Survey this month with a flat to down sales report.
While Homebuilder Confidence in a deteriorating market often stays too high for
too long (as it did in 2006 and 2007), this survey remained rooted in depression
territory until bursting out in the spring selling season. This really suggests
rather more improvement has been noted by actual homebuilders than the Census
Bureau statisticians that are charged with estimating their activity. In the
end, much will be revealed by the actual earnings of the public homebuilders but
in the meantime the official data will curb the recent burst of enthusiasm
surrounding the homebuilding sector.

Other data included in the report showed inventory at 144K, with only 41K of
these being completed homes, a record low and 20K below the level of a year ago
(see attached chart). This is interesting since although total inventory has
stopped declining it is now dominated by unstarted and partially completed
homes, with the number of "ready to occupy" properties only enough to cover
about 6 weeks worth of sales. This represents an extremely tight supply and it
suggests that builders have not yet really started to respond to the
improvement of sales that has taken place in recent months. -
D-NHSLTOT_Index.gif - D-HSMNTOT_Index.gif - completedhomesforsale.gif

Since Japan helpfully splits its overall export data into large regional blocks
it is possible to use its monthly trade data as a rough guide to demand in the
US, China and the EU. We would caution that trade data is very volatile on a
monthly basis and also can be greatly distorted by sharp shifts in currency
cross rates (as is currently the case with the ¥/€ cross). Allowing for these
deficiencies, June's data would suggest that the US demand for Japanese goods
remains in a steady recovery (underpinned by a recovery in auto sales) while
both China and Europe show distinct signs of slowing abruptly.

Exports to the US reached ¥989 bln, the highest June reading since 2008 (when
they were ¥1180 bln) and an increase of 15% from 2011. Although this annual
increase is boosted by the effect of last year's earthquake on the June 2011
data, exports to the US remain in a clear trend of improvement. This has taken
them back to the point that they seem likely to overtake exports to China,
which since 2009 has been Japan's biggest export market.

Exports to China in June were ¥1031 bln, a drop of -7.3% from 2011. Over the
last 12 months exports have been an average of -6.6% lower, indicating that a
clear trend of deterioration has been established. This is somewhat worse than
one may expect when looking at Chinese economic data itself.

In the case of exports to the EU these fell dramatically in June to ¥519 bln, a
decline of 21% over the last year. A good portion of this decline can be traced
to moves in the €/¥ cross, which has fallen over 14% since June 2011. This will
have acted to cause Europeans to seek alternative sources for imports while
also reducing JPY receipts for any goods that were already contractually
priced in EUR. It would seem clear that to the extent European demand remained
intact, Japanese exporters would not have been able to pass along a 14% price
increase in the current environment. Even so it would seem clear that European
demand has started to feel the pressure from the long lasting turmoil in
sovereign credit. - japaneuexp.gif - japanexports.gif

It is starting to look as if the slowdown in Brazil's economy is eroding the
tax base for the Federal government. If so, this threatens to place significant
strains on the Federal Deficit given the growing commitment to using "fiscal
stimulus" to attempt to reverse the deterioration of local economic conditions.

Total Federal Revenue for June came in at 81.11 bln BRL, below expectations of
83.9 bln BRL. This is a decline of 1.6 bln BRL (1.96%) from the level of June
2011. The government estimates that the June 2011 figure may have been inflated
by early tax payments to the tune of 5 bln BRL, which if true would keep the
June 2012 level of receipts just above the 2011 level. However, as the attached
chart shows the trailing 12 month ma has now started to decline which suggests
that we are dealing with something more substantial than a reconciliation error.

For obvious reasons Federal Tax receipts tend to be very good real time
indicators of economic activity (provided the level of evasion remains roughly
constant) and the slowdown in the growth of receipts is therefore an important
piece of data. It also suggests the deficit will continue to widen
significantly in the coming months. Over the 12 months through April 30th 2012
it has averaged -7.57 bln per month (including interest payments) and it will
be worth tracking this number quite closely going forwards. -
brazilfedrevenue.gif

In our experience, nothing powers a market's mood more than a metaphor. This is
equally true in bull and bear markets, with a simple phrase acting to channel
the disperse emotions and opinions of a myriad of market participants down a
much more narrow pathway. We are therefore always on the lookout for a new
dominant term in the financial media and commentary.

In recent weeks the term "Fiscal Cliff" has started to pop up with increasing
regularity. Sporadic mentions appeared back in early 2011 and August 2011 (when
13 stories were written in a single week), but it is really only since the start
of April that we have seen a sustained use of this phrase. Thus far, usage has
peaked at 184 stories in the week ending June 22nd but last week this ran very
close at 183 stories. To give a sense of how much attention this represents, we
have included a chart tracking usage of the term "Debt Ceiling". This bounced
along in the 200-400 range for most of the 2nd quarter of 2011 before exploding
to an obsessive peak of 4182 stories in the week ending July 29th 2011. It is
easy to forget that at the time worries regarding the "Debt Ceiling" forced
many investors out of their long dated US treasury holdings, a very poor
decision given the collapse in long term yields from 3.00% a year ago to 1.45%
today.

We would therefore term the usage of "Fiscal Cliff" to be persistent at
present, but hardly dominant. Over the course of the summer though we would
expect to see a great deal more usage as all eyes start to turn towards the US
election and upcoming expiration of tax cuts at the end of the year. We will
therefore monitor usage periodically and report our findings. - fiscalcliff.gif

June's Housing Start and Permit data is another generally encouraging report
from the Homebuilding sector since it shows the Single Family Home industry
starting to recover in the manner that Multi-Family starts managed to do 24
months ago.

Overall Housing starts were 760K slightly above consensus of 745K, while May's
data was revised up by 3K to 711K. Permits were 755K vs 765K consensus and
May's data was revised up by 4K to 784K. None of these variances are
statistically significant.

What is significant, however, is the fact that it was the Single Family Home
portion of the data which really contributed to strength. Annual Single Family
Starts were 539K on a seasonally adjusted basis, the best reading since April
2010 when tax credits boosted sales. Ignoring tax credit periods it is the best
level of starts since October 2008. The Non-Seasonally Adjusted data is perhaps
more encouraging. Monthly NSA Starts for May totaled 55.40K, which is the
strongest monthly starts since July 2008. This really is the number that
matters as far as the nominal level of activity is concerned (and homebuilder
revenues) and the fact that we have had strong seasonally adjusted data in the
key spring selling (rather than the dormant winter) season is very encouraging.

Permit data showed a similar tale. Total Permits only missed because of a large
dip in the Multi-Family series from 294K to 262K (Multi-Family data is very
volatile month to month but in a solidly improving trend). Single Family
Permits rose to 493K. Excluding tax credit periods this is the highest level
since September 2008 and takes the data very close to the trailing 60 month ma
(507K), which we have been using as a "confirmation level" for the breakout in
activity. - D-THUNSNUT_Index.gif - M-NHSPATOT_Index.gif - M-NHSPA1_Index.gif -
D-NHSPSTOT_Index.gif -

China's Property Price indexes for June continued to show a broad deceleration
of house prices in the YoY data but on a monthly basis June's data was stronger
than we have seen for several months.

On a Yearly basis the number of cities with rising prices for New Apartments
fell to 11, a new low reading, while the number of Decreasing markets hit a new
high at 57. This generates a new record negative spread of -46 more cities with
Falling rather than Rising prices. The Monthly data showed 25 cities with
Rising prices, 21 with Falling prices and 24 Unchanged. While this may appear
encouraging price fluctuation in a longer term decline is hardly unusual and we
doubt anything significant is indicated by this data.

The Existing Apartment data showed 12 cities with Rising prices (up from 11
last month) and 58 with Falling prices. Monthly data was again strong with 31
cities seeing Rising prices and 19 with Falling prices (compared to 18 Rising
and 30 Falling last month). As we note above, this change in the Monthly is
interesting but not unusual and in our experience housing slowdowns that have
progressed this far do not simply turn on a dime when interest rates are
trimmed by a moderate degree. - D-.CHREPINC_Index.gif - D-.CHEPINC_Index.gif -

July's NAHB Survey is an excellent report that fully justifies the robust
performance of the Homebuilding sector in recent months. The Overall index rose
to 35, its highest reading since March 2007 at the time that the first
sub-prime lenders started to implode. Present sales reached 37, the highest
level since February 2007. Future Sales were even stronger at 44, the best
reading since April 2007 while Traffic reached 29, also the strongest since
February 2007. Our cumulative chart (attached), which simply totals all 4
categories has now broken out and is back to where it was in March 2007. Our
conclusion is simple: after the false dawns of 2010 and 2011, the recovery in
the New Home market that has taken place in 2012 looks like the "real deal".
Given the very depressed level of activity and extreme affordability of new
homes, the pace of initial recovery can be expected to be fairly powerful, with
the main constraint being the availability of permitted land and labor, rather
than actual demand for homes. The record low inventory of New Homes will be a
key factor in this regard and we would expect to see some bottlenecks emerge in
more popular markets during the summer.

It should be noted that this report is completely at odds with the prevailing
mood of economic deterioration, and particularly concerns that the US consumer
has started to retrench. We remain quite positive towards the domestic portion
of our economy, with our concerns being directed elsewhere. - nahbjuly2012.gif

It is commonly assumed that the Spanish economy is under great duress but while
this may be true of the housing and banking industries (with obvious
repercussions for local demand) there have been persistent signs in recent
months that Spain's exporters have been enjoying far better conditions.

May's trade data continued this trend with the Spanish Trade Balance narrowing
to -€1.925 bln, the second lowest reading since 1992 (the lowest was July
2011). This takes the trailing 12 month ma up to -€3.511 bln, the narrowest
deficit since December 2002. Although most people would assume this has been
caused by a collapse in Imports the data shows these to be only moderately
lower in recent months with May's data at €21.39 bln, down 1.6% YoY. Exports on
the other hand rose 6.2% to €19.46, a new record for May. This strong export
performance probably represents a forced reallocation of resources away from
the depressed domestic market but it does also hint at sustained demand in
Spain's main export markets, 65% of which are in the EU. - spainexports.gif -
spaintradebalance.gif

China's FDI for June showed a -6.9% drop from the level of a year ago. This is
the 7th month out of the last 8 in which FDI has fallen on a YoY basis and the
trailing 12 month of this metric has now slipped to 0.86% (down from 18.18% in
June 2011) and would seem likely to push into negative territory in the next
couple of months.

It would seem clear that at the very least FDI has ceased expansion and given
the frenetic pace of growth in 2007/8 and mid 2009 to mid 2011 it is quite
likely that FDI will take a substantial step backwards as China's economic
problems start to temper the appetite for further involvement. Once more we
note commentary suggesting that a loosening of regulatory constraints can
reverse the deteriorating trend in FDI. Although there is clearly much China
could do to make its country a more inviting destination for capital
(respecting intellectual property rights would be a good start) we believe that
the decline in FDI has much more to do with the maturation and decline of the
business cycle. Given the likely disappointed returns generated on much of the
FDI committed in recent years it may well be that 2011 marked an important
cyclical peak in FDI that will take a significant period of time to be
surpassed. - chinafdijune2012.gif

We are currently in the midst of a US data-drawdown of considerable magnitude.
Since peaking at above 90 in January, the Citigroup Economic Surprise Index
(CESIUSD) fell into negative territory in late April and has now dropped to
-64. This takes the index down to the sort of area that can be expected to mark
the depths of a data cycle, with bottoms being formed at approximately -70 in
2006, -50 in 2007 and -60 in 2010. Of course the index does sometimes extend
much lower, last year's nadir was -117 and both 2003 and 2004 saw readings
below -100 (all of which proved to be false alarms) while the collapse of 2008
saw the index plunge below -140. As we have noted before, since 2010 US data
has exhibited a strong seasonal bias towards lower readings in the spring and
summer, and higher readings in the fall and winter (see seasonal chart).

Bottoms in the index are typically caused by consensus estimates for the
economy being slashed as much as data improving (the index measures the
difference between data and expectations). It is therefore interesting to note
that this morning's retail sales data seems to have been the final straw for a
number of commentators, with US economic estimates being cut in its aftermath
at a number of Wall Street firms. We may continue to get weak data through the
rest of the June report (although housing should be able to buck the trend) but
it will come as less of a "surprise" to economists and market participants.

Meanwhile, it is interesting to note the relative indifference of the US equity
market to the deterioration in data. As can be seen on the attached chart over
the last 90 days, the CESIUSD index has fallen by over -100 points, while the SPX
index is almost unchanged over this period. This is a significant change from
the much deeper equity market draw-downs of 2010 and 2010. This is in-line with
the prediction we made several weeks ago when data fist started to decline.
Mid-cycle data, even when it disappoints, tends to be much less destructive to
the market's mood than the fragile initial recovery from a recession. Thus the
data-declines of 2004, 2005 and 2006 were inconsequential to the equity market
compared to 2010 and 2011.

Of course all of the above assumes that we are experiencing the regular ebb and
flow of data over a cycle, rather than the start of a genuine deterioration of
economic conditions. This remains our view for the domestic portion of the US
economy, but we are less sanguine about those portions of the economy that have
been reliant on strong growth in foreign markets, which may account for at
least a portion of the recent weakness in data. - cesiusdspx.gif -
cesiusdseasonal.gif

The Census Bureau's estimation of Advanced Retail Sales show Total US Sales
slipping by -0.5% in June to $401.515 bln, compared to estimates of a 0.2% rise
for the month. This is the 3rd consecutive month of declining data. For Q2 2012
the measure has fallen by -4.685 bln (-1.15%) from its March 31st record, which
is the 3rd largest quarterly drop over the last decade (Q3 and Q4 2008 saw
sales plummet by -2.76% and -9.14%). Retail Sales ex-Autos (see chart) were
estimated to have fallen by -0.4% in June compared to consensus expectations of
a flat report. This takes the 12 month ma of sales down to 0.3% for an annual
growth rate of 3.6%.

Were this data to have been preceded by weak reported sales by public retailers
or poor auto sales data this would be a cause of significant concern. In fact
Q2 retail sales reported by the ICSC US Retail Chain Store sales were estimated
to have risen by 1.63% over the quarter and most public retailers have already
reported decent sales data for June (although there were some individual
misses). The number of New Cars sold did drop by -1.89% over the quarter, but
this followed a very strong Q1 when car sales rose by 6.23%. In other words we
are yet to see any "real world" confirmation of the weakness in retail sales
reported by the Census Bureau in recent months and would therefore be very
cautious in following its guide.

Census bureau data in particular has shown great distortion from seasonal
adjustments in recent years. In 2010 Retail Sales ex-autos were estimated to
have fallen in 3 consecutive months between May and July (one of the main
causes of the "double dip mirage") only to then accelerate later in the year.
In 2012's case the very strong Q1 data, when sales were estimated to have risen
by 2.06%, was almost certainly a significant overstatement and at least a
portion of Q2 weakness comes from a reversal of these "phantom sales". What
today's data does do is raise the scrutiny level for retailers reporting
earnings in the coming weeks, although we remain hopeful that this will be an
decent overall quarter for this sector. - retailsalesexautosjun12.gif

As we continue to look into the last 48 hours of Chinese data, one item we would
like to update is the continued surge in FX Deposits held in China. These
increased by 270 bln CNY (7.27%) to 4.05 trln CNY in June taking their annual
increase up to 58%. They now represents about 4.3% of total Chinese deposits,
which is still a small proportion but one which is growing quickly since CNY
deposits increased by a much smaller 12.3% over the last year. This would
suggest that FX deposits are being favored to a considerable degree by those
able to take advantage of them.

Meanwhile the value of the CNY continues to drift lower on the FX market,
reaching 6.379 this morning. The total drop over the year is now just over 1%,
which in itself is a trivial fluctuation, were it not for the fact that the CNY
has been in a strong trend of appreciation since mid 2005 when its value was
pegged at 8.28. Both these data points add to our sense that something
significant has started to change within China, although interpreting the
precise meaning and causes of much of the data remains frustratingly difficult.
- chinafxdeposit.gif

This morning saw the majority of China's monthly "data dump" which makes for a
busy morning parsing statistics. The headlines will be drawn to the Q2 GDP
report which shows GDP expanding by 7.6%. We do not have much specific comment
to add on this particular number, which is even less reliable than GDP reports
in other countries, other than to assume that a deterioration in GDP is a
result of worse economic conditions.

The other "big picture" data shows Industrial Production slipping to 9.5% YoY,
which compares to a growth rate of 15.1% in June 2011. This would seem to be
the heart of the slowdown, but again we would be very careful in interpreting
this broad data, or relying on the headline number. Looking at the official
sub-categories, Power & Heat would seem to be the main culprit, growing 1.7% YoY
in June and 5% YoY cumulative YTD.

Retail sales grew 13.7%, compared to 17.7% in June 2011. Sports and
Recreational products showed the worst growth at 4.2% (6% cumulative YTD),
while Automobile sales grew by 9.1% (note this represents Wholesale not Retail
sales). Fixed Asset investment remains unfeasibly high at 20.4%, down from
25.6% last June.

It would appear that China's slowing growth has started to generate a fiscal
response. Official measures of Government Expenditures show them to have
reached 1272 bln CNY in June, a record for that month and an increase of 17%
YoY. Government revenue was 1104 bln CNY, an increase of 9.8% YoY. This led to
a budget deficit of 168 bln CNY, the largest June deficit on record. We would
expect a slowing economy to eat away at Government revenue and for fiscal
stimulus to be increased, leading to a substantially wider deficit over the
coming quarters. - chinadeficit.gif - chinaipfaretail.gif

China's monetary data for June 2012 shows the initial effects of the monetary
easing undertaken in recent months. Total New Loans were 919.8 bln CNY,
slightly above expectations of 880 bln CNY. This takes the trailing 6 month ma
of New Loans up to 809.17 bln, well above its level of a few months ago.

M2 moved higher to 13.6% YoY growth from 13.2% in May, just above expectations
of 13.5%. M1 grew by 4.7% over the last year, again above expectations of 4.0%
and a distinct improvement from May's 3.5% level. However, this still keeps
narrow money growing well below any expectations for overall growth in the
Chinese economy at at a fraction of the levels seen in the 2009/10 boom (see
chart).

In general we would say that this data shows that the PBOC is capable of
managing the "easy part" of policy response. Banks have been directed to lend
to large government sponsored organizations and have responded by doing so. On
the other hand we very much doubt that liquidity conditions have improved
further down the food chain. Even if it were to do so liquidity itself cannot
reverse the deterioration of an asset cycle that has reached the limits of
activity capable of being absorbed by an economy and started to suffer from a
collapse of demand. That is the problem which the FRB has been grappling with
for the last 5 years and which the PBOC seems about to learn the hard way. -
chinam2loan.gif - chinam1loans.gif

In a move that was widely anticipated by the market, the Central Bank of Brazil
cut the benchmark SELIC rate by 50 bp to a new record low of 8.00%. This very
much fits the pattern of "Phase 2" of a protracted bear market, which is the
period in which the seriousness of the issues are first recognized by observers
and monetary policy starts to shift towards a significant easing.

The only question in our mind is whether sufficient damage has been wrought on
the local equity market to declare this phase to be complete. Our sense is that
this is not yet the case, since we would generally expect the IBOV to trade
below its (Phase 1) low last year. In USD terms this has been accomplished but
this is more due to the collapse of the BRL than the local market. We also have
not yet seen the sort of climactic liquidation that normally would mark an end
to a drawn out period of correction and so we suspect that a little more pain
will have to be endured before this phase has been completed. -
brazilretailsales.gif

Link to minutes:
http://www.federalreserve.gov/monetarypolicy/fomcminutes20120620.htm

The FOMC minutes for the June meeting shows the extent to which monetary policy
in the US is starting to be shifted to the margins. Simply speaking, there is
very little left for the FOMC to accomplish with short to medium term rates
near zero, long term rates at record lows and a banking system now able and
willing to lend funds to both the corporate and consumer sector, and has
roughly $1.5 trillion of spare reserves which can be used for this purpose (see
this morning's Weekly Speculator for a more detailed discussion). Unfortunately
for the FOMC it has undertaken far loftier policy goals and there spends long
days agonizing over how to control portions of the economy that cannot be
directly affected by a change in monetary policy, at least in the short to
medium term.

Brazil's retail sales data is starting to suggest that the deterioration in
local monetary and credit conditions is beginning to have an effect on consumer
activity. Seasonally adjusted sales fell -0.8% from April, well below consensus
expectations of a 0.6% gain. April's data was also nudged lower to 0.7% from
0.8%.

Although this still keeps retail sales growing at an 8.2% rate over the prior
12 months, the drop in May sales is the largest single monthly draw-down since
November 2008. The last steep drop took place in March 2010 when sales dropped
-0.7%, but this could easily be explained by the prior 2 months having
abnormally high growth rates of 3% and 2.4%. In the current case, Brazil's
retail sales growth has been exactly zero over the prior 4 months, the lowest
level for a 4 month period since sales were dropping in late 2008. -
brazilretailsales.gif

It is striking the degree to which Mexico has acted as a "51st state" over the
last 5 years rather than a typical member of the emerging markets complex.
While this hurt Mexico's performance during 2007/8 and the initial phase of
recovery (when the rest of the emerging market complex powered higher and
Mexico was relatively staid), in recent months it has made Mexico a rare beacon
of positive data.

This morning saw publication of April's Capital Investment estimates, together
with Car Sale and Production data for June. The Capital Investment data shows
Mexico to be in the middle of what appears to be a sustainable investment
cycle, with the series reaching 147.55 (Jan 2003 = 100). This is a record for
any April report and the trailing 12 month ma has also recorded a new all time
high of 150.70, while the YoY growth rate of 8.5% is not abnormally high.

One clear reason for this is a strong recovery in domestic vehicle sales
combined with very strong exports (mainly to the recovering US market). June's
domestic vehicle sales reached 78,508, and increase of 10K units (14.8%) over
the last year. This compares to record June sales of 81,400 in 2008. Meanwhile
a surge in exports means that total production reached a new June record of
268K, up 38.6K (16%) over the last year. With plenty of upside potential still
in place for US domestic car sales and Mexico's own internal demand looking
solid, we would expect to see production levels push off to further records in
the coming months. - mexicocarproduction.gif - mexicocarsales.gif -
mexicocaptialinvestment.gif

Brazil's financial system continues to see a deterioration of liquidity
conditions as the poor underwriting practices during the latter portion of the
boom have started to generate substantial losses in credit instruments. The
attached article describes how an uptick in fraudulent loans has led to much
higher default rates in Brazilian ABS. As a result issuance of pools investing
in asset-backed receivables (known as FDIC) have decreased dramatically in
recent months.

Once more, we see an echo to the path taken during the US sub-prime debacle. In
2005 and 2006 there was an explosion of issuance in what were known as SIV's
(Special Investment Vehicles) that packaged short term receivables backed by
low quality mortgage loans into short term securities that qualified as
commercial paper (and were hence eligible assets for money market funds). The
well publicized blow up of a number of these vehicles in late 2006 and early
2007 brought a sudden halt to this issuance, with the result that US commercial
paper outstanding started to shrink dramatically in the 2nd half of 2007 (see
chart). Note this was before the collapse of Lehman led to the total halting of
CP issuance a year later (the industry has never really recovered from this and
CP outstanding is still only $972 bln, compared to its 2007 peak of $2,222 bln)

The sums at stake in Brazil are considerably smaller (for this reason we expect
a worst case scenario similar to the S&L crisis rather than the destruction of
the sub-prime crisis), but the pattern of a deteriorating liquidity cycle
should still remain broadly similar. The full force of the impact on corporate
and consumer activity from tightening liquidity has yet to be felt in Brazil,
but we would appear to be approaching the point at which credit granting starts
to be substantially curtailed, with more exotic instruments (such as FDIC)
being the first to be shut off as sources of capital.

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

Fraud Allegations Deepen Asset-Backed Sales Slump: Brazil Credit
2012-07-10 12:12:36.333 GMT


By Gabrielle Coppola and Francisco Marcelino
July 10 (Bloomberg) -- Fraud allegations at Banco Cruzeiro
do Sul SA are deepening a sales slump in Brazil’s 25 billion
reais ($12.3 billion) asset-backed securities market, where
issuance has plunged almost 70 percent.
Companies raised 2 billion reais via sales of asset-backed
receivables funds, known as FIDCs, in the first half of the
year, down from 6.6 billion reais a year earlier, according to
Anbima, Brazil’s local capital markets association. In the U.S.,
asset-backed debt issuance jumped 71 percent to $117 billion,
according to data compiled by Bloomberg.
Brazil’s asset-backed securities market has stalled as
regulators write new rules to improve transparency, consumer
defaults jump and the central bank investigates accounting
practices related to Cruzeiro do Sul’s FIDC sales. Issuance is
declining even as policy makers drive down borrowing costs to
spur growth in Latin America’s biggest economy. The central bank
has cut rates four percentage points since August, the most
among Group of 20 nations, to a record 8.5 percent.
“Given the low interest rates, the volume should have
increased, so the low volumes are that much more representative
that something has happened in the market,” Johann Grieneisen,
a structured-finance analyst at Moody’s Investors Service, said
in a telephone interview from Sao Paulo. “These changes are
addressing a very valid point, which was not really factored in
by investors in the past and is now.”
Asset-backed receivables funds, created in Brazil in 2001,
are designed to allow banks and companies to raise money at
lower rates by pledging collateral such as trade receivables or
consumer or corporate loans.

Changes Studied

Brazil’s securities regulator, known as CVM, is studying
rule changes for FIDCs relating to the role of custodians of
funds, a Rio de Janeiro-based press official, who asked not to
be identified in accordance with internal policy, said in an e-
mailed response to questions. There is no set date for when the
proposal for new rules will be released, the regulator said.
Regulators have been scrutinizing the funding instruments
of payroll lenders since a criminal probe of Banco Panamericano
SA in November 2010 caused the market where banks sell their
loan portfolios to dry up. They’re seeking to ensure someone
other than the originator of assets is responsible for checking
documentation, according to Arturo Profili, who helps oversee
more than 1 billion reais of fixed-income assets at Capitania SA
and has participated in discussions with CVM as part of an
Anbima committee responsible for the FIDC market.
Regulators also want to increase disclosure to investors
about funds’ performance and ensure the payments flow straight
to the investors in the FIDC instead of passing through the
originator, he said.

‘More Manageable’

CVM “is always modernizing regulation of the capital
markets as a function of various factors such as innovative
structures, experience from supervision, and demand from market
participants, as a way to make risks not only more visible but
also more manageable,” the regulator said in an e-mailed
response.
Brazil’s privately owned deposit insurance fund, known as
FGC, is managing Sao Paulo-based Cruzeiro do Sul after
regulators found “unsubstantiated asset items.” Signs of
apparent fraud were found in a 1.3 billion-real portfolio owed
by the bank, FGC head Antonio Carlos Bueno said last month.
Cruzeiro do Sul declined to comment, according to an e-
mailed statement sent by a press official.
The investigation into the FIDCs of Cruzeiro do Sul doesn’t
mean the market as a whole has problems, said Jean-Pierre Cote
Gil, a fixed-income manager at Western Asset Management, which
has 1 billion reais invested in asset-backed funds in Brazil.

‘Best Instruments’

“FIDC is one of the best instruments to invest in
structured credit,” Cote Gil said in a telephone interview from
in Sao Paulo. “Cruzeiro’s event is an isolated case. We expect
the market will take up again after the implementation of the
new rules.”
The extra yield investors demand to own Brazilian
government dollar bonds instead of U.S. Treasuries was unchanged
at 208 basis points at 8:58 a.m. in Sao Paulo, according to
JPMorgan Chase & Co.
The cost of protecting Brazilian bonds against default for
five years rose three basis points to 156 basis points
yesterday, according to prices compiled by Bloomberg. Credit-
default swaps pay the buyer face value in exchange for the
underlying securities or the cash equivalent if a borrower fails
to adhere to its debt agreements.
The real appreciated 0.3 percent to 2.0265 per dollar today
after declining 0.9 percent last week.
Yields on interest-rate futures contracts due in January
2014 fell three basis points to 7.79 percent today.

Default Rate

The default rate on consumer loans rose to 8 percent in
May, the highest in 30 months, from 6.4 percent a year ago, the
central bank said.
FIDCs became an important source of funding for Brazil’s
payroll-deductible lenders, which lack diversified deposit bases
and have faced a shortage of long-term funding. Banks use money
from the securitizations to originate new loans.
Custodians are charged with collecting, distributing and
reconciling cash flows with the loans they hold in custody. In
practice, sellers of the assets end up safekeeping the
underlying documents under a separate agreement, something that
has been a topic of concern in the market for years, according
to Moody’s Grieneisen.
“The whole structure relies on the moral integrity of the
seller in giving correct financial information on the underlying
assets,” he said. “All you know from the point of view of the
FIDC is that you’re getting cash flows and you get an Excel
spreadsheet that says the assets are in there.”

- sivblowup.gif

China's trade data for June 2012 once more hints at a slowdown in the domestic
economy, as imports grew by 6.3% YoY, below consensus expectations of 11.00%.
Given the very volatile nature of trade data we would not make too much of any
one month's slippage but the trailing 12 month average of this metric has
fallen from 28.2% in June 2011 to 15.5%, which really does suggest a marked
slowing in import growth rates. The trailing 6 month ma is even more damning
with average growth of 8.1% comparing to 27.9% a year ago. With Chinese imports
dominated by raw materials, the production of which have long lead times, it
seems likely that the speed of the slowdown of import demand will be something
of a surprise for many producers. To an extent this is already reflected in the
poor YTD performance of many material stocks, but a further deterioration in
Chinese demand (which is still growing at the current time) would perhaps be a
catalyst for another leg lower for this sector.

Exports on the other hand continued to grow by 11.3%, just above consensus.
Even so the same slowing trend is in evidence, with a 6 month ma of 9.7%
compared to average growth of 23.9% last June. Unsurprisingly European exports
have lagged the rest of the world in recent months, although not to a degree
that suggests that it is the sole driver of this decelerating trend. -
chinatrade.gif

US consumer credit data continues to suggest that an expansion of credit usage
has taken hold, with the strong growth in non-revolving credit (dominated by
student and automobile loans) being finally matched by strong growth in
revolving credit (which is dominated by credit cards and store cards).

Total consumer credit grew by $17.1 bln in May, taking the total up to
$2572.80 bln, within $9 bln of the all time high recorded in July 2008. This peak is
likely to be surpassed sometime during the summer and with outstanding credit
growing by $141 bln (5.8%) over the last 12 months we would expect to see a
substantially higher peak at the end of this cycle. Of the two data series we
are much more interested in revolving credit at the current time, since this is
a much purer statistic for indicating changes to retail activity. May's saw
outstanding revolving credit increase by $8 bln, the largest single monthly
increase since November 2007. This takes the annual increase up to $13 bln
(1.5%), the largest annual growth since November 2008. Our expectation is that
this metric starts to return to the sort of growth rate seen in the early portion
of the last cycle, when revolving credit grew by a mid-single digit percentage
from 2002 - 2005. - revolvingcreditmay2012.gif - consumercreditmay2012.gif

China's local equity market has had a notably poor response to the recent
easing of monetary conditions. This is very much in line with our expectations
since the decision of the PBOC to change tack marks a belated recognition that
actual business conditions have been deteriorating for several months, which in
turn has been driving the local equity market lower.

The PBOC first cut the reserve requirements on banks in early December during a
period of steep decline for the the local SHASHR index. The index went on to
fall almost 10% to bottom at 2234 in early January, and then enjoyed a spirited
first quarter rally in line with the rest of the emerging market complex. From
early May onwards the downtrend has re-exerted itself, despite 2 further cuts
in the reserve requirement (in February and May) and 2 cuts in the 12 month
lending rate in June and July, reducing this by a total of 56 bp. This is in
marked contrast to commentary which has tended to only grudgingly admit the
reality of worsening conditions while predicting a 2nd half improvement in
response to monetary easing.

Last night's session saw the SHASHR lose -2.38%, wiping out Friday's positive
gain of 1.01% in response to the Thursday rate cut. The index is now less than
2% above its January 2012 low. Support around this level can be expected to be
considerable, but if it fails to hold the index will be probing price levels
not seen since March 2009, indicating that at least for the portion of the
economy that drives corporate earnings something is considerably amiss. -
D-SHASHR_Index.gif -

In contrast to the June ADP Payroll report the more widely followed official
BLS report showed job growth in June at a tepid 80K, below modest expectations
for 100K jobs added. May's data was nudged higher from 69K to 77K making up
some of the shortfall. Private sector payroll gains were estimated at 84K
versus 106K consensus but this shortfall was entirely covered by a revision to
May's data from 82K to 105K jobs. The unemployment rate was unchanged at 8.2%.

Probably the best thing one can say about this report is that expectations were
already muted and so we doubt that any major reaction will follow (although the
2 week bounce in asset markets was already looking tired before this release).
From our perspective we always hope for good data, and would have liked to see
something better, but recognize that seasonal adjustments during the 2nd
quarter (and to a lesser degree the 3rd quarter) make it very difficult for BLS
data to generate strong readings.

It is for this reason that we only use a 12 month ma in following this data,
and this fell slightly to 162.17K. This compares to an ADP equivalent of 164K
and therefore is probably a reliable enough guess of how fast employment is
growing over a 12 month period. This can be seen on the attached chart showing
annual changes to the non-seasonally adjusted non farm payroll data over the
prior 12 months. This reached a (suitably patriotic) level of 1776K in June,
exactly in line with its trailing 12 month ma. This is close to the repair rate
seen in February 2005 and October 1993, both of were periods of decent economic
recovery in the US economy. Our view remains that US employment is in a steady
(but sometimes frustrating) period of recovery. - nfpnsa12month.gif -
nfpprivate.gif

US New Car Sales came out on Tuesday after the market had closed but although
most readers will be aware of the data it is worth reiterating some important
points.

US auto sale for June were 14.05mm seasonally adjusted, somewhat better than
consensus estimates. This takes the trailing 12 month ma up to 13.60mm, its
highest level since November 2008 and is 2.64mm higher than the rate of sales
last June (when a shortage of Japanese cars depressed overall sales).

This keeps US car sales in a steadily improving trend that can still be
expected to project higher in the coming quarters. If we use 15mm as a
conservative target we could expect sales to continue to push higher for
another 12-15 months. A more optimistic target of 16.5mm (in line with
1999-2005 sales) would allow sales to push higher until late 2014. Either way
it would seem that US automobile sales will be a reliable positive force for
the domestic portion of the economy for several quarters. - usnewcarsales.gif

http://www.ecb.int/press/pressconf/2012/html/is120705.en.html

At the same time as the PBOC was announcing its interest rate cut the ECB
followed suit by cutting its refinance rate to a record low of 75bp from 100 bp
and its deposit rate to zero from 25 bp (the BOE also announced an increase to
the size of asset purchases, giving this morning the feel of a co-ordinated
response by 3 large central banks).

In his accompanying statement (see link above) President Draghi made clear the
commitment of the ECB to generate stability in its banking and financial system
and it is worth reminding oneself how dramatically the tone of the current
President differs from the Teutonic rigidity of President Trichet. Of the two
measures taken today the drop in the deposit rate to zero is the one which
seems likely to garner attention. Since the introduction of the LTRO overnight
deposits at the ECB have ballooned from around €100 bln last September to
almost €800 bln. This has led to some discomfort that the approximately €1
trillion injected into the Eurozone has remained trapped on the ECB's balance
sheet (note that something very similar took place under QE2 and Excess
Reserves on the FRB's balance sheet are actually much larger at $1.46 bln).

The hope of the ECB is that by cutting the deposit rate to zero some of this
€800 bln can be shaken loose and redeployed into more productive opportunities,
such as corporate and consumer lending or at least into expanding commercial
paper and other short term private sector liquidity. The implied threat in the
move is that at some point in time banks could actually be required to pay the
ECB for the right to park cash on their balance sheet. This would have far more
psychological than financial meaning, since the rate charged would be
minuscule, but it is a reminder of the fact that much of the world's capital is
obsessed with ensuring the maximum probability of "it being returned" rather
than the "return on itself". - ecbdepositfacility.gif

When the PBOC first cut the local lending rate last month we suggested that
this change in policy direction was likely to be followed by a raft of further
monetary and fiscal stimulus as Chinese authorities struggle to reverse the
deterioration in their economy. This morning's cut in the 12 month lending rate
to 6.00% from 6.31% (finally quoting Chinese rates on a "round number" basis)
therefore comes as little surprise and had been widely anticipated by equity
and commodity markets, although it is hard to untangle specific reactions to
China, the Eurozone and general reallocations at the end of the quarter which
have all combined to push risk assets higher in recent days.

This morning's cut takes the Chinese 12 month rate back to where it was in
March and April 2011, at a time that the Chinese economy was still growing
strongly. Unfortunately the relationship between interest rates and economic
activity is not linear over the course of a cycle. Relatively high interest
rates may still appear to be "easy" during the booming portion of a cycle
(anticipated financial returns typically dwarf peak rates) while during the
divestment phase even historically low rates face the hurdle of convincing new
capital to be applied in the face of prior over-investment. In our experience
lower rates and easier monetary policy in general are necessary palliatives to
moderate distress but do not simply reverse a cycle of deterioration once it is
underway. - china12mlending.gif

The ADP Payroll report got the June payroll data off to a strong start, with
monthly job gains estimated to be 176K, well above estimates of 100K. May data
was revised slightly higher to 136K from 133K. This takes the trailing 12 month
ma up to 163K, the highest reading since August 2006.

Of course a strong ADP report tells us little about what tomorrow's BLS survey
will bring to the table. It is well established that these 2 reports often
differ widely from month to month with differences as wide as 100K not
uncommon. On the other hand these differences tend to even out over time (the
trailing 12 month ma of Private Sector jobs gained is 162K according to the
BLS, only 1K away from the ADP estimation) and there really is no evidence that
either measure is a more reliable gauge of what is really going on in the US
employment market on a real time basis.

Our sense remains that US employment gains are steady around the 150 - 175K
range per month, which would allow the unemployment rate to be steadily chipped
away on the coming quarters, although at a pace that will keep political
leaders and the FRB under pressure to "do more". The equity market is likely to
be somewhat more forgiving and take the (correct) view that incremental gains
in employment are what matters for corporate earnings, not the number of people
left on the sidelines (the equity market is helped by having a much more
limited mandate, a point the FRB in particular may want to consider).

Tomorrow's report is estimated to show 100K of Private Sector jobs created,
which is in part a reflection of the recognition that seasonal adjustments
remain very negative at this time of year, and partly a fear that employment
gains may be ebbing. We doubt the latter is true and would encourage readers to
keep a sense of perspective no matter where the data falls tomorrow morning. -
adppayrolljune2012.gif

Brazil's Industrial Production data continued to deteriorate in May. Estimated
production dropped -4.3% YoY, below expectations of a -3.3% drop while April's
data was revised down from -2.9% to -3.5%. May's annual drop is the largest
since October 2009 and is dominated by a YoY drop in Durable Goods production
of -9.5%. The trailing 12 month ma slipped lower to -1.79%, indicating that a
prolonged period of negative growth has been established in Brazil. Our concern
is that this may start to show up in employment data later this summer as
industrial concerns start to adjust labor requirements lower in the face of a
prolonged period of soft activity. - brazilipmay2012.gif

Brazil's regulators remain committed to placing weak second tier banks into the
hands of stronger players. Although in the short run this policy helps clean up
particular issues and ensures that Brazil avoids the sight of a bank closing
its doors and defaulting on bonds, it does mean that the overall system becomes
increasingly infected with poor quality credit.

This is a fairly common path for a banking crisis. We saw weak sub-prime (and
prime) mortgage lenders eagerly scooped up in the US 5 years ago, while the
UK's "secondary banking crisis" saw a number of such transactions in the
build-up to the collapse of confidence. Should Brazil's overall level of loan
defaults continue to push on higher we would expect to see substantial losses
incurred in the legacy portfolios of rescued lenders, together with some
deterioration of the better managed loan books of the senior lenders. To the
extent this happens "under the same roof" of one institution, confidence in its
overall operation can be expected to take a hit.

We have been following Mexico's foreign worker remittances in recent months as
an interesting alternative source of data on the strength of US "blue collar"
employment. In particular this data can be expected to be correlated with
construction activity, which is an important source of employment for Mexican
workers.

May's data continued the recent string of strong data, rising to $2.336 bln,
well above estimates of $2.275 bln. This is the strongest May data since 2008,
just before the final collapse in US construction activity (May 2008 housing
starts were 973K compared to 708K in May 2012). Peak May remittances were
$2.534 bln in 2006 when housing starts were close to their all time high at
1,942K. The recent upsurge in remittances therefore confirms other data, which
suggests a marked improvement in US construction activity in recent months. -
mexicoremittances.gif

For the first time since July 2009 the ISM Manufacturing index fell below the
50 level to 49.7. Although the dip into negative territory was influenced by a
collapse in the Prices Paid index to 37, reflecting sharply lower commodity
prices (arguably a positive for overall activity), the rest of the report does
give some cause for concern.

Most clearly the sharp fall in the New Order index (red) to 47.8 (lowest since
April 2009) is a suggestion that something has changed. In the accompanying
conference call, the ISM noted that multiple comments regarding Chinese and
European demand had been received from correspondents. We ourselves have become
increasingly concerned about Chinese demand impacting export activity in recent
weeks. The Export Order index also fell sharply to 47.5 (lowest since June
2009), confirming this as a source of weakness (see separate chart), while
Imports remained positive at 53.5. Production (blue) remained positive at 51,
as did Employment (pink) at 56.6. Inventories (olive) though experienced a
sharp draw-down to 44.

Our initial take on all of this is that the ISM report suggests that a
deterioration in conditions may have taken place in Q2, but that this is
concentrated within export driven portions of the manufacturing complex. We
would be particularly aware of the danger that a down-shift in Chinese (and
other EM) related demand shows up in Q2 earnings, while more domestically
focused firms and industries (such as construction) can be expected to show a
steady improvement in line with prior quarters. Clearly much now will be riding
on future ISM reports. One single sub-50 reading is not in itself a cause for
great concern but a continued deteriorating trend in future months would be
another (and less positive) story. - ismmay2012.gif - ismexportorders.gif

The sharp decline in the Indian Rupee over the last 12 months (INR) is starting
to play havoc with India's trade data. May's trade report showed Imports in USD
falling by -7.36% while Imports ex-oil fell by 16.1%. However, measured in INR,
imports actually rose by 12.37% over the last 12 months. This makes it even
harder than normal to use trade data to estimate changes in the underlying
activity levels of the economy, but it does seem that even the INR based
metrics show a significant deceleration in import activity in recent months.

One thing we did note was a collapse in gold and silver imports by 51% over the
last 12 months (see link {NSN M6J4QB3HBS3K <go>} for Bloomberg users). Although 
the INR's decline will have accounted for around half of this abrupt decline the rest
of the shortfall represents a significant drop in physical demand over the prior 12
months. Gold's USD price rose by about 5% from May 2011 - May 2012, suggesting
that India imported around 20% less gold by weight in May 2012 than a year
earlier. This confirms our suspicion that gold's positive "safe haven" flows
have a powerful counterforce at the current time, explaining the ability of the
metal to make forward progress.

We also note that India's trade balance has deteriorated substantially in
recent months. May's data showed the USD balance at -$16.3 bln. The 12 month ma
of this data has started to suggest that India's massive trade deficit is
starting to improve (see chart), however this is largely a reflection that the
decline in the INR has eroded the value of the deficit in USD. Measured in INR
the deficit reached -886 bln INR in May, a widening of -56 bln INR (6.7%) over
the last 12 months. The 12 month ma of the deficit reached a new all time level
of -671 bln INR. - indiatrademay2012.gif - indiabalance.gif